

The Year of the Startup Default - jedwhite
http://www.thefunded.com/funds/item/8150

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pg
This is written as if convertible debt financings were like regular debt,
where if you can't pay a loan back by a certain time, you're in default and
bad things happen to you. That's not how it works in practice. Investors who
fund a startup using convertible debt are not hoping the debt will be repaid,
like a regular lender is; they want it to convert to equity. So in practice if
there's no equity round by the end of the term, the debt either gets converted
or the term gets extended.

It's not like convertible debt was invented in 2010. I've seen many startups
hit the end of the term of a convertible note before raising an equity round,
and it has never once been a problem.

~~~
cperciva
_I've seen many startups hit the end of the term of a convertible note before
raising an equity round, and it has never once been a problem._

Maybe I'm being a bit pessimistic, but this really sounds to me like "US
housing prices have never fallen by X%".

 _Investors who fund a startup using convertible debt are not hoping the debt
will be repaid, like a regular lender is; they want it to convert to equity._

I'm sure that this is correct _at the point that they provide the funding_ ;
I'm less certain about the situation 18 months later. Do you really think that
no investor will ever change their mind over the course of 18 months and
decide that they'd prefer to cut their losses rather than extend the term of
an investment in a company which no longer seems quite so hot?

~~~
AdeoRessi
It only takes one or two investors to pull out of one company, and that
company faces bankruptcy. With so many newbies entering the angel market, you
just never know.

~~~
localhost3000
kind of like a bank run on startups? scary thought

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iamelgringo
_Anecdotal evidence suggests that angels are now investing as much as $50
billion_

Naval Ravikant, who runs angel list states that there's been an additional
$500M that has been invested in early stage startups last year.[1] Which is
essentially a smallish VC fund.

Naval has also stated that 240 companies have received angel funding via Angel
list this past year. If every company received $1M, that would still only be
$240M invested in early stage startups.

I don't understand where the anecdotal $50B comes from.

Also..

 _Estimates are that there are now 10,000 angel financings per year, and as
much as 70% of these deals are now convertible debt._

Naval Ravikant runs the angel list, and he's saying there are only 240
investments that got money via angel list last year. That's a big discrepancy.

I don't have a comment on whether the structure of convertible notes is good
or not. I was just very surprised at the numbers Adeo brought up in the
article, because they are several orders of magnitude larger than what I'm
reading in other areas.

If he has other data sources, I'd love to read them. My instinct has been that
Angel List has been at the epicenter of getting all these startups funded, and
so I've been inclined to use Naval's numbers in my thinking.

ref:

[1] [http://www.sfgate.com/cgi-
bin/article.cgi?f=/g/a/2011/03/04/...](http://www.sfgate.com/cgi-
bin/article.cgi?f=/g/a/2011/03/04/businessinsider-naval-
ravikant-2011-3.DTL&ao=2)

~~~
nbashaw
It's my understanding that AngelList is just one small part of the broader
Angel market, even if it is the epicenter.

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ericd
Minor point, but from where I'm sitting, the standard term length seems to be
two years rather than 12-18 months.

Also, I think in a large percentage of cases, the angel can convert at the cap
if there's no liquidity event, so it's not necessarily going to result in mass
defaults. If the startup is doing really well, this seems like a more likely
outcome than the angels calling back their debt.

~~~
cperciva
_If the startup is doing really well, this seems like a more likely outcome
than the angels calling back their debt._

If a startup is doing well, the worst-case scenario involves issuing stock to
new investors in order to pay off the convertible debt.

The problem would come in the marginal cases -- where a startup is still
running and still has cash in the bank, and the founders aren't ready to give
up yet, but hasn't produced anything interesting enough to bring in new
investors... or to convince the convertible debt holder to keep his money in.

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jayzee
Another option where you can have best of the both possible worlds is to do a
convertible debt round with a conversion cap. That way the deal gets executed
cheaply and quickly benefiting the entrepreneurs. The cap benefits the angel
for taking some early risk. And such notes have a clause that convert the debt
to equity at the price implied by the conversion cap at the end of the term so
no fear of going into default.

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bradgessler
The good news, assuming this happens, is that it won't be as difficult for
profitable startups that aren't saddled with debt to hire great technical
talent since more startups will go under and more developers will be
available.

