Convertible round vs priced equity round?

What should founders be raising and what's the market standard? Avnish Bajaj & Rajinder Balaraman discuss the thought process behind this decision for both the founder and investor. Tune in to find out.

Rajinder:

Should I be raising a convertible round or a priced equity round, what’s market standard?

Avnish:

Market standard versus my answer are different. So, market standard in the US for seed has become a convertible round. And we do it also, we follow the market, we can’t change the market. My personal view, bad idea.

Let’s take both the investor view and the founder view, the investor view is, I don’t know the captable of the company, I don’t know how much I’m going to own—and therefore I’m always going to be a little less committed to your company. And wherever we have done these convertible notes, at least we have intended to put in lower cheques then we would have otherwise, if it was a price round. Because I’m in the business of risk and reward, you are telling me at a point in time, which is today, to price my round at a point in the future, it’s just unfair.

So, for me as an investor, we do it because it's market and we say if it's working we will increase our ownership later, but it misaligns risk and reward. Today’s risk is being priced at tomorrow’s reward and that’s not how investors think.

Interestingly, I believe it’s a bad idea for the founders because the founders get a fall sense of comfort. If I have a very high cap in some of these rounds, most founders just like the investors are, they are thinking at the cap level, they are thinking my next level is going to come there, they are spending money according to that, they are building their next round backwards, thinking according to that.

And if they don’t hit those milestones and the round ends up much lower, they suddenly own a lot less of a company than they thought they were and I think that's not a good place to be in. so, I think even though it has become market, my view is, but by the way it's market only for seed. I think for non-seed most people, I advise the companies don’t do a next round convert, wherever you can do a priced round.

Founders tend to balance greed and fear and they tend to want to do convertible through the next round, then my advice always is, ok if you are doing a convertible at least put a floor to it, obviously the investor will ask for a cap and don’t raise too much. Because the point remains the same, this is a business of knowing your captable and in a convertible you don’t know it. And therefore, people are not as committed as you think they are or either on the risk side or on the reward side.