Convertible Note Comeback?

A tweet by @cdixon, saying his angel group is active in August, led me to a link in @erickoester's tweetstream, which linked me to this intelligence @grellas posted on on Hacker News:

"Just some scattered notes I took on broad trends identified during the presentations:

  . . .

9. On the legal side, some 80% of recent early-stage funding deals in the presenting lawyer's recent experience have involved convertible notes ([presenter was] John [Bautista] of Orrick - this surprised me, as such notes have fallen into some disfavor over the past year in my experience)."

(I think the "presentations" referred to must be from the same Y Combinator event alluded to on this blog on Friday, picking up Fred Wilson's post about an Anthony Ha write up on the occasion.)

Eighty percent surprises me, too. Of the seed deals running through my firm right now, some are notes and some are priced (stock, with a valuation), but a majority are still priced. And today's status quo -- more stock rounds than note rounds -- is an inversion on how it used to be.

From a founder's perspective, notes are going to be better if fairly pricing the company is just too difficult or not possible. On the other hand, I'm coming to appreciate some of the company-friendly benefits of not taking on too much convertible debt. Among other things, the traditional note round tends to lock one in on planning a subsequent equity round of a pre-determined minimum and within a pre-determined time frame. Much depends on getting the size of the note round right.

There are term sheets, such as Dan Rosen's (link is to a pdf), which help simplify a priced angel round. And to make a priced round just as efficient as a note round, in terms of legal costs and turnaround time, there are Ted Wang's Series Seed docs (I love the Series Seed docs).

Eric's take is that, while some seed deals should be priced, "a note w/ valuation cap is a good hybrid option," especially when you are dealing with sophisticated angels.

Notes may be on the way back. But I hope we keep thinking through whether pricing may be the better alternative for the given situation.

Update 9:55 Pacific: @cdixon has tweeted a response to a tweet from @davidmeunier with the following: "my preferred seed is convert with cap. lower legal fees and investors get economics without control." I hope to someday soon be able to present Chris with evidence that a priced seed round can be done as efficiently (in terms of legal fees) as a note round.


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