Hitting the right note

A primer for founders raising using convertible notes

photo credit: https://unsplash.com/

Convertible notes are one of the most common ways of raising financing for a startup. Particularly the first round of financing. We currently use a form of convertible for all of our pre-seed deals at Seedcamp. Having reviewed and issued many convertible notes over the past few years, I wanted to distill this knowledge down into some key questions for founders to consider and why I think they’re important.

Before we get to the questions, some background..

What is a convertible note?

Broadly speaking, a convertible note is a financing instrument that can be used to provide funds to companies in advance of issuing shares. It is often used on early stage financings because it avoids the need to establish an explicit valuation. Convertible notes can provide a faster and simpler way to document a funding round than a priced equity round.

I’m using the term “convertible note” in this post but many of the below points will also apply to other convertible financing agreements such as: Simple Agreement for Future Equity (SAFE), Advanced Subscription Agreement (ASA) etc. The reason for choosing one variant over the other is often driven by potential tax preferences for investors (i.e. ASA for EIS / SEIS investors) or familiarity (i.e. SAFE for US investors).

For an example of a convertible note and advanced subscription agreement and some of the main differences between the two check out the Seedsummit site here.

8 questions to consider when reviewing a convertible note

(1) What constitutes a Qualifying Financing?

As mentioned above, the primary intention of convertible notes is for them to convert into shares (the clue’s in the name) and the majority of such conversions happens at the next financing round of the company that constitutes a “Qualifying Financing”.

The Qualifying Financing is usually the trigger for an automatic conversion of the note which is then calculated using either the valuation cap (see below), discount (also, see below) or price per share paid at the round -whichever results in the greatest number of shares to the note holder.

The amount (i.e. size of the next financing round) that constitutes a Qualifying Financing can vary depending on the stage of the company and how much the company is raising in total under the convertible note. A reason behind having a qualifying amount is that it protects the investor from having their investment converted to equity in a company that is under funded. Before it is converted the convertible note will technically class as debt and therefore rank higher in the event the company becomes insolvent. This can also ensure that the Qualifying Financing is a true financing for a meaningful amount. However, this lower bound amount should not be set too high so that the Company risks having the money not convert at a true financing round.

(2) Is there a Valuation Cap?

This is often one of the most negotiated elements of a convertible note. The level the Valuation Cap is set at can have a major impact on the number of conversion shares issued. Understanding how it works is of crucial importance. Simply put, it is the maximum value at which the convertible note would convert in a Qualifying Financing (see above), regardless of the price set at such Qualifying Financing. This mechanic prevents the shareholding on conversion from being reduced to a very small % in the event that the company raises at a high valuation for its next round. To illustrate how this would play out in practice let’s look at an example..

Valuation Cap — Example scenario:

Company X is raising a £1m priced equity round (i.e. they are issuing £1m worth of shares to the new investors investing at this round) at a £3m pre-money valuation (for the purposes of the two examples in this post, we’ll call this the “Seed Round”).

Previous to the Seed Round, Company X had raised £50,000 on a convertible note with a valuation cap of £1m (this is the only note they have raised to date).

Assuming that the £1m round is a Qualifying Financing (see above), the convertible note would automatically convert at the valuation cap of £1m because this will result in a greater number of shares than if the convertible note converted at the terms of the round (i.e. £3m pre > £1m cap). Broadly speaking, the convertible note investor would get an effective~3x lower price per share than that paid by the new investors investing at the round by taking the Valuation Cap as the basis for calculation rather than the pre-money of the round.

I always recommend founders model the impact that the notes they enter into will likely have on their cap table when they convert. As the above example shows, the Valuation Cap can have a significant impact on the dilution incurred by the company. However, it’s worth bearing in mind that the convertible note investor has likely invested at an earlier point in time and therefore should probably be entitled to better economics to reflect the increased risk they took.

(3) Has a Discount been specified?

Like the Valuation Cap, the Discount placed on a note is another variable that can have a significant impact when calculating the number of shares that the note converts into. Hence, it is also usually front and centre in any negotiation. Generally, where included, the discount it is drafted as a % of the price paid by investors investing at the round often ranging from 0–30%. Again, taking an example scenario to help illustrate..

Discount — Example scenario:

Using the Seed Round metrics from above (£1m at a £3m pre).

In this example, assume that Company X had raised £50,000 on a convertible note with no valuation cap but a discount of 20% (this is the only note they have raised to date).

