A convertible note is a loan that can be paid back in stock at a later date at an agreed upon price under agreed upon conditions. So if the company fails then the investor is a creditor who gets a chance to get some of the investment out. And if it succeeds then the investor stands to gain from the growth in value of the company.
The key feature from the founder's point of view is that you can effectively sell off any fraction of the company you still own at any price whenever you want this way. And you can sell to different investors at very different prices. Furthermore this type of deal is very good for smaller investments.
This is replacing the idea of a funding round where a bunch of investors put in money into a pool, decide what the company is worth, then trade their money for a portion of the ownership. The investors then divide up those shares evenly according to money invested.
The key problem with that type of funding round is that many investors would hold back until they knew that people whose judgment they trust were investing, then they'd buy a piece of the round. This forced a lot of work in coordinating a complex deal, and caused investors to be rewarded the same despite having done very different amounts of work in due diligence.
By contrast convertible notes mean that companies can raise money as they go. And it gives companies room to offer different rates to different investors. Which means, for instance, that an investor like Ron Conway might get a much better rate in recognition of the value there is in being in his network, and the fact that his having invested makes other investors more willing to invest. By contrast a random investor who knows nothing and just follows the herd can be offered much worse rates, if they even hear about the possibility before the company has enough money for their needs.
The winners are founders and the best investors. The losers are investors who mainly try to figure out where the herd is going and jump on the bandwagon.
A convertible note is a loan that can be paid back in stock at a later date at an agreed upon price under agreed upon conditions. So if the company fails then the investor is a creditor who gets a chance to get some of the investment out. And if it succeeds then the investor stands to gain from the growth in value of the company.
The key feature from the founder's point of view is that you can effectively sell off any fraction of the company you still own at any price whenever you want this way. And you can sell to different investors at very different prices. Furthermore this type of deal is very good for smaller investments.
This is replacing the idea of a funding round where a bunch of investors put in money into a pool, decide what the company is worth, then trade their money for a portion of the ownership. The investors then divide up those shares evenly according to money invested.
The key problem with that type of funding round is that many investors would hold back until they knew that people whose judgment they trust were investing, then they'd buy a piece of the round. This forced a lot of work in coordinating a complex deal, and caused investors to be rewarded the same despite having done very different amounts of work in due diligence.
By contrast convertible notes mean that companies can raise money as they go. And it gives companies room to offer different rates to different investors. Which means, for instance, that an investor like Ron Conway might get a much better rate in recognition of the value there is in being in his network, and the fact that his having invested makes other investors more willing to invest. By contrast a random investor who knows nothing and just follows the herd can be offered much worse rates, if they even hear about the possibility before the company has enough money for their needs.
The winners are founders and the best investors. The losers are investors who mainly try to figure out where the herd is going and jump on the bandwagon.