#1 — Avoid establishing a valuation

The initial belief with a convertible note was that it would enable a startup to delay the valuation discussion to the Series A. Assigning a valuation to a seed stage company is a difficult and non-formulaic task, so the ability to skip the valuation process AND raise funding is compelling. However, as convertible notes became more commonplace investors increasingly treated the cap on the convertible note as the pre-money valuation — and would negotiate and evaluate the company accordingly.

#2 — Simpler and cheaper

A convertible note is basically short term debt that converts to equity. There is some nuance with the structure but there are only three key elements that vary: Discount, Cap and Interest. So, there is minimal complexity and in turn limited legal cost in the creation and execution of a convertible note. On the other hand, the term sheet of a priced round in addition to the valuation terms, there are voting rights, governance and board of directors. As a result, the price of a term sheet previously could cost a company $10–15k even at the seed stage. Now while the above elements are still part of a term sheet, the explosion of seed stage financings has led to the standardization of a seed stage financing with only discussions and negotiations around a couple items. In total, your typical seed stage financing should now only should cost $5–10k. Part and parcel with that term sheet standardization is the shifting of power dynamics away from investors. The draconian and unnecessarily complex terms of old are largely gone.

So what do we like about Price Rounds?

#1 — Formality of establishing a board, option pool and fewer legal issues

Although the term sheet of a priced round costs slightly more than a convertible note, the added value significantly outweighs the costs. We have found establishing great corporate hygiene as early as possible pays massive dividends later. Establishing corporate responsibilities, a board of directors and voting rights from the very start prevents foundational breakdowns down the road. Every term around corporate structure on a term sheet exists for a reason — to prevent a potential issue that can arise down the road — so establishing those terms earlier prevents them from being a problem later. Good governance is good business. Similarly establishing an option pool sooner than later is invaluable for recruiting talent and letting employees know exactly what they’re gettingin terms of value and vesting begins for founder and employees.

#2 — Creates less problems down the road for Investor and the entrepreneur

As mentioned before, a convertible note is just debt that converts to equity upon the next financing. It does not come with any of the protections or definite rights of being a preferred equity. As a result, Series A investors as part of their financing proposal to a startup, may require convertible note holders to be converted into common, prevent further participation/investment of those noteholders or in some instances just pay back the convertibles notes and prevent the conversion entirely. In many instances, we have seen Series A terms that waive the discount on the convertible note. Entrepreneurs are put in a tricky position that pits them against their earlier investors as not accepting modifications to the convertible note which may put their financing at risk. And on the investor side, those terms could be disastrous for investment and could pit them against the entrepreneur. It is not just about priced round versus convertible notes it is about the investor.

We at Launch are increasingly bullish on the value of pricing a round versus a note. Of course there is a financing amount threshold amount that is part of this that varies situation to situation. We believe that a raise of >$250k and above makes a priced round the best practice. The convertible note versus priced round debate is that generalized advice is very different from the proposal of specific investor. A lot of what a convertible note represents is protection for an entrepreneur from bad terms, and unnecessarily high legal costs. The majority of the problems with priced rounds are because an entrepreneur is dealing with a bad investor not an inherently flawed legal document. Priced rounds are valuable when an entrepreneur is working with an investor they are excited to partner with and we hope to be that partner.

By Woody Benson (@wbenson): successful CEO, Venture Capitalist, Angel Investor & Passionate BOD Member

“We need more financial visibility.”

“We need more customers.”

No shit.

How is this kind of commentary from a board helpful to the first-time CEO who might be renting out his flat on Airbnb to save money since he isn’t taking a salary?

Worried Directors make for worried CEOs. And, trust me, CEOs are worried enough.

Some Directors are appointed due to their network, stature, or their ability to write a check — none of which fundamentally equips them for the startup boardroom.

One doesn’t need a Stanford MBA to see what’s wrong or not working in a startup. The key is to help the team figure it out. Every project is its own Rubik’s Cube. How do you solve it? First Things First.

In this 2X seed world, it’s important to get to value-creation milestones. John Doerr once shared with me that products and channels create all value.

So, let start there (and only seasoned directors do). It is key to understand the product or service from the customer’s perspective and compare it to the vision of the designer or engineer. Some say a match here is an MVP.

This is not an easy task as a board director; it involves a willingness to dig deep to understand what is being said. Is the product additive or a replacement, how much time/effort does it take, etc.?

