@TCNupdate #tcnLIVE Bob Bishop, Goodwin Procter LLP & Founders Workbench @BostonBishop Ben Littauer, Boston Harbor Angels & Walnut Venture Associates @LittWeb Olivia Dufour, NTT Data @Olivia_Dufour
@TCNupdate #tcnLIVE
Bob Bishop, Goodwin Procter LLP & Founders Workbench @BostonBishop Ben Littauer, Boston Harbor Angels & Walnut Venture Associates @LittWeb Olivia Dufour, NTT Data @Olivia_Dufour
Convertible Debt
Ben Littauer: viz.me/littauer @TCNupdate #tcnLIVE
Review of an Equity Deal
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• Company and Investors agree on a “pre-‐money valua=on” (PM) which leads to a price per share
• Investors put in $X • Investors then own: X / (X + PM) of the company
Example: PM = $1M X = $0.5M Investors own 0.5/1.5 = 33% Remember: New issuance NOT transfer of shares
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What is Conver=ble Debt
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• Many seed-‐stage companies use an instrument called Conver=ble Debt.
• Conver=ble debt is not tradi=onal bank debt • Converts exist for several reasons
– Investors and Entrepreneurs find it hard to agree on a PM valua=on
– Some=mes quicker and cheaper to document than equity deals
– May allow for “rolling close” accre=on of investment @TCNupdate #tcnLIVE
Basic Structure of Conver=ble Debt
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• Investor loans $ to Company an#cipa#ng another round of funding, usually triggered by the size of the next raise
• Investment accrues small interest (6-‐8% typical) • Debt is usually unsecured and inferior to most other debt
• When the funding occurs, investment + interest convert to equity on same terms as new money, usually at a discount (15-‐25% typical) and subject to a maximum valua=on (cap)
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Structure of Conver=ble Debt Ex1
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Example: • Investors loan $200K to Company • 20% discount; $2M cap • As of conversion, interest of $10k has accrued • Next Round PM = $2m; 1M shares before financing • New Shares offered at $2/each At Conversion, Noteholders receive 210K / 1.60 shares = 131,250 shares
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Structure of Conver=ble Debt Ex2
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Example: • Investors loan $200K to Company • 20% discount; $2M cap • As of conversion, interest of $10k has accrued • Next Round PM = $4m; 1M shares before financing • New Shares offered at $4/each; share price at $2M
pre would have been $2/each At Conversion, Noteholders receive 210K / 2 shares = 105,000 shares Without cap would be 210K / 3.2 = 65,625 shares
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Converts– Complica=ons!
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• What if only a lihle money comes in? • When does the debt convert? • What happens if PM of next round is huge? • Does the investor have any say in things? • What if there is an equity investment that doesn’t trigger conversion?
• What happens if it never converts? • What happens if Company gets bought?
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Converts– Solu=ons?
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• Caps and Floors • Default conversion price and security at maturity • Open round, minimum close • Quick sale preferences (ex. 2x) • Governance provisions • Careful ahen=on to conversion condi=ons Typical legal documents are a Promissory Note, a Note Purchase Agreement, and (for exis=ng shareholders), a Shareholder Agreement that codifies other condi=ons of the note (e.g crea=on of board).
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Converts: When Do They Work?
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• “Bridge” financing in an=cipa=on of an “event” – Another financing – A big sale – Company sale
• Seed stage investment – Valua=on not understood – Rolling closes (ooen with ratche=ng caps) – Proof points as an “event” – When the investor loves the company (cf. exuberant equity valua=ons)
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@TCNupdate #tcnLIVE
Bob Bishop, Goodwin Procter LLP & Founders Workbench @BostonBishop Ben Littauer, Boston Harbor Angels & Walnut Venture Associates @LittWeb Olivia Dufour, NTT Data @Olivia_Dufour