Don Dodge, a Developer Advocate at Google, wrote an informative post about the pros and cons of convertible notes for angel investments (What you should know about Angel Investors and Convertible Notes).
A convertible note is a debt instrument that can be converted into equity. The pros of convertible notes are well-known:
- The hassle of valuing an early-stage company is avoided – the angel can convert to equity when the Series A venture financing takes place.
- The terms of the note are straightforward – the principal amount and accrued interest can be converted into shares at a discount from (or with warrants applicable to) the Series A share price.
- As a result, legal fees for a convertible note tend to be far lower than those for a Series A financing.
The con is that the angel might not receive an adequate return if the Series A is delayed or never takes place (for example, if the company is acquired). Dodge suggests that these scenarios can be addressed by building into the note a specified valuation that will apply (or will establish a minimum) if one of these events occurs.
The bottom line: Angels, like other investors, should think about how to protect their investments if events to not proceed as initially anticipated.
Related post: Realistic Financing Options for Startup Companies
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.