| I think grella said the advantages of convertible notes are: 1. First note is capped but later notes can be uncapped;
2. Fewer tax risks;
3. Doesn't mess up your equity pricing;
4. You can do a number of notes with different amounts raised;
5. You don't give your investors the kind of protections they would get in equity rounds. I'd like to hear Mark's reply too. My opinion below. I tend to think that all of these things (aside from the tax risks) are either inconsequential in comparison to equity financing (3, 4), or simply the result of having unsophisticated or uncaring investors (1, 5). The tax risks he did not explain; I assume he means the risk that the IRS would use an equity round to peg a value on shares or options given to employees that differs from what the company assumed. If so, this risk exists no matter what. I agree that giving the investors less protective provisions or uncapped notes is better for the company. If you can get investors to agree to that, good for you, but that's separate from structure. The primary problem with convertible notes as they are used today for entrepreneurs is that the investor gets the lower of the cap or a discount to the next round. This optionality is paid for by the entrepreneur. And while, as grella points out, the cost of this optionality is usually pretty low, so is the value of the benefits he points out. |