We are in the golden age of seed financing. Venture capital funds, seed funds, super angels, angel groups, incubators, and “friends and family” are all playing the seed financing game and investing early in startups in an attempt to land the next Facebook.
As a result, the pendulum has swung dramatically in the founders’ favor, and the issuance of convertible notes for seed financing has never been more prolific. Indeed, as a corporate lawyer for 18+ years, I have seen this development first-hand.
This post is the first part of a three-part primer on convertible note seed financings. Part 1 will address basic questions, such as (i) what is a convertible note? (ii) why are convertible notes issued instead of shares of common or preferred stock? and (iii) what are the advantages of issuing convertible notes?
Part 2 will discuss the two most significant issues for founders in connection with the issuance of convertible notes: (i) the valuation cap and (ii) the discount (and how they interrelate).
Part 3 will cover certain special issues, such as (i) what happens if the startup is acquired prior to the note’s conversion to equity? (ii) what happens if the maturity date is reached prior to the note’s conversion to equity? and (iii) what securities laws do founders need to worry about in connection with the issuance of convertible notes?
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