On Air
Convertible Debt
December 12, 2013
Founders Workbench

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A free, online resource to help entrepreneurs navigate many of
the legal and organizational challe...
www.foundersworkbench.com
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Basic(Structure(of(ConverTble(Debt(
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Caps(and(Floors(
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On Air
Convertible Debt
December 12, 2013
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The Good, the Bad, and the Ugly of Convertible Debt

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Entrepreneurs love it, investors claim to hate it, but it’s still being used. Why? We’ll tell you, in this interactive Google hangout.
Hear from the experts on the pros and cons of convertible debt.
Experts:
Ben Littauer – Walnut Ventures, Boston Harbor Angels
Bob Bishop – Goodwin Proctor
http://www.thecapitalnetwork.org/events/optimize-your-corporate-structure-for-investment-2/

Published in: Business, Economy & Finance
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The Good, the Bad, and the Ugly of Convertible Debt

  1. 1. On Air Convertible Debt December 12, 2013
  2. 2. Founders Workbench •  A free, online resource to help entrepreneurs navigate many of the legal and organizational challenges faced by start-ups •  Resources include the Capital Calculator, Deal Dictionary, Document Driver, and Founders Workbench blog •  Site includes self-service tools for generating initial company incorporation and related documents Legal Standard of Excellence Award Winner Web Marketing Association 1st Place “Your Honor” Awards Web Site Winner CIO 100 Award Winner for Information Technology Department
  3. 3. www.foundersworkbench.com
  4. 4. Today’s(Experts( •  Ben(Li3auer(( –  –  –  –  –  –  Advisory(Board,(The(Capital(Network( Member,(Walnut(Ventures( Member,(Boston(Harbor(Angels( Director,(Several(Startups( Former(Entrepreneur( Geek((selfLdescribed!)( •  Robert(Bishop( –  Partner(Goodwin(Procter(LLP( –  Over(17(years(experience(represenTng(venture(capital(firms(and(high(growth( companies( –  Founding(team(member(of(the(Founders(Workbench( (
  5. 5. ConverTble(Debt( ( Ben(Li3auer( li3auer@blkk.com( vizibility.com/li3auer( @li3web( ( Robert(Bishop( rbishop@goodwinprocter.com( ( (
  6. 6. Structure(of(an(Equity(Deal( •  Company(and(Investors(agree(on(a(“preLmoney( valuaTon”((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(
  7. 7. What(about(ConverTble(Debt?( •  Many(seedLstage(companies(use(an(instrument( called(ConverTble(Debt.(Huh?( •  ConverTble(debt(is(not(tradiTonal(bank(debt( •  Converts(exist(for(several(reasons( –  Investors(and(Entrepreneurs(find(it(hard(to(agree(on(a( PM(valuaTon( –  SomeTmes(quicker(and(cheaper(to(document(than( equity(deals(( –  May(allow(for(“rolling(close”(accreTon(of(investment( (
  8. 8. •  ConverTble(Debt(provides( OpTonality( Conver'ble*Debt*=((usually)(unsecured(debt(obligaTon(of(the( Company(that(may(be(converted(into(equity(of(the(Company.(( ( •  Conversion*Trigger*=(Qualified(Financing(usually(at(some( minimum(amount(of(funds((ex.($500,000)( •  If*Notes*stays*as*Debt*=(Get(back(principal(and(interest(ahead( of(other(equity((behind(other(creditors(typically)( •  If*Notes*Convert**=(Convert(amount(of(debt(and(interest(into( equity(at(the(valuaTon(in(the(next(round( •  ( aier(applicaTon(of(a(Discount((oien(15(–(25%)( •  ( subject(to(a(maximum(valuaTon(amount((the(“Cap”)( *
  9. 9. Basic(Structure(of(ConverTble(Debt( •  Investor(loans($(to(Company(an#cipa#ng(another(round(of(funding( •  Investment(accrues(small(interest((6L8%(typical)( •  When(the(funding(occurs,(investment(+(interest(convert(to(equity,( usually(at(a(discount((15L25%(typical)( ( Example:( •  Investors(loan($200K(to(Company(( •  20%(discount( •  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(
  10. 10. Converts–(ComplicaTons!( What(if(only(a(li3le(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?( •  •  •  •  • 
  11. 11. Converts–(SoluTons?( •  •  •  •  •  •  Caps(and(Floors( Default(conversion(price(and(security(at(maturity( Open(round,(minimum(close( Quick(sale(preferences((ex.(2x)( Governance(provisions( Careful(a3enTon(to(conversion(condiTons(
  12. 12. Converts:(Worse(Than(Equity?( •  MulTple(liquidaTon(preference((circa(2008)( –  Ex.($500k(of(Notes(with(cap(at($2m(PM( –  Next(Round(at($6m(PM( –  Issue(Noteholders(3x(number(of(shares( –  3x(shares(equals(3x(liquidaTon(preference!!( •  Without(a(floor,(effecTvely(Full(Ratchet(AnTLdiluTon( •  Preference(Overhang( –  In(prior(example(Noteholders(bought($262,500(of( preference(for($200,000.((( –  All(other(Series(A(Holders(bought(1:1(preference( •  Not(Just(a(Price(Adjustment(
  13. 13. Converts:(When(Do(They(Work?( •  “Bridge”(financing(in(anTcipaTon(of(an(“event”( –  Another(financing( –  A(big(sale( –  Company(sale( •  Seed(stage(investment( –  ValuaTon(not(understood( –  Rolling(closes((oien(with(ratcheTng(caps)( –  Proof(points(as(an(“event”( –  When(the(investor(loves(the(company((cf.(exuberant( equity(valuaTons)(
  14. 14. On Air Convertible Debt December 12, 2013

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