[sachinag]

This is the first time I've seen the optional conversion into Series AA at a $5 million valuation. If it's optional at the company's option, that eliminates the one and only risk I could think of: the lender calling back the principal + interest of the note. At 2% interest, that's just another 3.12% dilution to the founder(s) on top of YC's 2-6% (source: http://www.google.com/search?sourceid=chrome&ie=UTF-8&#3...).

So, unless I'm missing something, worst case is you get into YC, you get $165K, and you still own ~90% of your company. That's a no-brainer deal.

[jacoblyles]

IANAL, but I would guess that "optional maturity conversion" means the investor can choose to convert at those terms if the two-year window expires without a prior conversion being triggered. So if the startup doesn't raise a $1 million financing round in the first two years, the investors can grab 3% of the company at their option.

It would be strange if the company would get to choose when the investors' debt converts.

[yokumtaku]

Yes, it's the investor option to convert upon maturity into Series AA, not the company option to force conversion.

[sachinag]

OK, so in practice, what happens if the company can't raise a round? Do they just return what they can to the fund and close up the doors?

[yokumtaku]

The note stays outstanding. Generally speaking, there's no good reason for the investor to want to convert into equity, as debt is better in a bankruptcy situation.

Some companies might return money to investors before shutting down.