An article by Leena Rao – a senior editor at TechCrunch.com – suggests that while convertible debt may be getting popular with early stage investors, it can cause a lot of problems. This is especially true where Series A funding doesn’t come along before the notes become due – putting start ups in default.
This is an interesting read – Convertible Debt or Equity – but I’ll let you read it for yourself.
In BC there is a different problem for which convertible equity may also be a solution. With this province’s VCC incentives, angels are in certain circumstances (EBC investments) encouraged to hang on for 5 years in exchange for an immediate 30% return to investors. While this lowers the risk, it may also extend the amount of time that the money is at risk. Regardless of which investment model is used, it is often difficult for investors to achieve an exit.
As I mentioned in an earlier post – convertible equity may be used by VCC or EBC investors as a means of ‘encouraging’ a management buyout, thereby securing an exit, where funds may be stranded in a ‘lifestyle business’.