New Venture Lab: Equipping Christian Entrepreneurs

Question

I need to raise capital for my software startup and I have investors ready, willing and able to invest in the range of $1m - $2m, but my dilemma is that I have a couple of significant events that are likely to happen in the next several months (major initial customer commitment and a major channel partner deal) that would dramatically increase the value of my business.  I do not need a lot of capital now (in the range of $100k - $250k), but would need significant capital later if one or both of these events occur (in the range of $1m - $2m).  How do you recommend I deal with the investors since I do need some money now, but I do not want to suffer an inordinate amount of dilution of ownership at our current stage and valuation?

Answer

Since you have already stated that you need venture capital, I will skip the warnings about potential unequal yoking and the debt servitude of taking money from someone for your business (whether it is debt or equity, it still bears a tremendous stewardship burden.)  In order to minimize your ownership dilution and since you only need sufficient funds to finish the development of your software and close these significant near-term deals and since there is a willingness of your potential investors to invest a larger amount, I would suggest the following:  take in a smaller amount from the investors now (the $100k to $250k you need now) in the form of a convertible Note that will convert into equity upon the successful closing of your Series A round of venture capital financing.  This is a very simple 2 – 3 page document (download an Investor Convertible Promissory Note legal template) that does not carry the tremendous time, legal and cost burden of a full Series A financing and easily allows you to close on a small financing with the investors in order to reach the next stage.  Then the Note and its accumulated interest simply convert into the same security as the potential future Series A at a step-up in value.  That step-up in value may be 10%, 25%, 50%, 100% or more and is sometimes written into the agreement such that it escalates over time.  The reason the Note holder gets a value premium compared to the rest of the Series A investors is that they took a greater risk by investing at an earlier stage and a lower company value than did the rest of the Series A money.