Assuming that the £1m round is a Qualifying Financing (see above), the convertible note would automatically convert by taking the price paid per share and discounting by 20% because this will result in a greater number of shares than if the convertible note converted at the terms of the round (i.e. Seed Round price per share> 0.80*Seed Round price per share). Broadly speaking, the convertible note investor would get an effective 20% lower price per share than that paid by the new investors investing at the round.

Note: Convertible notes can also be drafted to include a Valuation Cap and a Discount (and, in rare cases, they could include neither). If they include both, the convertible note holder would choose to either convert into shares using the Valuation Cap or the Discount (whichever would result in them receiving the most shares).

Overall, both the Valuation Cap and Discount are very important terms and care should be taken in particular when determining the effect they can have on the ownership position following conversion.

(4) Is there an Interest Rate?

To flag, not every convertible note will carry an Interest Rate (i.e. the note we use as the basis for our pre-seed investments at Seedcamp does not carry an interest rate). If it is included, the Interest Rate will usually start accruing from the day the convertible note is signed and issued until the day the note becomes due and payable or converts. The interest rate is important to consider because, on a conversion, the accrued interest can be thought of as acting like an additional discount. Overall, the Interest Rate is an additional factor that impacts the investor’s return and therefore can form part of a negotiation.

(5) What happens if the next round is not a Qualifying Round?

Usually the convertible note holder would have the option of whether to convert or not if the next round does not constitute a Qualifying Round. The Valuation Cap or Discount may be set at different levels compared with how the note would convert on a Qualifying Financing (if different it would be common for the valuation cap and/or discount to be more favourable for the investor). This provision may also give the convertible note holder the option to convert the note to shares in the event there is no financing round prior to the maturity date (see below) based on an agreed pre-money valuation. This clause can have an impact in the event things don’t go to plan and the company has to raise a smaller than planned round (i.e. a bridge financing or similar).

(6) What happens if the company is acquired before conversion?

There will usually be a specific clause that addresses the situation in which the company is acquired before the convertible note has had a chance to convert into equity in the company. This situation is common in “acquihires,” or the acquisition of a company at a very early stage, and in which the amount being paid for the company is based on the recruitment of its employees rather than the company’s intrinsic value (i.e., the company’s intellectual property, revenue, etc.). The three most common possible scenarios for the treatment of the note are: (1) the convertible note converts into ordinary shares of the company, and then proceeds from the acquisition are distributed to the common stockholders on a pro rata basis; (2) the convertible note converts into preferred shares, which provides protection of liquidation preference, among others; (3) the convertible note holder is entitled to a return of a certain amount, based on then balance of the note (i.e. the amount they invested under the convertible note). In (3), the return entitlement can be 1x, 2x or higher. This clause is important for founders to consider particularly if aquihires are common in their industry or they believe the company may be acquired prior to a conversion.

(7) What’s the Maturity Date and what does it mean?

The Maturity Date is the date that the convertible note technically would need to be repaid if it is still outstanding (i.e. it has not converted or been repaid in some way). In practice, if the Maturity Date comes to pass it is often agreed by the convertible note holder that it can be extended (particularly common for VC investors, experienced Angels etc.). Look out for wording explicitly stating that the Maturity Date can be extended. However, investors may enforce the repayment which could have dire consequences for the company (i.e. if they have insufficient funds or if such a call on funds would lead to insolvency). Most sophisticated investors would appreciate that extending is likely the best route because, in practice, it is very unlikely that the company would have sufficient disposable funds to repay the note. However, the same may not be true of all investors. Be careful in picking your investors – particularly if they have not invested using a convertible note before and don’t fully understand the risks and what the situation would likely be in the event the company does not succeed.

(8) What type of shares will the note convert into?

Generally, this will be either ordinary shares or the same class of shares that are issued to other investors at the round. It’s favourable for the investor to receive the same class of shares as those issued at the round because they will generally be preferred shares and carry such rights (i.e. protection of liquidation preference etc.). It’s important for founders to understand this clause because they are potentially increasing the size of any liquidation preference (see this post) they create on a future round.

The above points are by no means exhaustive but hopefully they provide a useful primer. I’d recommend founders run any detailed points past a lawyer and get legal advice before entering into any agreements.

Originally posted on Medium.

Legal Tech – Mapping Disruption

We (Seedcamp) recently hosted a Legal Tech focused event in partnership with Next Law Labs to bring together influencers in the Legal Tech community and those interested in finding out more. The turnout for the event was great and speaking to the founders who came along it really feels like the space is at a tipping point. Being an ex-lawyer this has always been a space that has really interested me, I wanted to share the below map and some market insights on why I think now is a great time for Legal Tech.

