Q: What happens when an angel investor’s convertible note in a tech startup is converted in to equity? Is this positive for the angel?

Ok, in theory, it’s great.

You now own the stock you bought the convertible debt to convert into.

In practice, though, notes are risky for angels IF they expect the “face value” of their pre-money valuation (i.e., the “cap”) to be the same pre-money they get in practice when their notes convert to equity.

Three scenarios happen:

  • Best case — good VC invests, honors notes on their face.  If it’s a nice up-round, with an ethical VC, and your SAFE was at say $6m pre and they invest at $30m pre … you get a 5x “step up”.
  • Worst case — the terms are essentially ignored.  Notes can be amended.  Cap tables can be gamed.  Note holders can be wiped out.  It’s not that hard, especially if no one represents the note holders on the board.
  • Medium case — the terms are mostly honored, but not really totally.  This is more common that you’d think, especially if the company only does OK.

A lot of times this is nickels and dimes.  But it’s 100x easier to game or rewrite a bunch of notes issued to a collection of individuals, than it is to retroactively change the price you sold equity for.

View original question on quora

Related Posts

Pin It on Pinterest

Share This