While convertible notes have many benefits, they also have certain drawbacks that are often overlooked or under-discussed. Based on our own experiences, we have encountered numerous situations where the use of convertibles has led to uncomfortable dynamics between ourselves, founders, and other investors. We believe these instances may be more prevalent than commonly recognized and wanted to highlight them in the article below.
They make our lives much easier – we don’t have to negotiate with founders over onerous deal terms that normally exist in an equity round (e.g., liquidation preferences, board seats, protective provisions, etc.) or go back and forth with their lawyers, a mentally draining process that rarely feels productive.
With limited legal due diligence to conduct, VCs simply need to negotiate the valuation cap and/or discount rate – two terms, which over the last couple of years, were set by the market anyway (20%-25% dilution and a 20% discount rate), leaving negligible effort on the investors’ end to close a deal.
At best, some VCs will go the extra mile to negotiate a Most Favored Nation clause, information rights and/or pro-rata rights – rights which actually sit outside the convertible note and in a side letter.