Monkeys in Early-Stage VC;
I left my post in the corporate world 5-months ago to pursue an entrepreneurial venture. We are a pre-seed healthcare technology startup that is moving into deploying a commercial beta pilot. Recently, I have received an exploding offer from an accelerator firm. Although I find 8% for $30,000 a bit on the low end, there is enough value in the program's mentorship, connections and other value-add services for it to make sense for us. What scares the living shit out of me is the "Add-on" & "Follow-on" convertible notes; I don't know what to make of them.
Screenshots of anonymized term sheets can be found here -- https://imgur.com/a/l6rLCdP
TL;DR of "Add-on" & "Follow-on" convertible notes, interpreted by @dedline" :
Before I reach out to formal legal council, I was hoping WSO could weigh-in to equip me with enough context to have a productive conversation with the VC's MD.
Is this sort of deal standard at the pre-seed level?
If you received this deal, what terms would you be looking to negotiate?
If this post receives over 10 comments, I'll award the most upvoted (non-troll) comment $100 via BTC.
It looks like both the add-on and follow-on convertible note pages are both 'for discussion purposes only' rather than concrete terms as part of your deal. It looks like your deal for now is a straightforward $30K for 8% equity. The pages included look like examples of what the terms could look like in the event you did want to make a deal with that VC for convertible notes (e.g. for an add-on convertible note they would then give you up to $100K as short-term debt at 7% annual interest with the option to then 'convert' their investment into equity later on in the event of a qualified financing round (e.g. Series A or similar raising at least $500K.) at a slight discount (they'd either get shares at 90% or 80% of the price aka 10% or 20% discount to what other investors are paying in that round OR they would get shares at a $1.4M or valuation - whichever option is 'cheaper' for them between the % discount vs the fixed valuation).
All in all, it again looks like it's not part of your actual deal so I wouldn't be too worried about it - though always good to double check. In the event you did make a deal w/ convertible notes, you would be getting additional cash in exchange - it's not necessarily related to the $30K you're getting now.
juicetin Thank you for the insights!
True: the documents being circulated now are 'for discussion purposes'. In the future, they are asking me to sign all three documents: "Stock Purchase Agreement", "Add-on Convertible Note" "Follow-on Convertible Note". It benefits the VC to have the rights to purchase shares of my organization if we are performing well throughout the program.
What I was afraid of was the $100K (Add-on) or $250K (Follow-on) being applied at the implied valuation of $375K (derived from 8% for $30K). That would completely sink us and we'd be wholly owned by the VC firm + their investors. But I think that you are correct in that any injections of cash would convert during a qualified financing round.
Under this assumption, the things to negotiate then would be their valuation caps ($1,500,000 for "Add-on"; $3,000,000 for "Follow-on"), the maturity / graduation date (currently arbitrary) and who gets to price our next round.
Any other thoughts on what I might be missing?
Yep I believe that's right - one more potential point of negotiation to consider would be the interest rate. 7% is not unreasonably high but still a bit on the higher end, especially given how low interest rates are in general.... that's just my inclination though. I recommend doing a quick search on negotiating convertible note agreements just to make sure you cover your bases of course - but I'll affirm that you shouldn't have to worry about these notes being converted at the current pre-money valuation of $375K!
I'll confirm what was discussed above. Basically, the accelerator wants a "first right of refusal" to invest $100k and then $250k allocations in further financing rounds within 18 months and 24 months respectively via convertible notes. Juicetin is also correct regarding the valuations.
You don't have to worry about the interest rate so much since, if all goes well, you'll raise more funding and the notes convert to equity. And if you go belly up, you go belly up. If you do REALLY well, it'll probably be a sore spot to have to allocate room to the accelerator in the future rounds at the aforementioned valuations, but that's sort of a moot point if you really need the accelerator's help at this point.
Feel free to PM me the accelerator's name - I'm happy to share additional info if I know them.
Following. m_1 may be of some help here as well?
RE: Valuation. The biggest determinant of value at pre-seed is: a) Founder background. b) How fast they've moved already. c) Market/thesis, etc..
I would pick up Brad Feld's book "Venture Deals" and read through it. It's a couple of hours long but 100% essential for all founders.
Found a copy and finished that book this morning. What an absolutely fantastic read. I went from having a piecemeal understanding of the VC process from blog posts + YC comments to now a much firmer grasp on what this world is. I need to go back and read "economics & control" one more time to cement my points of negotiation but now I'm not scared of what I don't know.
Very appreciative for this timely recommendation.
Great! Brad's blog is quite good too FWIW. He is awesome about replying to emails as well.
Worked as an intern (so take everything I say with a grain of salt) at a Pre-Seed/Seed VC in the Healthcare space for 1.5 years.
Our standard terms fell in line with what you have outlined in your term sheet, so without knowing anything within the black box of your startup, nothing seems particularly out of line.
Feel free to PM.
After much consideration, I am going to respectfully decline the offer and position to maintain a relationship moving forward.
We are a strong team and a strong idea trapped in-between the Pre-Seed & Seed stage. I don't need the money (have enough burn for Q1 2021) and my co-founders are both still full-time W2 employees. This offer is not big enough to provide the catalyst for them to quit their jobs and go all-in. I need to deploy our technology in a commercial setting and write-up a case study (w/ testimonial) on the results. Once I have that case study, I believe I will be firmly in the "Seed" stage and will approach VC's directly for a qualified financing round instead of approaching through the "Accelerator" channel.
Thank you to everyone who chimed-in in a timely manner juicetin Bsimhead m_1 lenbias7
Time to get back to developing :)
Good decision if you feel confident in yourself and your team. It's tough to give away 8% so early for such a small investment and I know the challenges of the "limbo stage" of being stuck between pre-seed and seed - too late for $30k to be meaningful, but too early for a seed vc firm to invest. Better off doing an angel/hnw round that'll get you to your next milestones, then go for a real vc deal.
Are you in a healthcare hub city? Do you have board members/advisors in the space? Definitely use them for making decisions like this as well.
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