Raising capital is often critical to business growth, but founders of startups may have a harder time securing funding, especially during seed rounds.\u00a0<\/p>\r\n\r\n\r\n\r\n
Fortunately, there are solutions that cater to founders while still appealing to investors. Two common fundraising options for early-stage companies are convertible instruments and priced rounds.\u00a0<\/p>\r\n\r\n\r\n\r\n
A convertible instrument<\/a> is a type of investment that lets founders raise money while postponing negotiations on the company\u2019s valuation until a later time. Many founders turn to convertibles because they\u2019re typically faster, cheaper, and more flexible than raising money via a priced round.<\/p>\r\n\r\n\r\n\r\n Here\u2019s how convertible instruments work: An investor who sees potential in your business gives you money, and in exchange, they receive an instrument that can convert into equity in your company at a later date, usually in conjunction with the next priced round. In some instances, like in the case of a liquidity event<\/a>, the investor could receive a cash payout instead of equity. There are two common types of convertible instruments: notes and SAFEs.\u00a0<\/p>\r\n\r\n\r\n\r\n A convertible note<\/strong> is debt that can convert into equity upon a future qualifying event or transaction, like a priced equity round of $1 million or more.\u00a0<\/p>\r\n\r\n\r\n\r\n SAFE <\/strong>stands for Simple Agreement for Future Equity. SAFEs convert into stock in a future priced round. They\u2019re considered a type of warrant\u2014not a debt\u2014meaning they give investors certain equity rights.\u00a0<\/p>\r\n\r\n\r\n\r\n Convertible notes often include a valuation cap and\/or conversion discount.<\/p>\r\n\r\n\r\n\r\n These features are designed to reward early investors who’ve taken a bigger risk with a better price than investors who come in later. If a convertible note has both a valuation cap and conversion discount, the investor typically gets to take advantage of the option that gives them the lowest conversion price per share.\u00a0<\/p>\r\n\r\n\r\n\r\n As debt instruments, convertible notes also come with a maturity date and fixed interest rate. The maturity date is when the note expires. If the note hasn\u2019t already converted into equity by the maturity date, the company is required to repay the noteholder\u2019s principal investment plus interest. However, if both parties want to extend the maturity date, they can amend the note. Until the note either converts into equity or<\/em> is repaid by the company, the note will accrue interest (usually anywhere between 2-8%).\u00a0<\/p>\r\n\r\n\r\n\r\n Since SAFEs aren\u2019t debt instruments, they have no maturity dates or interest rates, but they do typically come with a valuation cap and\/or conversion discount. However, unlike convertible notes, which require the company to raise a certain amount of capital for equity conversion, SAFEs typically convert at any dollar amount the company raises during the next priced round.\u00a0<\/p>\r\n\r\n\r\n\r\n Convertible instruments can be a good option for founders who need capital and want to fundraise quickly, but also want to reach certain company milestones before doing a priced round.<\/strong><\/p>\r\n\r\n\r\n\r\n And though convertible notes and SAFEs are similar, SAFEs can be a better bet for founders who want to avoid maturity dates and accrued interest on investments.\u00a0<\/p>\r\n\r\n\r\n\r\n Priced rounds are equity investments based on a negotiated valuation of a company. After agreeing on your company\u2019s valuation, an investor gives you money in exchange for preferred stock<\/a> in your company at a price per share determined by the valuation.\u00a0<\/p>\r\n\r\n\r\n\r\n Preferred stock financings typically provide investors with liquidation priority<\/a> payouts over other stockholders and other preferential features.\u00a0<\/p>\r\n\r\n\r\n\r\n Priced rounds require more upfront accounting and negotiating than convertibles, but they also give you a clearer picture of how much your company is worth.\u00a0<\/p>\r\n\r\n\r\n\r\n The price for preferred stock is based on what the company is worth at the time of the investment. Given that the price is set at the time of investment, investors get equity immediately.\u00a0<\/p>\r\n\r\n\r\n\r\n Investors may also get more control rights in your company with a priced round, including voting rights, anti-dilution rights, and a potential seat on the board as a lead investor. Lead investors, or institutional leads, can serve as liaisons between you and other investors, acting on your behalf to drum up interest in the company and raise more capital. As a founder, you may get more money as a result of having an institutional lead, but you also have to cede more control to investors<\/a>.\u00a0<\/p>\r\n\r\n\r\n\r\n Priced rounds can be a good option for founders who are confident in what their company is worth, expect impressive growth, and need to raise a lot of capital.<\/strong><\/p>\r\n\r\n\r\n\r\n Fast and affordable:<\/b> Fewer terms to discuss means you spend less time negotiating and less money in legal fees.\u00a0<\/span><\/p>\n Straightforward:<\/b> You don\u2019t need a lead investor to gather funding, nor do you have to give up control.\u00a0<\/span><\/p>\n Valuations aren\u2019t always necessary:<\/b> If you\u2019re not sure how your company will grow, you have the time to develop appropriate metrics to measure your company\u2019s value for the next round of funding.\u00a0<\/span><\/p>\n Enticing to investors:<\/b> Investors may be willing to take a risk on your company because of the valuation cap and conversion discount that protects them.\u00a0<\/span><\/p>\n Rolling closings:<\/b> You can raise capital from several different investors over a period of time, instead of all at once.\u00a0<\/span><\/p>\n Can dilute future rounds of funding: <\/b>If you raise too much in convertibles, or if they convert at low valuations or with discounts, they can <\/span>dilute<\/span><\/a> your stock as a founder.\u00a0<\/span><\/p>\n May still require valuations:<\/b> If you decide to\u00a0 put a valuation cap on a convertible note or SAFE, you still end up having to agree upon some type of pre-money valuation, which can cancel out the benefit of deferring that valuation until a later date.\u00a0<\/span><\/p>\nHow do convertible notes work?\u00a0<\/h3>\r\n\r\n\r\n\r\n
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How do SAFEs work?\u00a0<\/h3>\r\n\r\n\r\n\r\n
What is a priced round?\u00a0<\/h2>\r\n\r\n\r\n\r\n
How do priced rounds work?\u00a0<\/h3>\r\n\r\n\r\n\r\n
Pros and cons of convertibles<\/h2>\r\n\r\n\r\n\r\n
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\n \n\n Pros<\/th> Cons<\/th><\/tr>\n<\/thead>\n \n
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Flexible:<\/b> It\u2019s fairly easy to amend the terms of the note.<\/span><\/td>
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Can limit other investment opportunities:<\/b> Without a clear lead to galvanize interest in your company, it may be difficult to secure other investments. <\/span><\/td> <\/tr>\n <\/tbody>\n <\/table>\n