Transcript:
David Nelson:
Start up investing is highly speculative. Investors invest in potential and often fund companies based on no more than a business plan and the quality of the team of founders. There may be too many unknowns for the parties to agree on value and price for the start up shares. As a result, many early stage financing transactions involve convertible securities. Here, the amount invested is converted or exchanged into shares of the start up in a later round of investment. This allows the investors to get comfortable with the value of the company and the price of its securities.
Also, by offering the investor a right to convert into the same securities to be sold in a later round, without having to provide additional funds, the founders can forgo the negotiation of value and price and having to figure out precisely how much of their company they will need to give up to the investor in order to obtain capital. In the interim, the founders can use the early stage funds and focus on developing their business and even show significant growth and interest in their products and services. This may lead to a higher valuation and thus to giving up less of the company to the investor when the initial funds ultimately convert. Of course, savvy investors are aware of this, and they will usually seek some type of discount on the price at which their investments convert in the later round. The challenge for founders is how they use these early stage funds to get to that higher valuation.
If you would like to learn more about early stage financing for your company, visit us at Cozen.com/copilot.
