Working Capital
Matt Quinn

The Rise of High-Resolution Fundraising?

 

Venture capital firm Y Combinator co-founder Paul Graham sent the VC blogosphere into a tizzy this week when he tweeted:

'Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.'

At issue for everyone was whether this was 1) true and 2) a good or bad thing.

If you're interested in the various opinions, I offer up these links:

Those are some pretty big responses to a 25-word Twitter message. In the end, no one could really agree on who benefited from the trend. The most common answer: well, it depends.

But back to Graham himself. He offered a follow-on post at his website explaining why he thinks the rise of convertible debt is a positive trend for both entrepreneurs and investors. The short answer is that it speeds up the fundraising process and is generally fairer to everyone involved.

In terms of legal complexity, drawing up a convertible note is a breeze compared to equity. Therefore it's a lot cheaper. Additionally, you don't get sucked into the debate over valuation.

By far the biggest influence on investors' opinions of a startup is the opinion of other investors. There are very, very few who simply decide for themselves. Any startup founder can tell you the most common question they hear from investors is not about the founders or the product, but "who else is investing?"

Since no one wants to be the first mover when it comes to investing and putting a valuation on a company, it's easy for fundraising to grind to a halt.

Graham argues that the beauty of convertible notes is you can bypass the groupthink and give different prices to different investors, rewarding those taking more risk and those likely to help you in the future. He refers to this variable pricing as 'high-resolution fundraising.'

(This is presumably opposed to the low-resolution process of fixed-size equity rounds where no individual investor is willing to pipe up with his or her intent to invest or valuation.)

This seems a lot more equitable to Graham (pun not intended):

Bolder investors will now get rewarded with lower prices. But more important, in a hits-driven business, is that they'll be able to get into the deals they want. Whereas the "who else is investing?" type of investors will not only pay higher prices, but may not be able to get into the best deals at all.

And whether or you're on board with this kind of system, it doesn't much matter to Graham: 'Different terms for different investors is clearly the way of the future.'

Matt Quinn contributes to the Wall Street Journal's corporate finance blog. He has also written extensively about banking and corporate finance for publications including Inc., American Banker, and Financial Week. He lives in Brooklyn, New York.