Excelerate Blog

Convertible Debt: really Bridge Loans and Equity Replacement Debt

A post from Troy on Convertible Debt and how he thinks we should really be thinking about it…

Over the last few years, convertible debt has become a popular vehicle for early stage companies that are raising money.   A lot has been written about it from how it affects your cap table to how it is good or bad for both the investor and the entrepreneur.  But there is still a lot of confusion surrounding convertible debt and its uses.  The core of this confusion stems from the language we use and the fact that there are actually two entirely different use cases that get lumped together in that one vague term “convertible debt.”  I am going to be bold and propose that we eliminate the vague term from our vocabulary and adopt a new term for each of these:

-       Bridge Loans

-       Equity Replacement Debt

Bridge Loans are used when a company has a pending round of funding but needs a little help with cash flow between now and then (usually no more than 90 or 120 days) They will open up a round of debt financing where investors receive both interest on their money invested and a discount on the next round when it closes.  This is helpful to the company to solve their immediate cash flow problems and it is helpful to the investors as they are guaranteed to be in that next round and are rewarded with a discount for taking the risk of providing the capital before all the details and all of the capital of the round are solidified.

Equity Replacement Debt is something totally different; this is when the company decided to use convertible debt in place of doing an equity round.  The capital provided will typically provide 12 – 24 months of runway for the company.  These rounds typically have a “cap” in the valuation (and may have a discount too) as the investors are taking the risk today, based on the progress that the company has made to date.  Since the valuation on the investment will be made at the next round, in the future, after more progress has been made, many investors insist on a “cap” on that valuation (“My money will go in at a maximum pre-money valuation of $xxx”).

In my opinion as both an investor and an entrepreneur, I am fine with Bridge Loans – they solve a real problem for the company and reward the investor with a better price for the addition risk that he/she is taking by providing cash before the details of the round are complete.

The Equity Replacement Debt rounds have a host of problems with them.  First the “cap” is a misnomer, it really should be called a “valuation” because it is an attempt at placing a value on what the company is worth at the time of the transaction.  But, valuation is just one of many terms that go into an equity financing, is the equity participating preferred stock or convertible preferred?  Is there a preferential return?  What are the anti-dilution provisions?  Is there any board control specified?  All of these work together with the valuation to make a fair deal.  No experienced entrepreneur or investor would establish the valuation without knowing what the other terms were going to be.  YET, it is effectively done all the time with Equity Replacement Debt!  Recently, I have seen some term sheets that attempt to spell out some of these details in the convertible debt document, inching the process closer and closer to a real equity round both in its complication to execute and its cost to complete, reducing the benefits that most entrepreneurs site for doing it in the first place.

As you see just how different these two use cases are, it is no wonder that there is confusion and debate around the issue of “Should we use convertible debt?” If we would be more specific in our language we could provide a lot more transparency and focus our energy less on fancy investing vehicles and more on building great companies!

If you agree, then PLEASE start being more specific and let’s start talking about Bridge Loans and Equity Replacement Debt rather than using a vague, generic term that just confuses the issue…

 

Filed under: Status Updates — Tags: — November 26, 2012

Overview of Excelerate Labs – Summer 2012

We just posted a new video on the home page and wanted to share it here as well.  Julian from Indirap Productions did an amazing job on filming and editing and deserves a ton of credit.  Take a look and see if you agree!

 

Excelerate Labs overview from Excelerate Labs on Vimeo.

Filed under: Status Updates — Tags: , , — November 11, 2012

Some more good ink for Excelerate in Elite Daily

“Incubators are to Startups as Steroids are to Baseball. They are not necessary to succeed, but they sure as hell help. In this third installation to Elite Daily’s Incubator Series, we lay out the best startup accelerators for entrepreneurs in the North and Midwest regions of the United States: from Pittsburg to Chicago. ”

Chicago

 

Excelerate Labs – ranked 3rd best incubator worldwide – is an intensive summer accelerator for startups driven by proven entrepreneurs and investors. Led by world-class entrepreneurs Sam Yagan (OKCupid, Sparknotes) and Troy Henikoff (SurePayroll), the program is unique in attracting scores of mentors from around the country to work with the teams in direct 1-on-1 meetings. The catch: they only accept ten applicants each session. But if you are accepted, Excelerate Labs may provide the best trade out of any startup: $25,000, resources, connections and press for only a 6% stake in the company.

Read the entire story on Elite Daily…

Filed under: Status Updates — Tags: , , — October 27, 2012

BuiltInChicago’s CEO Spotlight on Troy Henikoff

This was produced as part of the CEO Spotlight series that BuiltInChicago does in conjunction with NBC Chicago each week.  It gives a great overview of Excelerate, check it out…

Filed under: Status Updates — Tags: , — October 14, 2012

What does it mean to be a “coachable” entrepreneur?

I spent this summer as a CEO leading a startup through Excelerate Labs. We underwent a pretty major pivot during the summer, a pivot that probably saved our business.

I think people misunderstand what happens inside this program. They hear its leaders say that entrepreneurs must be “coachable.” And when they hear me explain how we changed our business model, they put these two facts together and say things like “Oh, so did Excelerate tell you to make that change?”

Uh, no. They didn’t. Nobody inside Excelerate Labs tells you what to do. Truly, sometimes I wish they did. It would have been a lot easier.

But in fact what happens is that they ask questions, they provide tools, and they point out problems and force you to confront holes in your business model or your pitch. Then you have to find a way forward by listening to your customers, interpreting a mess of data and making intuitive decisions.

When we found a way through to a successful and more scalable business model, I learned to tell the story of our decision-making in a way that seems logical, linear and even obvious. But this is hindsight talking.

And with the same wisdom of that hindsight, what I think they really mean by “coachable” is a difficult balance between “sticking to your core identity” and “humble and open to other perspectives, ideas and criticisms that can make your company better.”

Because there will be mentors and investors who just don’t get what you are about. For us, it was those who suggested that we change our business from re-using gently used kids’ clothing to just shipping cheaply-produced new clothing straight from the manufacturer. I learned to say to those folks “I’m certain that would be a very successful business, but that’s not the business I am trying to build.” I was determined to stick to my guns on the core values of reducing parents’ consumption and helping them reuse great kids’ clothes.

And then there will be those who get the core but still challenge the execution of your idea: how you are marketing it; how you are defining your customer; what those customers really want from you. One mentor from IDEO said to me “Is your approach really the best way to solve this mother’s problem of constantly replacing her kids’ wardrobe?” I was too scared at first to seriously entertain the question, because it had the potential to blow up our whole business model. But it was exactly this question that led us to the changes we needed to improve and survive. People who can frame those tough questions are incredibly valuable, and being coachable means listening to them.

“Coachable” doesn’t mean young, it doesn’t mean inexperienced and it doesn’t mean easily influenced. It means being open-minded–but not so open-minded that your brains fall out.

Filed under: Company Blog Post,Status Updates — Tags: , , , , — October 12, 2012