Investing in an early tech company seed round costs our fund an average of $40 K to $50 K. As a result, making a $100,000 investment simply does not make sense for most VC funds. Angel investors fill the much needed “gap” in pre-Seed startup financing
Convertible notes allow angel investors to minimize their legal expenses and to defer valuation negotiations until a subsequent round of financing. This allows the startup flexibility for the timeline to develop metrics which can be used to determine a fair pre-money valuation in subsequent rounds of funding.
Here is seven things you need to know is about convertible notes.
1) Uncapped Convertible Notes. Usually means that the valuation for the note conversion will be the same as the Series A valuation.
2) Capped Convertible Notes. The note conversion caps the valuation during the Series A conversion. For example, if the term sheet has a $6 million conversion cap, even if the Series A valuation jumps up to $20 million the note will convert at a $6 million valuation. The convertible note seemed ideal to defer the valuation question till the company has metrics to determined valuations, but with caps the valuation question remains in play.
3) Conversion Rate Discounts. For example, the note holder gets a discount (ie a 15%) of or when the note converts.
4) Aggregate Proceeds. Usually required by the VC to convert all convertible debt to equity in this round. VCs usually want this so that no debt is senior to their investment.
5) A common mistake made by founders is to raise too much convertible debt without understanding precisely how much dilution that occurs when the note converts to equity. This is easy to do because of the rolling nature of convertible notes versus a “one time event” of a Seed or Series A financing. In addition, many founders forget to calculate the dilution that will occur from the convertible debt conversion to equity and how it also diluted the option pool.
6) Convertible debt is usually simpler and less costly than Seed and Series A rounds. Nevertheless, it’s still most likely considered a “security” as defined by the SEC. So be sure to always have an experienced attorney draft these documents. This is not something you want to “do-it-yourself.”
7) The VC Valuation on the term sheet is post money. Post money equals the VC investment plus the amount of the VC investment. Convertible notes are usually included in the money valuation.
For example, the term sheet post money valuation is $20 million and the VC invests $5 million for 25% equity. Let’s say that $3 million in convertible debts after caps and convertible note discounts are factored in. Here is where the cap and conversion rate discounts can have a major impact on founder dilution. Also, the employee option pool is agreed to be $2 million. Keep in mind that typically convertible notes and employee option pools dilute only the founders and not the VCs. Assuming no other variables, the founders in my example might be getting a much lower percentage of equity than they were expecting. Founders must know that the devil is in the details.
Blockchain seems to be that hot topic that everyone talks about but no one seems to understand. It feels like the pet-Internet days when new platforms are coming out every six months and they get better and better.
As I am going through this old town of Virginia City, I am reminded that I can virtually live entirely off of bitcoin. Uber to work. Eat at restaurants. Buy groceries at Whole Foods. Shop for clothes. Watch a movie. Take a trip. Pay employees and get them computers. Renovate my home. Buy a book. Get a concert ticket.
The easiest way to use bitcoin is to use BitPay to keep loading up your Amazon Gift Card and almost everything can be bought on Amazon. Here is a list of what I can spend bitcoins on.
(1) Travel including hotels, flights, cruises and rental cars. Check out Expedia and Cheap Air.
(2) Furniture. Check out Overstock.
(3) Computers, Software and Electronics. Check out Newegg, Dell, Intuit, Microsoft and Tiger Direct.
(4) Payroll. Check out BitWage.
(5) Use Gift Cards Any Retailer Through BitPay. Use bitcoin to refill Gift Cards to Amazon, AMC Theaters, Home Depot or Lowes, Amtrak, AutoZone, Bath and Body, Barnes and Nobles, Bed Bath & Beyond, World Market, tons of restaurants, Uber, Whole Foods, StubHub, etc.
(6) E-commerce. Check out Shopify.
(7) Buy ads to promote my business.
In March 2000, Barrons predicted massive tech failures in an article titled “Burning Up; Warning: Internet companies are running out of cash—fast.” The Federal Reserve raised interest rates which lead to an inverted yield curve. March 10, 2000 is the day the Dot.com bubble popped. In April 2000, the Nassau crashed by 34.2% and hundreds of tech companies nose dived more than 80% in valuation. $8 trillion in wealth vanished overnight.
Back in 1999, everyone seemed to know that a market crash was coming. Stock advisors told their clients that tech stocks were overvalued. 1999 reminds me a lot of 2019.
The major cause of the Dot.Com Bubble was the Taxpayers Relief Act Of 1997 which lowered the maximum tax rate on capital gains for individual investors from 28% to 20% for equity held for more than 18 months. This law incentivized average investors to speculate on the super hot tech stocks.
In addition, bubbles are always caused by easy capital, speculation and innovation. Today’s innovation buzzwords include the “internet of things,” blockchain, artificial intelligence, virtual reality, machine learning and the Gig economy.
In 1999, tech stocks rose as fast as 300% to 1900% as opposed to 350% increases in 2019. In 1999, 550 tech companies went IPO, cashing out billions for venture capital funds. Venture capitalist made over $43 billion between September 1999 and July 2000. The losers were average people; the average 401k lost 25%-35% of it’s value.
In 1999, the cyclically adjusted price-to-earnings (CAPE) ratio of the S&P averaged 45 compared to long term averages for the traditional 12-month rolling PE (price-to-earning) ratio of 16. When earnings are low, the traditional P/E jumps up and makes shares look overpriced. When profits are high, they make the traditional P/E look like a great buy. Cyclically adjusted P/E (CAPE) ratio corrects the “illusion” caused by fluctuating earnings.
