Convertible bridge loans are an investment instrument often used by startups, usually to raise a smaller amount of money ahead of a bigger round. It is called a bridge loan because it bridges the company until the full funding round (or sometimes to another event, e.g. an exit). It is called a ‘convertible’ because the intention is usually that it will ‘convert into the next round’, normally at a discount.
For example, company Acme Software might raise a £1m bridge round from existing investors designed to cover losses until they close their £5m Series B round which it is hoped will happen in the next three months. The loan might convert into the Series B round at a 20% discount to the Series B share price. The discount is designed to compensate the lender for the extra risk they are taking by investing in the company before it is properly funded.
To show the maths: if the share price in the Series B was £10 then the £5m Series B investment would get the investor 500,000 shares (5,000,000/10=500,000) but the lender’s discounted shares would be 20% cheaper at £8 a share and their £1m would buy 125,000 shares. The total number of B Shares in issue would then be 625,000.
The two headline terms of convertible loans that most people focus on are the ones mentioned above – the amount of the loan and the discount to the next round at which it converts.
That is fine so long as everything goes to plan and the next round is closed, but the loan documentation also has to deal with what happens when there is no new investment round, lets call that Scenario B. These additional terms are often neglected when the loan is initially discussed and agreed and they are also the ones that can cause the most problems.
Typically if there is no new investment round by an agreed date one of two things happens, either the loan converts into an existing class of shares at a pre-agreed price or it is repaid. Most commonly, if there is no new round the loan converts into the previous round at the previous round price. In the case of Acme Software that would have been the Series A and the loan investors would get the benefit of the Series A price of some time ago, despite the progress the company has presumably made since then. This only works if the company has been going forward. If the company hasn’t been moving forward then lenders often ask for a low share price conversion which gives them a big equity stake if the company isn’t successful in raising that next round.
With some bridge loans if there is no new round the documents stipulate that the company simply has to repay the money to the lenders, usually along with interest or a repayment multiple. From the company perspective the thing to watch out for when negotiating the loan documents is the ability to repay, because if the they can’t then the lenders may well be in a position to take control of the company. If the date at which repayment becomes due is a long time after the date at which the loan is granted it can be tempting to think that someone is bound to have invested in a new round by then or otherwise not give the scenario proper consideration. That could be a big mistake.
This topic is on my mind because we have seen a number of cases recently where insufficient consideration has been given to the scenario B – where things don’t go to plan and there is no further round. Nine times out of ten Scenario B works out better for the lender than the shareholders in the company, sometimes much, much better.
In hilarious news from UK retailer GameStation updated its T’s and C’s on 1st April as an April fools joke adding an ‘immortal soul clause’ and since then 7,500 have accepted the following:
By placing an order via this Web site on the first day of the fourth month of the year 2010 Anno Domini, you agree to grant Us a non transferable option to claim, for now and for ever more, your immortal soul. Should We wish to exercise this option, you agree to surrender your immortal soul, and any claim you may have on it, within 5 (five) working days of receiving written notification from gamesation.co.uk or one of its duly authorised minions.
and better still:
we reserve the right to serve such notice in 6 (six) foot high letters of fire
The company made the change to illustrate the serious point that nobody reads online terms and conditions – something made clearer in this example by the fact that customers were given the option to opt out of the ‘immortal soul clause’ and instead receive a £5 voucher – something very few people did. In fact, due to the number of people who took advantage of this offer GameStation estimates that 88% of people didn’t read the T’s and C’s. Their Terms and Conditions are here, still containing the immortal soul provision.
My question, which I’ve raised before, is whether any court will enforce these documents, given that everybody knows nobody reads them?
For some reason I can’t find that old post now, but I recall that either Barry or Danvers from Bootlaw replied saying that the law is very clear in this area and that therefore site owners don’t have anything to worry about. I’m still not so sure about that, particularly if someone suffers through misuse or leakage of their personal data in a way they didn’t expect and the court thinks is unreasonable.
