Instrument

Instrument refers to the various financial instruments that companies raise money through. The most common include: Equity, SAFE, and Convertible Debt.

Equity

Also known as a "priced round," equity rounds involve investors directly purchasing stock from the company. This investment represents a defined percentage of the company and is based on the current valuation of the company. 

Equity rounds usually require higher legal fees to negotiate, more documents to generate, and a wider range of terms to negotiate. They also lock in the company's valuation at an early stage in the company's life cycle.

 

SAFE

SAFE stands for Simple Agreement for Future Equity. They serve as a placeholder for an equity investment in the company's next equity financing. They do not accrue interest and they do not have a maturity date. They also do not require the company to adopt a valuation early on.

Similar to convertible debt, they can lead to dramatic gains for investors because there is no upper threshold to cap what equity value the investors might receive in the next round. 

 

Convertible Debt

In convertible debt financing, investors are not directly purchasing stock from the company. Instead, convertible debt allows investors to loan money to the company, in exchange for the future right to convert the debt into shares of the company stock. The percentage and amount of shares that the debt will convert into is determined by the specific terms of the notes. Generally, the debt will convert to new shares offered in the company’s next equity financing. The convertible note also bears interest at a fixed rate, and the angel investors receive a liquidation priority before all of the company’s stockholders.

Convertible debt rounds delay the question of the company's valuation until later in the company's life cycle, which provides more flexibility with later-stage financing. They also involve fewer negotiation terms and less paperwork, which drives down the legal cost and deal timelines.

The main disadvantage of convertible debt is the fact that it is technically debt, and investors may call the debt after the maturity date or upon demand at any time. An early-stage startup is not likely to have the cash on hand to repay investors if the debt is called. In addition, it's important to pay attention to the valuation caps on convertible debt financings. A small cap will allow investors to receive a much higher percentage of the company upon an equity financing, and dilute common investors.

 

Was this article helpful?
0 out of 0 found this helpful