Tag Archives: seed capital

Mentorship over Money (and Office Space)

With the success of Y Combinator and TechStars, several incubators (sometimes referred to as “accelerators”) have popped up everywhere.

Some have done quite well. Here in Dallas,Tech Wildcatters had a strong class and is opening up applications for the Spring 2011 class later this month.

But this morning I read a Dallas Business Journal article that I found amusing: A new accelerator is planning to invest $200,000 and provide up to 45,000 square feet of office space to about 10 mobile app startups in exchange for 15-20% equity in each startup.

(a) That’s $20,000 per startup for a 15%-20% equity stake. Pretty expensive seed capital. Good luck trying to convince even the most nascent of startups to take your investment at around a $100k post-money valuation. Furthermore, the $20k is more like a living stipend than something the mobile startup deploys for development, etc.

(b) Office space is a nice kicker, but no entrepreneur is going to give up equity in their mobile app startup company for office space. Let me put this another way: No entrepreneur worth investing $20,000 in is going to take up an office space-for-equity offer. How much office space does a 2-3 person mobile app startup really need? Not much and they’ll likely office at a coffee shop, their own residence(s), or a local coworking facility. And more than likely all 3 places. The article mentions:

The accelerator’s space-for-equity approach is similar to the tactics some North Texas building owners used during the tech/telecom boom and bust of the late 1990s and early 2000s.

Partying like it’s 1999 is one thing — running a 2010 accelerator like it’s 1999 is probably not a great idea.

(c) Mentorship is key. And it is missing, at least for now, from the model. One of the 2 partners plans to provide personal mentorship. Regardless of how well the partner can provide mentorship, it falls way short of the roster of mentors provided by typical accelerators.

Whenever a client discusses with me whether they should join an accelerator, the decision always comes down to the quality of the mentorship. Startups don’t evaluate their participation in an accelerator by asking “Is the $20k worth the equity given up to the accelerator?” Rather, startups ask “Is the mentorship worth the equity given up to the accelerator?”

In the case of the planned accelerator, mobile app startups will be deciding “Is the mentorship from this one person worth 15%-20% of my startup?” That’s a tall order for the accelerator.

I wish the accelerator the best of luck — I just doubt they understand what mobile app startups desire and value from an accelerator.

TechWildcatters Launches Dallas Microseed Fund

TechWildcatters is a mentorship-driven microseed fund and startup accelerator that just launched in Dallas, Texas.

TechWildcatters is now accepting applications for their first 12-week accelerator “bootcamp” and 20 startup teams will have the opportunity to pitch on March 11, 2010.

The first program begins April 5, 2010. The selected startups will get up to $25,000 in seed funding, intensive top-notch mentorship, and the opportunity to pitch to angel investors, venture capitalists and corporate dev teams at their biannual “Demo Day”. Their first Demo Day is scheduled for June 30, 2010.

Here’s the type of startups TechWildcatters is looking for:

-Applications: B2B Web/Enterprise 2.0, BI/data/analytics, gaming/simulation, etc.

-Technology: Web, SaaS, open source, data integration, middleware, etc.

-Customers: SMB through Fortune 500 (no consumer apps)

-Location: Come from anywhere, willing to locate to Dallas for the program

-Founders: Well-rounded founder teams >1 person, demonstrated understanding of entrepreneurship, relevant technical and business knowledge

-Capital: Needing seed capital to support living expenses while bootstrapping, can make efficient use of limited capital, would generally be planning on self/angel/customer financing as a next step coming out of the program

Apply to TechWildcatters here.

How to Set Conversion Discounts in Convertible Notes

Convertible promissory notes do not include a stated pre-money valuation. Instead, the convertible note seed investor and startup agree that the pre-money valuation for the convertible note investment will be determined by the pre-money valuation the startup receives at the Series A round. However, the convertible note investor does not receive the Series A pre-money valuation, but rather a lower pre-money valuation as determined by the conversion discount.

The convertible note seed investor gets a lower pre-money than the Series A investors for investing in the startup before the Series A round. Since the convertible note investor made the higher-risk investment in the startup, the seed investor’s reward is the ability to purchase (not by investing new cash, but by exchanging the debt) Series A shares at a price per share lower than the per share price paid by the other Series A investors.

So how do you set the conversion discount in a convertible note?

Conversion discounts are set to approximate the amount of risk the convertible note investor is taking by investing in the startup. In addition to the general risk of investing in an early-stage startup, other factors include time and the likelihood of the startup’s valuation increasing between the convertible note investment and the Series A round,

The majority of convertible note deals I see have the conversion discount set at a fixed percentage somewhere between 10% and 40%.

Occasionally, I have drafted conversion discounts that increase over periods of time. For example the conversion discount may be:

(i) 15% if the Series A round occurs within 6 months of the convertible note investment;
(ii) 25% if the Series A round occurs within 7-12 months after the convertible note investment; or
(iii) 40% if the Series A round occurs 12 or more months after the convertible note investment.

How Convertible Debt Works

Convertible debt is a type of security frequently issued by startups when raising seed capital. With convertible debt, the startup issues the seed investor a promissory note, for the investment amount, that contains a conversion feature. The conversion feature is the mechanism by which the debt (the promissory note) will convert to equity (new shares for the investor) upon a future event.

The Qualified Financing

Most (if not all) convertible promissory notes contain an Automatic Conversion clause that dictates the automatic conversion of the convertible debt upon a “Qualified Financing.” The Qualified Financing is typically defined as an equity financing by the startup, for the purpose of raising capital, in which the aggregate of $1,000,000 (this amount can vary per deal) is purchased by investors. Thus, the Qualified Financing event is the trigger by which the convertible debt will automatically convert to equity. The conversion is considered “automatic” because it does not require the vote of either the startup or the investor.

The Qualified Securities

The equity raised in the Qualified Financing (the $1,000,000 above) is typically termed “Qualified Securities.” Think of this as the Series A round. The convertible debt held by the investor will convert to the Qualified Securities. The amount of shares of the Qualified Securities issued to the convertible debt investor is dependent on the conversion discount per the terms of the convertible promissory note.

The Conversion Discount

As a sweetener to the convertible debt investor, convertible promissory notes have a conversion discount feature by which the convertible debt holder will exchange the debt for Qualified Securities at a price per share equal to 80% (this amount can very per deal) of the price per share paid by the Qualified Financing investors (the investors with the new $1,000,000 above).


Here’s the basic outline of how convertible debt works:

(1) Joe Angel invests $100,000 in Startup.

(2) Startup issues Joe Angel a convertible promissory note for $100,000. The convertible promissory note has an automatic conversion feature at $1,000,000 (the “Qualified Financing”) with a conversion discount equal to 20%.

(3) Startup closes $1,000,000 Series A Preferred Stock round (the “Qualified Securities”) by a VC at a Series A Preferred Stock price of $1.00 per share.

(4) Since the Automatic Conversion feature in Joe Angel’s convertible promissory note is triggered by the Series A round, Joe Angel’s convertible debt will be converted to Series A shares at a per share price of $0.80.

(5) The Startup issues Joe Angel 125,000 shares ($100,000/$0.80 per share) of its Series A Preferred Stock. The convertible promissory note is cancelled.