There is a big point missing in the article: The dynamics of the folks entering the next round with those in the current round.
For example: The purchasers of the next round would be idiots to let the first investor execute the equivalent of a full ratchet, and all such provisions are usually throw-aways in a negotiation.
Not true. The full ratchet is implicit in the deal. If the deal said $8m cap and next investor invests at $4m then the deal gets done as $4m and doesn't impact the next investor. It comes out of founders' equity. It is the "equivalent" of a full ratchet but disappears after the deal is done.
Sounds like the convertible note would discourage a down round and end up making investors less as more companies fold knowing their equity is about to get mostly taken by investors.
That's a genuine possibility, I guess it is an upside for the founders. They can see they equity is going to disappear and can take the out rather and accept the huge equity loss - although convertible loan is higher up the debt chain so the VCs will still get a chunk back
So to me the real advantages of convertible debt are:
1. They often don’t have control provisions. With equity often investors want “blocking rights on a sale or future finaning” that they often don’t get in a convertible debt deal. If this is the reason you’re doing it, then perhaps talk to investors about whether they’d be willing to give up that right in a Series Seed equity deal.
2. They often don’t have board seats attached to them. Again, this should be negotiable with a Series Seed.
--Summary of the argument.
The rest of the article is useful, too. It provides good background and context for his conclusions.
Relevant Lectures: http://ocw.mit.edu/courses/sloan-school-of-management/15-431... http://ocw.mit.edu/courses/sloan-school-of-management/15-431...