Market Map

The aim of the map is to provide an overview of many of the different startups within the Legal Tech space. It’s not designed to be all encompassing or fully comprehensive. I’ve included a full list of all the companies on the map and how much they’ve raised to date at the end of this post. If I am missing something, tweet me @tom_wils

What is Legal Tech?

Firstly, what is Legal Tech? Broadly speaking, the Legal Tech market covers companies (mostly startups) utilising technology to build products solving problems faced both by industry (i.e. law firms, corporates etc.) and consumers related to legal services.

Why now?

Whilst the space has been slow to take off (i.e. in comparison to Fin Tech), a combination of factors are coming together to make now a great time to build a startup focused on the Legal Tech space:

  1. Maturing ecosystem – as the map shows we are seeing increasing numbers of well funded startups. This in turn raises the profile of the industry and provides further validation for startups looking to get those first customers in a notoriously risk-averse market.
  2. Increased transparency – the legal services market has historically been viewed as one that is opaque when it comes to knowledge and therefore costs. The introduction of marketplace models and startups focused on document services (see the Map above) are improving this information asymmetry. This increased transparency is presenting opportunities for startups to compete with the more well-established players.
  3. Automation – advances in natural language processing have enabled people to build solutions addressing various verticals within the overall legal tech market (see eDiscovery, IP Management, Contract Review). In particular, such solutions are taking advantage of large data sets to assist with the automation of certain low level repeatable tasks. The opportunities here to reduce the time taken and therefore costs are significant (law firms still tend to bill by the hour). As this technology improves and the data sets they work on are scaled up it could be possible for solutions to be built to automate more advanced work.
  4. Innovation – we are seeing the emergence of startups that are aiming to go beyond the automation and provide additional insights (see Legal Research). Whilst this space is still in its infancy, this arguably could lead to the removal of the need to instruct lawyers for certain tasks.
  5. Generational shift – there is an increasing interest in the space both from those within the law (particularly towards the junior level) and those building solutions from outside the law aimed at the sector. Furthermore, law students and future practitioners will start and grow their careers utilising advances in technology.

— –

Map: Breakdown by sub-sector

I’ve taken the following as sub-sections of the overall market:

  1. eDiscovery – solutions to manage emails, documents and other files specific to the litigation process.
  2. IP Management – tools to help track and analyse trademarks, copyrights, patents and other IP assets.
  3. Marketplace – tools to help people find lawyers for specific matters.
  4. Research – tools to help lawyers with legal research and / or make more data-driven decisions.
  5. Practice Management – tools to help law firms with issues around on-boarding clients, tracking matters, billing, invoicing, time-tracking etc.
  6. Document Services – providing legal documents or forms and (in some cases) legal advice. i.e. covers contract creation, management and / or legal services.
  7. Contract Management – helping companies keep track and manage contracts throughout the contract lifecycle.
  8. Contract Review – technology solutions (e.g. natural language processing and machine learning) for automatically abstracting contract terms to help with contract review.

Map: Breakdown by company


Kcura — raised $125m, developers of e-discovery software.

CS Disco — raised $12.4m, e-discovery platform.

Everlaw — raised $9.6m, litigation platform beginning with e-discovery.

AccessData — raised $45m, digital forensic, e-discovery and incident response solutions.

RenewData — raised $41m, e-discovery, e-storage risk management solutions, and forensic.

Lighthouse eDiscovery — raised $34.5m, e-discovery litigation services.

Guidance Software — raised $7.54m, e-discovery, data discovery and computer forensics.

Catalysy Repository Systems — raised $31m, provides litigation support software and hosted document repositories.

PSS Systems — raised $18m, provides solutions for legal holds and retention problem.

StoredIQ — raised $41.84m, analysis and governance of unstructured data (acquired 2012).

Recommind — raised $22.5m, enterprise search and categorisation platform automatically organises, manages and distributes large volumes of information from multiple sources.

X1 Technologies — raised $12.2m, enterprise wide collection and processing as well as review and analysis platform for litigators.

Modus eDiscovery — raised $10m, data management firm that helps organisations leverage eDiscovery intelligence.

Cicayda — raised $6.8m, Saas based e-discovery software.

Zapproved — raised $17.24m, e-discovery for corporate legal teams.

Mimecast — raised $90m, amongst other features, e-discovery (went public in 2015).

Logikcull — raised $4m, e-discovery platform.

Cloud Nine — e-discovery platform.

IP Management

Trademarknow — raised $3.5m, trademark search and watch results.

Anaqua — raised $125m, provides a range of IP management software solutions.

Lecorpio — raised $25m, provides IP management software to automate intellectual property processes.

PatSnap — raised $13.6m, search platform for patents.

