Many entrepreneurs understand the fundamentals of finance when founding a new company. At the same time, many founders could benefit from a deeper understanding of the typical components of a financing term sheet. To help founders better grasp the key points, Goodwin Procter partner and Founders Workbench contributor Bob Bishop participated in a recent “On Air” Google Hangout hosted by The Capital Network to discuss this topic.
The following is the first in a series of posts that summarize Bob’s discussion. This first post provides some background on convertible debt vs. equity, which is a question that seed stage companies often face in contemplation of their first round
Preliminary Consideration – Convertible Notes vs. Equity
One of the preliminary questions Bob said he often gets from founders just before term-sheet stage is: should I do convertible debt or equity? The answer really depends – mostly on what the investors are willing to do. For seed stage financings, convertible debt has the advantage of typically being more cost-effective to implement and, in the absence of a “valuation cap,” has the advantage of “kicking the can” on valuation, which usually benefits the founders with less dilution, as the round is not priced until the first equity round after the company has had the opportunity to use the invested proceeds to build value.
That being said, many angel and seed investors are increasingly reluctant to do convertible note deals, because they want to lock in valuation in light of concerns that they may be asked to renegotiate the conversion terms in the context of the first equity round when the notes convert.
To learn more about the anatomy of a Series A Term Sheet, watch the full Google TCN On Air Google Hangout with Bob Bishop.
To access helpful documents for financing a start-up company, visit the Founders Workbench Documents Driver tool.