| If the company goes bust convertible debt is worth nothing, like equity. Not entirely true. Convertible debt is subordinated debt, which means that you don't get the first choice of pickings in bankruptcy court. But you are a creditor, and so there is a possibility of getting some money returned from bankruptcy proceedings. Where's the upside? Convertible debt seems like a strictly worse investment than stock. Paul Graham's answer is that convertible debt is worse for the investor but better for the founder. Therefore when founders have power they will choose convertible debt, and the upside for the investor is that they have the option to participate in a potentially profitable deal that otherwise they couldn't. If pg's theory is correct then entrepreneurs with power should choose convertible debt, and investors should express a preference for equity. And indeed it is not hard to find articles like http://www.avc.com/a_vc/2010/08/some-thoughts-on-convertible... where investors make it clear that they don't like convertible debt, and try to convince entrepreneurs that they shouldn't either. (Note, when you're negotiating with someone who is trying to convince you of what you should think, you don't have to look hard for a hidden agenda.) In abstract theory, the extent to which investors don't like convertible debt should be reflected in their offering worse terms on convertible debt deals. Bias the terms enough, and the investor should become indifferent. However my reading of pg's observation is that different terms are being offered to different investors. So the parallel trend is that a few top angels potentially get better terms than the old equity deals, but most angels get worse terms. Which makes most of the angels even less happy. As confirmation I note that http://www.sethlevine.com/wp/2010/08/has-convertible-debt-wo... raises the experience of an anonymous super-angel and says a year ago these caps “approximated what I’d pay in equity” that they’re now “33% higher than what I’d normally agree to pay now.” |