A key threshold question for any entrepreneur seeking to raise capital for their startup is whether they should do a priced equity round or use convertible debt instead.
So what is the difference between the two?
For starters, a priced round is an offering and sale of newly-created stock in your company at an agreed-upon per-share price. Investors who buy these stocks become part owners of the company.
A convertible note, on the other hand, is a loan from investors that converts into stock at a future date, based on some yet-to-be-determined price, instead of being paid back.
While many startup founders like convertible notes, this option can be challenging when it comes to pricing the stock later, usually within 12-to-24 months when it goes for another funding round.
A high eventual price is usually to the advantage of the entrepreneur while a lower price favors the investor.
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Priced rounds mitigate this through anti-dilution protections and protective provisions, including the right for preferred shareholders to veto certain major actions such as change of control and amendment to governance documents that adversely affect the preferred investors’ securities.
It is still not yet clear if priced rounds are better than convertible notes.
A recent survey of Angel Capital Association members published in Forbes found that 82 percent of the survey respondents preferred priced rounds for initial investments.
However, 78 percent said they had participated in at least one convertible note in the prior 18 months. A quarter of respondents said they used convertible notes for more than half of their first investment deals.
