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Many new startups find it difficult to understand how to choose between financing choices. In this article, we will delve into three main options: equity, convertible debt, and venture debt.



Convertible Debt

Venture Debt

Quick summary

Issue stock from your company

Convertible note = part debt, part equity.

Functions as debt, until some point in the future, when it may convert to equity at some predefined terms.

Venture debt is a senior secured loan that sits on top of the pile, in terms of liquidation preference (repaid before all other debt or equity holders).

When to choose this option:

When you can’t predict cash flow.

If you don’t want to set valuation. Usually used for smaller rounds of financing at the early stages of a company’s life

If you know you can pay debt back in cash

Who generally provides?

Angel investors or venture capital firms

Angel investors or venture capital firms

More aggressive banks, like Silicon Valley Bank and Square 1, or venture debt investors, like Western Tech, Hercules or Oryx Capital

Representative Terms

1. Typical series A investor will ask for 25-35% of the company.

2. Issue preferred stock*

3. Security provisions settled to protect investors

1. Interest at 4-8% per year and paid “in kind”

2. Interest at 4-8% per year and paid “in kind” (grow the principal each month, not paid as cash interest)

3. Typically converts into equity in the company’s next financing

4. The term of the convertible note can be as short as six months or as long as two years, depending on the needs of the company or the investor

1. The note will most likely be secured by 100% of the assets of the business, and the lender will typically lend 25%-75% of the fair market value of assets, depending on the nature of the assets (e.g., ease of liquidating) and the performance of your business.

2. The lender will also most likely require that cash collateral be posted or the executives to personally guarantee the loan, in the event the company cannot repay it.  

3. The note typically comes with a six- to 18-month term, and carries a monthly cash-paid interest rate in the range of prime plus 2%-4% per year.

4. Issuers are typically looking for a 25-35% annual ROI.


Doesn’t have to be repaid. Gives certain valuation to your company.

Quicker and cheaper than equity, both legally and in terms of ownership

Valuation is flexible.

Interest payments do not typically need to be paid in cash each month.

Keep 100% ownership of your startup


Complex to structure legally. Often requires giving control to investors

Limited time frame before you have to pay or convert to equity

If you fail to pay back, you can be forced into liquidation or bankruptcy

Glossary of terms:

Preferred stock: 6-8% interest and a liquidation preference of one times their money back before the common shareholders begin to participate in any sale proceeds for the business.

  1. Participating preferred: investors “double dip” on their interest and liquidation preference and also get their equity upside pro rata with common. However, if this structure is used there is frequently a limit of two to four times the liquidation preference before the participating feature goes away.

  2. Straight convertible preferred: an investor will get their 6% to 8% interest rate plus money back or they can convert and get the equity upside of their stock pro rata with common.

Security: measures taken to protect investors. They can include the following:

  1. Anti-dilution protection for investor so that if company is valued lower, their investment is protected

  2. Protective provisions in terms of rights as shareholders to block certain actions/changes they see as threatening/bad choices

  3. Asking owner to vest ownership of shares in case of leadership change

Interest “in-kind”: Interest in which you grow the principal each month, not paid as cash interest

Whichever financing option you choose, be sure to seek legal counsel in order to draft favorable terms and ensure that both your interests and your investor’s interests are properly reflected in the financing. With the right financing option, your startup can kickstart and grow. It is all about finding the right fit for your startup’s stage, maturity, and performance.

Source: Forbes

Meredith Peng


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