Introduction to convertible notes - a follow-up
We wanted to respond to their post with a few comments of our own – including, of course, the effect of patents on the process.
Briefly, as our friends at Ligo pointed out, convertible notes are a loan that can be changed later into equity under some circumstances – for example, when the startup raises enough money. They put the valuation question off to a later date--when the valuation of the startup may be clearer. They can be a super-convenient and super-fast way to raise money.
On the other hand, because convertible notes kick the metaphorical valuation “can” down the road, they can have problematic consequences.
Ed Zimmerman (a lawyer with experience in these deals) writes in Forbes magazine that startup founders should model their deal flow in a way that can occur with a proposed convertible note. Otherwise, they may find themselves with problems if the startup is either not so successful – resulting in an acquisition – or wildly successful – and end up raising a lot of money in the next round.
So, as in any legal dealing, you need to check out the fine print before you sign!
But, problems aside, how can you make convertible notes work for your startup?
IPEG, the intellectual property (IP) consultants, recommend increasing your startup’s valuation with patents and other IP. As they point out, strong IP can attract corporate partners and create a valuable property that persists even after a pivot.
The Stout advisory group, which specializes in determining valuations and investment banking, also recommends patents to increase your startup’s valuation – and to make it easier to close a round with a VC.
And of course, there are other options – like the increasingly popular SAFE (Simple Agreement for Future Equity), which Y Combinator recommends.
Ultimately, all of these different types of financing are meant to give startups additional tools to raise money – and to be successful.