- Twitter Weekly Updates for 2010-04-11 http://goo.gl/fb/N9jFW #
- Twitter Weekly Updates for 2010-04-11 http://goo.gl/fb/IvCey #
- Congratulations to Plink on becoming Google’s first UK acquisition http://goo.gl/fb/zIrf9 #
- The potential in European venture capital http://goo.gl/fb/RYI8s #
- Twitter to announce its ad offering today http://goo.gl/fb/UIdN7 #
- Eric Schmidt plays up GOOG's mobile strategy and HTML5 over apps http://bit.ly/dyq6Oh #
- FT deal with Foursquare lets users earn points which give free access to FT http://bit.ly/c16l7K #
- Social networking passes email – not sure this is a like for like comparison, but v. interesting RT @fredwilson http://bit.ly/d8IcMk #
- Twitter is moving to control the user environment so it can make money http://goo.gl/fb/p9abw #
- Interview with me up on WeLoveBusiness: http://bit.ly/cqhqTt #
- "A fan is worth $3.60" on FB etc, good analysis, like the methodology, some assumptions dodgy http://bit.ly/d7pPSY #
- @ZanderDuDuh not to value a business, maybe to help predict revenues in reply to ZanderDuDuh #
- Jagex does £38m rev and £18m profit with freemium virtual world game RT @gamesbrief http://bit.ly/a6RAi5 #
- RT @ianbissell: Twitter more popular than previously believed, now over 100m registered users as per Biz and Ev @Chirp http://ow.ly/1yzZ4 #
- @kathybris welcome to Twitter mum 🙂 #
- Using offline data to target and track online ads http://goo.gl/fb/f08Vn #
- Intellect without will is worthless, will without intellect is dangerous http://goo.gl/fb/5jSg1 #
- Google posts solid quarter in line with expectations http://bit.ly/c96jhn #
- Ning to makes layoffs and cuts free service in another blow to ad models http://bit.ly/cr3Wql #
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When I come across great quotes I normally put them on my Tumblog but I like this one from Art of War author Sun Tzu so much I decided to share it with all of you. As you will notice I’ve used an excerpt from the full quote as the title for the post.
The essential thing is action. Action has three stages: the decision born of thought, the order or preparation for execution, and the execution itself. All three stages are governed by the will. The will is rooted in character, and for the man of action character is of more critical importance than intellect. Intellect without will is worthless, will without intellect is dangerous.
– Sun Tzu, as quoted in the Marine Corps Warfighting Dotrine
There is so much in here that is relevant to startups:
The importance of striking a balance between thinking everything through properly and not letting too much thought get in the way of action
The consequences of acting without thinking properly first
The importance of thorough preparation
The importance of character in an entrepreneur and leader, and how that is about so much more than raw intelligence
The centrality of ‘will’ and ‘determination’
The limits and the importance of intelligence
It is easy to write about the balance between thinking and acting in a blog post, but is much harder in the every day maelstrom of running a business – I see that in the running of our fund and in the companies in which we invest, which is maybe why I wanted to reflect on the quote at a bit of length.
Back in February I wrote about Yahoo’s deal with Nectar that takes offline loyalty card data and uses it to target ads on the Yahoo network, and then looks back again at the Nectar card data to see if the targeting has any impact. Yesterday there was more detail on this scheme on the Econsultancy blog, coming from an interview with David Buckingham of Nectar.
The most important new information for me was that only 30,000 people have opted in so far, BUT that they have looked at the surfing behaviour of these 30,000 and found 1-2m others on the Yahoo network who are similar. If this extrapolation from a small data set to a larger one works and is repeatable with other data sets then we have the beginnings of a scalable model that could dramatically improve the performance of online advertising and hence publisher profitability.
These are big ‘ifs’ though. As Iain Henderson pointed out in the comments it is easy to see scenarios in which people buy stuff with their Nectar card which isn’t indicative of their normal buying behaviour (e.g. someone comes for their one a year visit and you buy something for them that you wouldn’t otherwise get). These sorts of problems can be ironed out by the statisticians if the data set is large enough, but if it isn’t then the targeting won’t be much good.
The acid test of course is how the results turn out, and David Buckingham informs us that it is still too early to say on those. He does promise to release the results as soon as they are available, so I look forward to those.
Thinking about it some more, there is a ton of data out there now which isn’t being used effectively, and even if this initiative doesn’t work I expect that before too long someone will find a way to link views of online ads to offline behaviour and make a lot of money from it.
I have been thinking some more about Twitter’s Promoted Tweets, their acquisition last week of iPhone client Tweetie, and the launch earlier this week of Twitter’s own Blackberry client. It seems to me that all these moves are about the same thing – to get more control of the user environment so they can put ads on it and make some money. Roger Ehrenberg put it this way on his Information Arbitrage blog:
All of a sudden it is as if Twitter has finally come around to a strategy for controlling and extracting value from its vast assets – its users and those who wish to reach them.
If Twitter were to have continued its role as utility, it is hard to see how it could have generated an acceptable return for its investors (and sustained itself over the long run).
I don’t have a problem with this strategy, a company has got to make money after all. That said, it will be interesting to see if they can make the ads sufficiently effective that they can make big revenues without detracting from the user experience too much. There is only one company I can think of which has pulled of this trick well before, and that is Google.
The people who might have a problem with this strategy are the ecosystem developers. Clearly if your business was a competitor to Tweetie or a Blackberry Twitter client your competitive landscape has now shifted against you, maybe decisively. The big question here of course is the extent to which Twitter will attempt to compete its developer ecosystem out of existence. Here it is interesting to refer back to Fred Wilson’s Twitter Platform Inflection Point post of last week. If you haven’t already you should read the whole thing, but in summary he looks at the Facebook and desktop computing platforms and says that the interesting ecosystem partners for Twitter are ones who create entirely new business areas like social gaming on Facebook and desktop publishing on the desktop rather than those who fill in ‘holes in the platform’, like SuperWall did on Facebook.
