Today’s Pill (5): Predatory practices by early-stage investors

You start a business, need money and don’t know how to raise (you’re too stubborn to have a coach/mentor,) and when somebody gives you money against some equity stake plus a convertible at a cap and discount (as you think you have no other choice,) you ”eat” whatever terms they feed you with. Hire an experienced lawyer, as everything you do has an impact in the future (for ex., participating preferred.) And then you need more capital, so you raise a new convertible, at a higher cap, followed by additional convertibles at higher and higher caps, instead of doing a traditional priced round. The investor will tell you that they price the Co higher (caps are proof,) and there’s no need of a valuation now. Assuming you’re doing ok, you’ll get to the (lead) VC for the next round; then everything converts, and it’s a blend that makes the cap table hairy. Depending on the number of convertibles, the caps and the discounts, the riskiest capital may not be rewarded for the risk taken (execute side notes!) A scumbag VC may push a lower valuation (he’ll say the latest caps are too high, blah, blah, take it or leave it) to get more for themselves and to lower previous investors’ equity; and shame on entrepreneur! if s/he accepts.

Joanne Wilson (Gotham Gal) has a great podcast on this, which you can listen here.