Priced Round or (un)Capped Note

A common question is if a company should raise convertible debt or price the round for equity at the Seed. The simple answer: find a good lead who will make the decision easy. "Convertible note" has become synonymous with "Seed round" because of a trend, but it isn't the de facto use case. You can use convertibles or a priced round at any point. 

There are several mechanics within the terms of a note and priced round that become a bit complex when you start considering the current terms' effect on a future round (which you should absolutely do). I'm going to focus on valuation to keep it short because it's typically the most impactful economic term.

First off, a company doesn't have to worry about this if they haven't raised any capital. It doesn't matter as long as the terms are properly aligned for both sides, so find a good lead investor.

A convertible note with a cap has an implied valuation that sets a max price for those investors, but they could convert anywhere below that. While a discount is in place to protect them if the new investors get a price lower than the cap, it creates a weird signal to old and new investors-- a proof point of missed milestones.

A priced round has the obvious pre and post-money valuation. Like the convertible note investors, equity investors are expecting you to hit certain milestones and successfully raise the next round of funding at the highest possible valuation that makes sense for the company (this should be read differently than “for the founders”). There isn’t a conversion to worry about in that next round, simplifying negotiations between the company and new investors.

An uncapped note happens more than you'd expect just based off of understanding the mechanics for investors. You basically take the money, and those investors get a discount upon conversion or, in crazier cases, get the same valuation as next-round investors. This means the entrepreneur didn't reward the investors with anything after they took the early risk. If you can get it, great, but why would you do that to investors you're building a relationship with? You want them to invest in your future companies so treat them fairly.

A priced round has the clearest path to the next round if the terms are fair and 15-30% of the company is taken before the A round. This percentage is also what convertible investors are looking for once converted into preferred stock. Those investors will be diluted down in the long run if you build something successful so don't balk at the percentage. A capped note should be structured strategically and at healthy market terms. Be very aware of the conversion triggers and what milestones are needed to raise the next tranche/round to convert the investors at the best terms possible for the company.