Seed Money: Convertible Notes vs Preferred Stock
This post from Redeye VC provides an excellent analysis of the factors that affect the decision of a seed round (pre-VC) investor to invest in preferred stock or convertible notes, stating:
"Over the last few years, my fund has made over 20 seed-stage investments. While we strive to be the "first money" into a company, we recognize that we typically don't provide enough capital to get a company to profitability. So we invest with the assumption that there will be another "institutional" (or venture) round after us...
In general, I have a strong preference for Preferred Equity..I believe that:
Preferred equity better aligns the interest of the Investor and the Entrepreneur...
Preferred equity prices in all of the risks facing seed-investors...
Preferred equity typically does not create liabilities for the venture round...
So what are the cases when I'm OK with a convertible note?
When a VC round is already underway or imminent...
When I'm not expecting (or expected) to be an active investor...
When the discount (or warrant) coverage increases over time...
When the note has some equity-like protections..."
For more on this topic, see this Jeff Clavier post.