Zhiguoguo — raised $3.7m, IP management software including registration and legal services.

Naming Matters — IP visual search and related naming tools.

RPX Corporation — raised $undisclosed, provides patent risk litigation solutions (went public in 2011).

Innography — raised $13.02m, patent management software.

P Street — raised $6.96m, IP and patent search tool.

Turbopatent — raised $2m, patent application and prosecution solution.

Deltasight — raised $400k, IP analysis and visualisation.

IPlytics — raised $undisclosed, monitors and analyses company’s competitive position for patenting.


Ravel — raised $9.2m, legal search, analytics, and collaboration platform for lawyers. (Acquired 2012).

Judicata — raised $7.8m, turning unstructured court opinions into structured data.

ROSS Intelligence — raised $undisclosed, using IBM Watson to provide answers to legal research questions.

vLex — raised $5.2m, multilingual database of legal content.

LexMachina — raised $10m, IP, litigation data and predictive analytics to law firms. (Acquired 2015).

Casetext — raised $8.8m, community site for lawyers to share knowledge.

Juristat — raised $3m, big data analytics and research tool focused on patent prosecution.

Practice Management

Clio — raised $26m, practice management suite that is designed for sole practitioners and small law firms.

Apperio — raised $2.4m, enables firms to track legal spend at an overall or matter level, in real time. (Seedcamp is an investor).

Peppermint — raised $15m, platform that delivers application services across accounts, practice, case document, risk management.

Total Attorneys — raised $15m, practice management software and customer acquisition for attorneys.

Viewabill — raised $1.1m, real time access to time entries and billing practices.


Avvo — raised $132m, legal marketplace, directory, and question and answer forum that connects individuals with lawyers.

Lexoo — raised $1.7m, lawyer comparison marketplace for businesses.

UpCounsel — raised $14m, marketplace for legal services.

LawDingo — raised $790k, marketplace for virtual legal consultations.

Lexdir — raised $420k, legal marketplace and directory.

Zhuanjiabao — raised $692k, legal marketplace plus virtual legal consultations.

Priori Legal — raised $undisclosed, lawyer comparison marketplace for businesses.

Legal Reach — raised $900k, legal directory.

LawAdvisor — raised $590k, marketplace for virtual legal consultations.

Lvgou — raised $1.9m, legal marketplace.

Legal Hero — raised $750k, legal marketplace focused on fixed fees.

On Legal — legal case management platform with marketplace.

LinkiLaw — legal marketplace.

Access Solicitor — legal marketplace.

Lexstep — legal recruitment marketplace.

Document Services

LegalZoom — raised $266m ($200m of secondary), contract creation and legal services.

Rocket Lawyer — raised $53.3m, contract creation and legal services.

DocStoc — raised $4m, contract creation and sharing platform.

LawPath — raised $1.9m, contract creation and legal services.

Docracy — raised $850k, contract creation and signing.

Juro — raised $80k, contract creation and management. (Seedcamp is an investor).

Dragon Law — raised $410k, contract creation and legal services.

LawBite — raised $170k, contract creation and legal services.

Clerky — raised $120k, contract creation and management.

IronClad — raised $undisclosed, contract creation and management.

Shake — raised $4m, mobile-first contract creation. (acquired 2015)

Intelligize — raised $3.59m, legal form (i.e. SEC filings) creation and management.

Brightleaf — raised $3m, contract creation and management.

Iubenda — raised $100k, privacy policy generator.

Contract Management

Icertis — raised $21.4m, contract creation and management, focused on enterprise.

Contract Live — raised $1.4m, contract creation and management.

Avvoka — contract management.

SpringCM — raised $85m, work flow automation and contract management.

Selectica — raised $23.3m, work flow automation and contract management. (went public in 2010)

Exari Systems — raised $10m, contract creation and management.

Pekama – raised $undisclosed, contract management and collaboration tool.

Clausematch – raised $600k, contract management and collaboration tool.

Contract Room — raised $850k, contract management and collaboration tool.

Seal — raised $13m, contract management and analytics.

Contract Review

eBrevia — raised $500k, natural language processing and machine learning to understand legal language.

Legal Robot — natural language processing and machine learning to understand legal language. Focused on both B2B and B2C.

Beagle — natural language processing and machine learning to understand legal language. Focused on B2B.

LegalSifter — raised $1.6m, natural language processing for contracts.

Kira Inc — natural language processing and machine learning to understand legal language.

LawGeex — raised $2.5m, natural language processing for contracts.

Cognitiv plus — natural language processing for contracts.

Originally posted on Medium.