In the second clip, David Lee calls a cap on a convertible note a "valuation." This is so wrong it makes my brain hurt. You only value a company when you buy equity. You don't value the company when you buy debt. As an entrepreneur, I think caps are the worst innovation that investors have cooked up in a long time and I also think they are completely counter productive. The only entrepreneurs who agree to caps are those who think they are valuations. Do you really want to invest money with the dumb people who don't understand that they're getting screwed on the transaction?
The problem with a cap - or rather calling a cap a valuation - is that unsophisticated entrepreneurs don't understand the consequences of the cap. To you point about entrepreneurs offering terms, I find that terms are negotiated and that angels are the ones who suggest a cap (and call it a valuation). The problem comes when the naive entrepreneur finds out what a cap really is. This is where they lose focus on building the most value with the capital they have raised and start focusing on the investors who "screwed" them. Once this realization is made, entrepreneurs will try to raise a series A _at a valuation equal to the cap_. After all, why try to add more value when it will go disproportionately to those investors who added a cap and called it a valuation.
Anyway. I understand that caps are a way for investors to avoid dilution in massively up rounds. I just think they are the worst way to do it. It gives the entrepreneurs the incentive to raise their next round at the cap and not a penny more. In my opinion, a good deal will give the entrepreneur the incentive to raise the next round at the highest valuation possible and not at some arbitrary number. If you want anti-dilution protection as an investor, I think warrants are a much better tool. They allow you, as an investor, to maintain a desired percentage of your portfolio company without removing the entrepreneurs incentive to go for the highest valuation possible in the next round.
At the end of the day, the most important thing is the relationship between entrepreneur and investor. And this is where I have the biggest problem calling a cap a valuation. It can really destroy the bond of trust and leave an entrepreneur feeling screwed. That's just not a good mindset to start a company from.
4 comments
[ 3.6 ms ] story [ 13.0 ms ] threadYou realize that the startups write the convertible note right? They are the one offering the terms to the investors.
The issue with uncapped converts is that you are taking risk early but getting priced later. Thus the appearance of caps in the terms.
Of course I'd prefer to have an actual priced round.
Anyway. I understand that caps are a way for investors to avoid dilution in massively up rounds. I just think they are the worst way to do it. It gives the entrepreneurs the incentive to raise their next round at the cap and not a penny more. In my opinion, a good deal will give the entrepreneur the incentive to raise the next round at the highest valuation possible and not at some arbitrary number. If you want anti-dilution protection as an investor, I think warrants are a much better tool. They allow you, as an investor, to maintain a desired percentage of your portfolio company without removing the entrepreneurs incentive to go for the highest valuation possible in the next round.
At the end of the day, the most important thing is the relationship between entrepreneur and investor. And this is where I have the biggest problem calling a cap a valuation. It can really destroy the bond of trust and leave an entrepreneur feeling screwed. That's just not a good mindset to start a company from.
"... startups in the Twitter ecosystem ti stop “filling holes.” "
"He disagrees with Michael’s ffirst Blubble post in which he..."