False dichotomies in convertible note vs equity seed rounds

Using convertible notes vs priced equity in seed rounds is a hot topic right now. For background, see recent posts by Seth LevineChris Dixon, Fred Wilson, Paul Graham, Ben Yoskovitz, Bill BurnhamMark Suster, William Carleton and Patrick McKenzie as well as older posts by Venture Hacks, Yokum Taku, Brad Feld, and Josh Kopelman. If I missed any good ones, please let me know and I'll add them to this list.

In an attempt to usefully add to this discussion (instead of repeating things from the above), I want to highlight what I think are false dichotomies between convertible notes and priced equity rounds. FWIW, I've done four deals so far (including both types), and between each of those reviewed a ton more.

Control vs no control

You can do priced rounds with no control (just economic rights) and converts with some control (e.g. converts into preferred shares w/ control provisions on maturity, stipulations about early acquisitions and next financings, etc.).

High-res vs non-high-res

High-res in this context means giving different investors different prices based on their risk taken and value added to the company. You can do priced rounds at different share prices or converts with different valuation caps. In practice I currently see more high-res in priced rounds via advisor shares. In that case, you reward the more valuable investors via options to be dispensed over time if they continue to add value.

Cheap vs expensive

You can do both on the cheap (or expensively). All my deals so far have had literally zero legal expense on my side. Use the standard docs and you're set.

Simple vs complex

You can do both in a simple or complicated way. Again, use the standard docs and it is simple. Personally, I find converts to be more complicated currently because there are no good standard docs yet and there are a lot of edge cases, e.g. what happens on acquisition, no Series A, a non-qualified financing, on default, etc. So I therefore find myself having to carefully review any convert wheras I'm ready right now to sign the series seed docs.

Better vs worse (for founders or investors)

There are valid reasons on both the entrepreneur side and the investor side to prefer doing a particular seed round with either a convertible note or priced equity (more on that below).

Quick vs long

I haven't perceived any difference in time to close. 

Fixed amount vs variable amount

Priced round term-sheets generally have a range of money you're willing to raise. You can easily make the docs such that that high number is high and leave time to add more investors ad-hoc.

Valuation vs no valuation

Converts (mostly) all have caps now, which is effectively a valuation. At least that's how I view it.

The debate of convert vs equity has seemingly turned binary, which is hardly ever a great approach to anything. Instead, it should depend on your particulars. One particular that I think matters more than the others is what probability the company is planning to do another round of financing and in what time frame. 

For example, if you're planning on definitely raising a series A within 6 months and the seed round is really a bridge loan to de-risk an assumption and get a higher valuation, then that is a decent argument for using a convert. On the other hand, if you have a decent probability (say 50%) of never needing another round of funding, or you think this seed round will last you 18+ months, those are decent arguments for doing a priced round.

Thank you to Roy Rodenstein & Jeff Miller for reviewing this post.


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