Get Dirty

Ask yourself: How do customers buy, when do they buy, from whom did they buy, did they do research, did they look at reviews, who did they buy for, what will they pay, who did they pay? Often this is like a petri dish experiment: put the early customers in the lab and examine EVERYTHING. This may not determine conclusions, but will gather insights.

And smart directors and experienced investors know that insights like these can lead to some kind of pattern recognition. From here, true value can be established. Often, a problem or challenge can resemble another that a Director has seen, and they can relay that war story or history to the startup team. This is a way of de-personalizing the feedback and is easier to digest to a first time CEO. Sharing the lessons learned or nuggets as a former CEO has said, establishes H.O.P.E. — Hearing Others People’s Experiences.

Quickly from here the solution process begins, and the effective Director knows that simple, straightforward assignments and goals are best. The more quantified then the better. (Quantifications are hard. But once a simple dashboard is created, it creates an “it is what it is” mentality and the process of solving something becomes more in-focus, versus wondering how did we get here, what went wrong, who’s to blame, etc.

In these projects only three things matter:

1. Where Are We?

2. Where Are We Going?

3. How Do We Get There?

Avoiding the Confrontational Environment

Remember, all reporting is a statement of past events. The important thing is to create agreed-upon action plans moving forward. While this sounds simple, often this can be confrontational, as inexperienced directors may not be on sure footing about what to do. As a result, a smart CEO, even if inexperienced, will let the lead director or “alpha dog” carry this part of the conversation.

Comforting phrases that might work include:

• “In my experience, I would…”
• “Based on a similar challenges, we did….”
• Or a question like, “What do we know now that we didn’t 30 days ago?”

At the early stage of company formation, potential market sizes or TAMs are misleading. Every market has a gorilla, some chimps, and a bunch of monkeys. The folly of only thinking big markets matter for startups is that it is brutal to get a leadership edge (unless you are creating a new category e.g. Dropbox, Uber). Getting leadership position in a small market can lead to cross-over benefits. (Didn’t Amazon start with books?)

Back to the Worried Director

The Worried Director is consumed with forecasts and their attainment, both with revenue and cash burn. However, the reality is that very few companies hit the forecast given to investors for funding purposes. Last year, I asked Mike Simon, founding CEO of LogMeIn (now a successful public company), if they met the forecast they used for fundraising. He said they weren’t even close to the hockey stick eye-candy used to raise funds. So, once a baord is assembled, it is best to create a forecast from the ground up, discuss how many units or products of features, the when and where and how of the business, etc., to preempt the creation of a Worried Director.

Additionally, the Worried Director might look at cash burn as the end-all and be-all. Surely, it’s important, but only in the context of AP. Young startups don’t pay their vendors and sometimes employees, regularly, if at all.

The worried Director, who may have a great network, thinks he is helping by making an intro or two. Often times, the context of the intro is lost when the CEO has time to follow-up. The effective intro has to have a specific purpose — e.g. “I’d like you to meet Adrian, the world’s best Facebook re-targeter who can help optimize your funnel.”

Understanding CEOs is a challenge. They move in waves of momentum, obvious or not, but often self-programmed. It’s impossible to get a CEO to change their current wave; the challenge is to get to them to the next wave. Their internal programing creates this — it’s not a covert thing. It could involve the co-founder, culture, product status, tech or anything. It takes a keen ear to figure out exactly where the CEO is parked at the time. The worried Director has time to worry. The consumed seed CEO lives a 24/7 life, and if the BOD experiences are negative, they will spend less time caring what the BOD says or thinks.

Manic Directors create manic CEOs. And anxious directors create anxious CEOs. (Note: The difference between anxiety and fear is that at least with with fear, you know what you are afraid of.) It’s fine to worry and obsess about specific business problems. On the other hand, since CEOs need to be optimistic, they can adhere to the mushroom style of BOD management (which ironically, pleases the worried Director). They talk about the great & wonderful things going on with product, company, etc. The way to counteract this is to get the CEO to segment their thoughts into three buckets:

1. What’s working?

2. What’s not working?

3. What’s on the edge?

The Worried Director can flip out at this, but just hope the content of each slide changes as time goes on, given there is never a time, in any company, where everything is working.

Leave on a High Note

It’s tough enough for management to execute, but a beating from the BOD doesn’t help (although it is a rarely used tool in the toolbox). There is no straight path to success and if the worried Director can learn a few lessons than the odds to a successful outcome is increased.

It’s not like Normandy or Apple didn’t have issues too.

The Worried Director was originally published in Better Everyday on Medium, where people are continuing the conversation by highlighting and responding to this story.