Fall is just about here. Autumn leaves, apple cider and, of course, football! Also, being traditionally the start of the new school year, fall is a time when start-ups dig in, push hard and perhaps even undertake a little self-reflection and planning, rushing to get things done before the holidays. I recently commented on some

In your free time, while not grinding away at your corporate day job, you’ve developed an early-stage version of an application that allows users to chase small digital emojis around town while staring at a smart phone. You’re confident it’s the next big thing, and the opportunities to monetize are endless. The problem: you’re not independently wealthy and the Powerball odds are awful. Thus, the hunt for capital begins…

Often, the first place founders look for cash is from friends, family and their professional network. Incubators, accelerators and “angel” investors may also be sources of initial seed funding. In any event, the discussion with any potential investor quickly turns to how they will put their money in, and what they will receive in return. In exchange for their cash, investors can receive common or preferred stock (or units if the entity is a limited liability company). Common stock brings the highest risk for the investor as they could lose their entire investment should the company fail. Less risky is preferred stock that carries certain rights and privileges not associated with common stock. Such rights may include a preference on distributions of profits, preference to receive payment ahead of other equity owners upon liquidation, and perhaps a guaranteed rate of return over a stated period of time. Common and Preferred stock owners are shareholders of the startup, and have all the rights (and potential headaches) that traditionally come with that moniker.

A useful alternative to standard equity in early stage investment is convertible debt. Key features of convertible debt are: (1) principal amounts that are due at a maturity date; (2) a fixed rate at which interest accrues on the principal balance; and (3) a claim on the company’s assets that is senior to all equity holders, but junior to any bank or other secured debt. 
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