Convertible Notes Recent News/Trends
Angels are typically anti-convertible note period, as the usual notes do not protect them
as much as they feel they need to be protected.1 With the rise of incubators and Y Combinator,
however, they may be more open to such an option if the note has certain protective provisions.
Y Combinator does use a model convertible note, but it is as of today not publicly available,
unlike their series AA docs on Scribd.2 If/when they do release it, it will most likely post there.
An investor, however, did write about aspects of their note online after encountering it.
He, as an investor, still prefers equity, but he says that their note is one of the best he’s seen, and
is more palatable to investors than others:
Key terms and items in this note are:
1. Cap on the conversion price.
2. Interest rate.
3. Automatic conversion happens when qualified equity financing occurs and we convert
into that preferred round’s terms.
4. Investors can convert at their option (on majority vote of investors) in a variety of
situations. These are at 1) non qualified equity financing happens, so we can convert to
preferred stock via the attached term sheet; 2) maturity of note, so we can convert to
preferred stock or get paid back; 3) at change in control then we can convert to common
stock before the change in control or get paid back.
5. A preferred equity round term sheet is already predefined and attached to the
convertible note, to be used in conditions where we may convert into the company's
After going through all the convertible note samples I found online and through Westlaw,
I have found two model notes that are both very recent and have most of the provisions noted
“In a blog post that is already making waves in Silicon Valley and throughout the startup community, Mike Arrington says that
he recently walked into a secret meeting of the Valley’s so-called “super-angels.” . . . topics discussed included how to blunt the
competitive force of YCombinator, how to keep valuations down and how to convince startups not to use convertible notes for
financings.” http://gigaom.com/2010/09/21/angelgate-whos-thinking-about-the-startups/ ;
Techcrunch-post-So-a-Blogger-Walks-into-a-Bar ; http://www.techdirt.com/articles/20100921/18574611100/are-silicon-valley-
“The rising popularity of convertible notes, which are actually debt rounds that convert to equity later on, is increasing stress on
the system. In some cases there aren’t any price protections for investors in those deals at all.
Note from American Jurisprudence Legal Forms (July 2010 updated database)
This note is distinguished for a few reasons. It sets the interest rate as a variable based on
the LIBOR (“London Interbank Offered Rates”) rather than a flat rate. This might be better or
worse for an investor depending on rate fluctuations (this is not my area of expertise). It allows
for optional and automatic conversion, which investors would like. It does not, however, offer a
price cap, which might be a dealbreaker in most cases. There is also a Subordination Clause
which may scare of some investors, because it subordinates their right to payments in respect to
Convertible notes from Fletcher Corporation Forms (4th Edition with Sept. 2010 update)
This document is actually a few sample notes shown together. The first two are short
form note with little protections for investors and look to be designed for small amounts. The
third (beginning on the middle of page two of the doc) is more expansive. It notably lacks an
automatic conversion provision, but it does contain a voluntary conversion clause that provides
protection to investors by converting into the most favorable series of preferred shares being
offered at date of conversion (plus for investors). It also lacks a cap provisions, though.
I think that a blend of the two above model notes, with additional price cap / discount
provisions, should be the most attractive to investors.4 Until the Y Combinator model is
published, I think this approach will build a solid starting point.
A sample price cap terms: “an investor may request that the conversion price is the lower of (i) a 20% discount from the Series
A price, or (ii) the price per share determined if the valuation was $[X]M. Typically, the valuation might be some reasonable
projection of the valuation range in the eventual Series A financing. The valuation is typically higher than what would be set if
the investor and the company negotiated a valuation at the time of the convertible debt financing, but lower that the expected
Series A valuation if the company achieved their objectives. Similarly, in the event of a sale of company before a Series A
financing, a sophisticated angel investor may request that they receive the better of (i) 2x their investment back (plus interest), or
(ii) the return if they had invested their money at an $[X]M valuation.”
The discounts I read were at least 20%, and as high as 50%. This powerpoint has an interesting take – a shifting discount that
starts at 20% and gains over time to a max of 50% to compensate early investors.