Early Stage Valuation

CHAPTER 11Valuation of Debt Securities

In an early stage enterprise (ESE), debt financing can be challenging to obtain. ESEs may not have adequate collateral and guarantees to offer for the issuance of a commercial line of credit or unsecured bond financing. An ESE may, however, be able to attract capital from certain specialized players in the private debt markets, such as venture banks, specialty finance companies, and venture capital funds. In most cases, ESE debt financing will take the form of convertible notes. Similarly to preferred stock, convertible notes may convert into equity and participate in the company's equity upside potential. Convertible notes have seniority rights in the company's proceeds from liquidation or insolvency relative to all equity classes and may accrue interest over their time horizon. As companies develop an institutional investor base, a history of customer adoption, and revenue growth, they may also find ways to access mezzanine debt financing without conversion features. Even for companies that have not yet issued debt, a valuation analysis may include debt in the company's projected capital structure at exit and will typically include debt in the company's capital structure at later stages of development in a discounted cash flow (DCF) model.

A debt instrument may be valued from the perspective of a debt holder, for example, as an instrument in a venture capital fund portfolio, or from the perspective of an equity holder, as a liability ...