The problem with the stock market today is that profits are being driven by unsustainably low-interest rates and over $8.8 trillion in corporate debt. For example, the corporate growth rates have been outpacing GDP growth.
It is alarming that the cyclically adjusted P/E (CAPE) ratio today hovering around 30 is almost exactly the same as the eve of the 1929 crash. In fact, the greatest economist in the world reknown Yale economist Irving Fisher resolutely predicted that if a correction came it would look like a harmless slump because the tradition P/E (price to earning) ratio was along historical averages.
On October 15, 1929 (just days before the Great Crash), Fisher predicted that stocks prices were in alignment to corporate earnings and “what looks like a permanently high plateau… I expect to see the stock market a good deal higher within a few months.“ Fisher lost his reputation by making the same mistake as economists today who are overlooking the cyclically adjusted P/E (CAPE).
The tech bubble will pop. It’s impossible to know when precisely but it will happen in the near future.
If the Dot.com serves as a predictor, over 200,000 tech workers will lose their jobs after the crash, the stock market may lose 30%-40% of it’s value and venture capital funding will dry up.
As a founder, how do you increase your chances for financial success? After all, a lot of self-development content out there is a bunch of bullshit… rah rah garbage getting hyped up by a charismatic speaker. In fact, modern paradigms in law, politics, medicine, science, economic and psychology are so flawed that I’ve learned to be agnostic about everything.
Since Plato, most people have viewed our “humanness” as logical thinking that must suppress our “animalistic” emotions. Scientists from the 1950s explained that our logical thinking occurs in the neocortex, our emotional reactions occurs in our limbic system (which includes the amygdala), and our subconscious habits occurs in our “reptilian” brainstem. These are dangerous ideas because they are completely false.
Thinking, subconscious habits and emotions actually are pretty similar. They are all simply our brain’s prediction machine. External sensory data including our visual cortex getting processed in the occipital lobe, our olfactory (smell) cortex, our motor cortex, our auditory cortex, and our somatosensory cortex (taste and touch) combine to form an auto-correction machine. We don’t learn, experience or simulate the world from our external sensory inputs. The brain’s prediction machine is like a scientist who makes billions of hypthosis; our external sensory input is like the research data that tests the hypothesis.
When the sensory cortexes fire together in different regions, they wire together. This is called neuroplasticity and it is mostly predetermined by our epigenics. Our epigenetics is the combination of our genetic predispositions plus the culture, concepts, values, self-identity and beliefs of our parents. Humans are the only species capable of goal-derived concept learning. Language adds even more richness to our concepts.
Modern neuroscience provides us with the scientific research that emotions are constructed. Animals don’t have emotions; they have survival circuits based on body budget management. In humans and only in humans, goal-derived concepts always proceed emotional experiences.
As an example, let’s take a red apple. So you grab an apple out of the basket and take a juicy bite. Clearly, the 🍎 is real, right? The truth is that your brain tricks you. In milliseconds, a human adult has the concept of an “apple” and of “red.” Based on our past neuro associations, our brain makes predictions about what our experience with the red apple will be. If your past neuro associations is that red apples always have worms, your brain will predict a “worm taste” 🐛 when you bite.
Ladies and gentlemen… we live in the Matrix. The red apple is simply a virtual reality simulation created by our brain. All emotions are constructed based on predictions upon past neuroassociations and auto-corrected by external sensory data.
Humans have a natural tendency towards hallucinations. The schizophrenic person hearing voices has an unbalanced body budget featuring underperforming external sensory data auto-corrections. The hallucinations are the brain’s prediction machine at work but the system fails without external sensory autocorrections. Other mental illnesses like anxiety and depression works exactly the same derived from unbalanced body budgets. On the other end of the unbalanced body budget spectrum, mental illnesses such as autism work exactly the opposite. In autism, the brain’s prediction machine fails and so a non-functioning autistic child only experiences external sensory data without prediction concepts.
Emotions, logical thinking and subconscious habits are all the brain’s prediction machines. When someone cuts you off on the freeway, your amygdala is not reacting with road rage. Your brain comes loaded with a pre-mapped instruction manual (it’s concept) of how your body should respond if your “boundaries” get crossed. The amygdala did not create this emotional reaction. The brain’s prediction machine created the emotion based on your concept and the amygdala executed it’s signals to the rest of the body.
What does all this jargon-laden neuroscience have to do with succeeding as a tech start-up? Well, I believe it has everything to do with your success. Successful startups come from successful cultures. Culture predetermines how we build our prediction machine concepts. It is not a coincidence that 85% of the US-based “unicorns” (aka the $1 billion companies) come from the San Francisco/Silicon Valley Area. Who we hang around and surround ourself with matters.
Our epigenetics matter. If you’re like me and grew up in a poor and emotional abusive environment, you’ll likely struggle and fail a lot more than a “tech bro” from Atherton who was walked into Stanford. In fact, I’ve come to the conclusion that Bay Area tech startups don’t have more talent than non-Bay Area companies. They simply have better connections to the right mentors and access to way more capital.
For those that don’t have the access to the “tech bro” epigenetics, I’ve devoted my life to researching and developing resources to help you rewire your neuro associations. Unless you learn how to rewire your wealth self-identity (spindle neurons), emotion constructions, thinking, beliefs, values, subconscious habits and all other neuro associations, you will likely fail as a tech founder.
Venture capitalist are in the business of making predictions about your success. If they make wrong predictions, they lose other people’s money.