Convertible Debt
One of the most common forms of investment in early stage business is convertible debt. Convertible debt is exactly that – debt which is convertible into equity at some later point in time. Many entrepreneurs like convertible debt for a number of reasons. Here are a couple:
1. Typically convertible debt is much faster. Most often there are fewer lawyers involved so it seems to move a lot quicker than an equity deal.
2. It is cheaper. Most often convertible debt is cheaper because there are also fewer hands in your pockets .This means fewer lawyers which is great because more of the capital being raised goes to the operations of the business.
3. Convertible debt holders are not shareholders so they don’t get to vote on issues. Every founder of the business loves this reason as they are still given a big check but get to make all the decisions.
4. The biggest reason entrepreneurs like convertible debt is because it helps put off the valuation question to a later date.
My Two Cents
Traditionally convertible debt is used for initial funding rounds that are smaller in size, where the financing isn’t substantial enough to cover the greater legal costs of a more traditional seed equity round, where the investor base lacks a “lead” to price and negotiate terms, or where the financing size is such that all parties agree that not enough money is being raised to put a stake in the ground around pricing.
Every situation calls for a different type of financing structure and of course, the more fair for both sides, the better. It is important that each benefit is weighed to see what is right for the startup and for the investor. As a startup, you want to give your early investors good terms because they are helping you accomplish your goals. As an investor, you want to make it as easy as can be for the startup because they need to be focusing on building the business and not revising terms for an offering but you also want to make sure you are being fairly compensated for the risk they are taking.
Crowdfunding is another way to receive the capital you need without worrying about valuations. At Belay Capital gives small businesses an opportunity to raise capital. Instead of relying the traditional sources of capital to receive their line of credit, businesses can instead seek out “the crowd” to help businesses get funding. The crowd--YOUR community members--have a tangible way to support businesses while also receiving special rewards, VIP treatment, and--down the road--equity within the companies they support. Thus passions are shared, relationships are strengthened, and the sense of community is increased.
Brian Schmitt
Founder
Belay Capital
Sources
http://www.bothsidesofthetable.com/2010/08/30/is-convertible-debt-preferable-to-equity/
http://www.sethlevine.com/wp/2010/08/has-convertible-debt-won-and-if-it-has-is-that-a-good-thing