The danger with convertible notes

We recently shared a video talking about the danger behind the convertible notes. You could watch the whole video here, but here's an excerpt:

Over the last few months, our advisors and our legal team have been working tirelessly to solve a terrible startup predicament that nobody plans for growth. Slow growth.

And notice how, for any other company, 'growth' means success, but not for a venture-funded company: this is a fundamental concept you have to understand if you intend to pursue venture capital.

Let's draw a line between startup success and startup failure in the eyes of a venture capital investor, in the eyes of Silicon Valley.

On this side, we have failure. The company goes out of business. Slightly better is when the company's scraps get acqui-hired, which probably doesn't pay investors back, but at least it saves the tech and gives part of the team a job.

On this side, we have unicorn status: a startup gets funded, and within a few years, it reaches a billion-dollar valuation. Raising money is not the definition of success, mind you, but a billion-dollar company must be doing something right, for the most part (show WeWork and other failed unicorn startups).

In most cases, this means that the company has been able to scale revenue by around 300% YoY. That's not a typo; it's 3x annual growth.

To get to that Unicorn status, companies often raise multiple funding rounds: it's impossible to grow that fast without external capital. Those rounds are often called Seed, Series A, Series B, Series C, etc.

Now, the first round startups raise, is often structured as a convertible note. We have a full video about them if you want to understand the instrument a lot better.

In a nutshell, money is raised as convertible debt: the company commits to converting the investment into shares; but delays the decision until a new round of funding happens so that the convertible note investors follow the same terms as the new investors.

On paper, it sounds great, and convertible notes certainly have their advantages: they are a cheap instrument. You can close investors at different times and get money in your bank account faster than any other approach.

The problem is convertible notes (or bridge rounds as they are often called) are designed for these startup stories, and there are many stories in the middle where convertible notes can become a hassle.

If you want to read the whole article, you'll find it here