The other day, Mark Suster wrote a critically important post titled One Simple Paragraph Every Entrepreneur Should Add to Their Convertible Notes. Go read it – I’ll wait. Or, if you just want the paragraph, it’s:
“If this note converts at a price higher than the cap that you have been given you agree that in the conversion of the note into equity you agree to allow your stock to be converted such that you will receive no more than a 1x non-participating liquidation preference plus any agreed interest.”
I also have seen the problem Mark is describing. As an angel investor, I have never asked for a liquidation preference on conversion that is greater than the dollars I’ve invested. But, I’ve seen some angels ask for it (or even demand it), especially when there is ambiguity around this and the round happens much higher than the cap. The entity getting screwed on this term are the founders, who now have a greater liquidation preference hanging over their heads than the dollars invested by the angels. Mark has a superb example of how this works on his blog.
We’ve been regularly running into another problem with doing a financing after companies have raised convertible notes. Most notes are ambiguous>>> READ MORE at: