Hot Seat

Chapter 22. Notes or Priced?

While I’ve mostly stayed away from the details of financing terms because they’ve been covered well by others already,¹ there’s one question I hear more than any other. It concerns the decision between the two investor financing instruments in wide use today: convertible debt and a priced round.

A priced round works like this. Bob has a company called Brown Bar, Inc. Its sole asset is a slightly melted chocolate bar, estimated value $2. Susie has, in her pocket, a shiny and crisp $1 bill. Bob and Susie both think the chocolate business is promising. Susie decides to invest $1 in Brown Bar.

Before Susie’s investment, Brown Bar was worth $2 (its “premoney valuation”). After taking on outside capital, Brown Bar is worth $3 (its “postmoney valuation”)—that’s the sum of its total assets of $1 and a melty chocolate bar.

Bob is going to own 67% of the company—$2 (the premoney valuation he brings to the table) divided by $3 (the postmoney valuation after Susie’s dollar). Susie’s going to own the remaining 33%.

That’s a priced round. No too complicated.

Let’s talk notes.

Now Bob says to Susie, “Hey, I don’t want to pay my lawyer to draw up a priced round. And while you think this company’s worth $2, I actually think it’s worth a lot more. You see, this is a very special melty chocolate bar. And I have deep cocoa expertise that offers synergistic value to the organization.”

So Bob proposes that Susie loan him $1, under the following terms:

• The debt accrues ...