The most visible ecosystem partners at the moment are third party client developers like Tweetdeck and the ad platforms like Tweetup and at this stage I think it is a little unclear how they will co-exist with Twitter – it doesn’t seem to me as if they qualify as entirely new business areas as per Fred’s definition. As you would expect this question of co-existence has been put to Twitter and their answer is a little ambiguous. In tones which echo Apple, Twitter has started talking about maximising the user experience and how they will take steps to remove any user confusion – language which could be used to justify almost anything.
You can see from the interview with Twitter COO Dick Costollo on All Things Digital that Twitter wants to keep its developer community onside, but you can also tell from the slightly tortured language he uses that the company is now engaged in a much more visible balancing act between its own interests and those of its partners. Which brings me back to the title of this post – Twitter needs to make money, and lots of it, and that means lots of advertising revenues, which requires their ads running where people are using Twitter. I think that means they will develop more clients (having done Blackberry and iPhone it is difficult to see the logic which says the desktop is different) and they will protect their Promoted Tweets from competition.
We are witnessing Twitter growing up here, just as we watched Google grow up before them. Unfortunately growing up usually means that it is no longer possible to be simple, open, transparent and an unequivocal force for good. Instead responsibilities to different stakeholders like shareholders and ecosystem partners have to be balanced and that usually means people’s interests get sacrificed, and it is usually the small partners who suffer first. It will be interesting to see how much Twitter is able/willing to play totally fair with its ecosystem partners, but I suspect it would be a world first if they were able to manage this phase of their evolution without upsetting some people. Indeed the founder of the popular third party Blackberry client UberTwitter is already claiming that the Twitter Blackberry app makes use of API calls that he doesn’t have access to.
Twitter will today announce the launch of ‘Promoted Tweets’ that will appear both in the normal stream and in Twitter search results. In the latter case they will be matched to the query in the same way that Google matches Adwords ads to web search queries. Promoted Tweets will be identified by some small text type and by turning yellow when the cursor rolls over. Best Buy, Virgin America, Starbucks and Bravo are reportedly participating in the launch.
There is a long write up on the NYT and a good summary of the situation and its implications on Econsultancy. The latter makes the good point that Twitter searches may lack the intent which makes Google searches so valuable. The other great thing about the Google model is that click through is a great measurement of effectiveness, and measurement begets budget. It will be interesting to see if Twitter finds something analogous – maybe replies or retweets.
To close, I agree wholeheartedly with Econsultancy’s conclusion:
The good news is that Twitter is finally moving to monetize one of the internet’s hottest properties. At the very least, within six months it should be possible to go from talking about Twitter’s potential to talking about Twitter’s profit (or lackthereof).
Update: Realtime search engine OneRiot has a great post up describing their experience with monetising the realtime web. They are finding that targeting is very complex and to effective needs to factor in things like trending topics and choice of Twitter client. They also point out that advertisers buying keywords is too slow and that instead advertisers have to trust OneRiot to simply index their ads.
My partner Simon Cook recently gave this data-packed presentation to a European Venture Capital Association (EVCA) conference. It does a great job of comparing the US and European venture capital industries and makes the case that Europe has all the fundamentals in place for a great decade going forward. The most important of these are a strong base of innovation, low supply of venture capital (normalised for GDP), an increasing number of serial entrepreneurs, an increasing number of experienced funds and VCs, more capital efficient companies, and a growing number of successful exits.
There is, of course, a long way to go and this is no time for complacency, and for one thing we still don’t have enough large indigenous tech companies here, as I wrote yesterday. That said I feel confident the next ten years will be the time when European venture capital finally comes of age, and that is good news as much for the startups that take investment as for the funds themselves.
I don’t know the guys at Plink but I was really pleased to read on the Guardian website this morning that they have been acquired by Google. Plink is a mobile visual search startup which will now contribute to the Google Goggles product. The terms of the deal were not disclosed.
This is great news for the UK ecosystem on a number of levels, but probably most importantly it will now be much easier for Google to make their next deal here. It is a fact of life that the large tech aggregators prefer buying companies that are close to home – but the more experienced they get with M&A the weaker that preference becomes. The reasons are fairly straightforward – local acquisitions feel more comfortable because there are more touch points both at a business/product level and at a personnel level and because post acquisition integration is easier the closer you are to corporate HQ. Once the first deal in a geography is done all these reasons get weaker.
That said, they don’t disappear, and the fact that Google, HP, Oracle and a bunch of other serial acquirers are based in the Valley is one of the reasons it is still easier to build a startup over there than it is over here. As I’ve said before, if we want Europe to equal the Valley as a startup centre we need more indigenous large tech companies to join the likes of Autonomy, Software AG, ARM and CSR, particularly in the internet sector.
The other reason to be pleased about the news of the Plink acquisition is that the founders, Mark Cummins and James Philbin, will hopefully stay in the UK and build on this success by becoming serial entrepreneurs and mentoring and investing in other startups.