Fund India

𝗪𝗵𝗮𝘁 𝗠𝗮𝘁𝘁𝗲𝗿𝘀 𝗶𝗻 𝗮 𝗖𝗼𝗻𝘃𝗲𝗿𝘁𝗶𝗯𝗹𝗲 𝗙𝗶𝗻𝗮𝗻𝗰𝗶𝗻𝗴𝘀?

Convertible Instruments are commonly used by Angels and Syndicates in a startup's earliest financing stages.

They're also used in extension rounds as a source of capital that helps avoid re-pricing a company. That scenario is increasingly common matters in a 'funding winter' where capital is scarce.

What actually matters in a convertible financing?

Convertible instruments feature a conversion into equity at a valuation cap, a discount to the next priced round (or both). I always want a valuation cap at a minimum. Uncapped, discount only notes are a deal breaker.

The dominant forms are Convertible Notes and SAFEs. By default, assume they adhere to pre-money conversion. The post-money SAFE is a notable exception. The difference is more than just whether the valuation is on a pre or post-money basis.

Their conversion mechanics into equity is fundamentally different. It shifts dilution impact when multiple financing rounds using convertibles are used. 

Speaking as an investor, I'm a proponent of post-money SAFEs. They're become the de-facto standard in the US. 

In other markets, it's a mixed bag of pre-money SAFEs and convertible notes. Between those, I prefer pre-money SAFEs because many clauses in convertible note ultimately don't matter (or can work against investors).

The main one is expiry which is commonly 24 months. After this time, your investment into equity at the valuation cap whereas SAFEs do not have an expiry). Having both a valuation cap and discount gives investors 2 options that give investors an upside benefit and downside protection. An expiry puts an end date on that optionality. 

If a company hasn't raised equity financing after 2 years, they're probably not doing well so what's the point of forcing a change into equity? There isn't going to be a buyer so it doesn't offer liquidity. The only marginal benefit is that you might have more rights as equity holders.

7% interest rate on the note also doesn't matter. No early stage, cash burning startup will be able to pay a cash dividend. Every investor is getting that same interest rate which is inconsequential relative to venture returns. All it does is force dilution on founders.