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Convertible notes with a personal guarantor from the founder?

An investor is requesting that I be listed personally as a guarantor for a covetable note. First time raising capital, is this a common term or should I run the other way. My guy says it’s not right but not sure how common this is.

  • It’s utterly unacceptable. The founders are already putting in sweat equity, taking less than market salary, and risk their professional careers as well. So if investors want to share in the upside they have to share in the downside. That means they’ll have to write off their investment if they choose unwisely.

    Reject the investment, and consider yourself lucky you dodged this bullet.

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  • This investor is not an investor. Convertible notes are not the right way for startup, but adding a personal guarantee from founders is a shame.

    Your investor want to make a 5-10x multiple on his investment without taking any risk. You can’t accept that. Except maybe if the note interest rate is about 0.5%, but I really doubt so.

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    • Why do you believe a convertible note is not good for startups? I believe otherwise, and think they’re actually better for founders than they are for investors, especially if you can get uncapped terms like those coming out of YC or AngelPad.

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      • I think convertible note is not the way to finance a startup because in my opinion, a startup is about innovation and risk. You must NEVER finance research and innovation with debt. You must finance those risky bets with equity. This is a basic point in corporate finance. And this is also popular wisdom. Would you finance gambling with debt ? Of course not.

        Startups and innovation are risky bets. You can take those bets with what you have. Founders with no money have their skills, energy and their time. They invest their lives, because they have it at the beginning. Investors must finance innovation with equity, not convertible notes, which basically is debt.

        This is for the principle. But there are of course cases where convertible notes or classic debt can have their place in a startup: when you have proven your product and business model, and it’s time to invest in factories, plants and so on. You will have the choice between equity and debt for financing, in the proportions you choose. Because this is now investment, not research and innovation financing. And if the business goes south, you can sell things to repay most of the debt.

        Other case: if you consider a startup like any other small business, it’s a matter of wording. You can start a brand new business with debt if it is not about innovation. If you buy a delicatessen shop, you can finance it with debt because the risk is low. Any bank will finance your shop, but no bank will finance a real startup at the beginning.

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        • -5

          Are you an economist or an actual founder? I can tell you any founder that has actually ever been in this situation knows that the terms (and in particular exit terms) for equity and large favour the VC. If you can sell conv notes at an early stage – this is way more preferred – the math of it is just way better for the founder. If you’ve ever actually been in this situation – what I am saying will ring true. I’m not tolling (never have) and will say that you seem to be making a moral point where none applies. To all founders out there make the best deal you can sell whenever you can sell it. Problem is that no on will do a conv deal early stage – too much risk for the investor – which is exactly why it’s a good deal for the founder.

          I’m still bootstrapping. Not willing to sell a comb note to family and friends until I have derisked a bit and not willing to give up equity/control to an investor. When I do it will be on my terms either way.

          Conv notes ftw.

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          • I’m not an economist, I’m a real founder. But I’m bootstrapping, and I’m in Europe. It may explain different point of views. Here, we don’t have personal bankruptcy, and failure is not socially acceptable. That’s why many founders in my country stick on this kind of principles, like I do. Maybe US founders are more springy about financing startups with debt, but you should be very careful with that. Debt can become a remorseless life crusher.

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            • I reply my own answer to continue this. Because I’m in Europe, I wanted to check the differences on the other side of the pond. I found that convertible notes are not better in US than in Europe. If you have no other choice to finance your startup, you should really consider giving up.

              Please read this article from Mark Suster: http://www.bothsidesofthetable.com/2014/09/17/bad-notes-on-venture-capital/

              What means a convertible note ? Investor thinks your idea is quite good, he wants to see what could happen, or does not want to miss an opportunity, and at the same time he does NOT believe it will be a success. So he puts all the risk on you. Then you become in charge of make it a success: either you succeed and you can find a real investor for equity later, so the first investor gains equity in a proven business, either you fail to find any other investor, and then you are personally responsible to give back the money. You can’t win at this game.

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          • quote: “Problem is that no on will do a conv deal early stage – too much risk for the investor..”

            We’ve been told the opposite by our mentor, investors do prefer conv notes for lower risks, and would rather do that than a standard investment.

            My vote is definitely against the founder’s personal guarantee!

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      • IMO, convertible notes are a 2 edged sword for everyone.

        On the plus side, there’s somewhat less hoop jumping involved for the startup. However, it is a debt. On the minus side for the investor – if the startup really blows up, the convertible holder gets hosed.

        From this viewpoint, what a convertible note from an investor says is that they really don’t think you have much upside beyond the conversion cap.

        Do you consider this a positive as a startup?

        Reply

    • Could you tell us more about this ? As a founder, I think convertible notes are a “scam” for founders, and a “blessing” for investors… It would be interesting to develop the opposite idea here. Thanks in advance for that.

      Reply

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