My Zombie Musings about Convertible Promissory Notes

ImageThe many ways a company can raise capital reminds me about the wide variety of Zombie movies.  Now I see that there are Zombies in Cuba – who, of course, grunt with a Spanish accent, and in Equatorial Africa, where they attack the coastal towns.  There are slow zombies one can easily outrace and fast running zombies who appear to be track stars. So every time I think of convertibles, I do think of them as Zombies: hard to kill, easy to create, and reliable.  Still I am perplexed about how Zombies can survive without feeding or walking around aimlessly.  And sometimes I am equally confused on how convertibles are discounted or what is the valuation cap.

The most frequent discount rate I have observed in Silicon Valley has been 20%.  Now I compare that number against the loan interest rates for risky SMBs at about 36% APR.  Or even the 18%-24% APR factoring rate against inventory for SMBs with little or no credit.  And, in stark contrast to startups, these SMBs should have some cash flow and probably has been operating for years. So the note discounted rate of 20% is a relative bargain for startups with little or no revenue history.

Then you have a valuation cap which projected value is anticipated by the maturity date of the notes, somewhere between one and two years.  Basically the company is providing a ceiling valuation for the note holders.  Now I have calculated valuations.  But this magic number is purposely chosen from low figures that should satisfy the risky nature of the notes.  Of course, if the number is too high, then the note holders just get a fair exchange.  And if the post-money valuation skyrockets, then the note holders have the benefit of a real bargain.

But as one can see, there are yardsticks to establish a price.  It boils down to the cost of capital and the financial projections. There is a saying on Wall Street when establishing sales projections: under-promise, over-deliver.  So in the case of the valuation cap, you are always better off to price the discount at the most pessimistic value. And once one sees what community banks or lending clubs charge for interest rate, the discounted rates seem to be a bargain.


About Juan Ramón Zarco, SVVGP 胡安•雷蒙•扎尔科

Juan Ramon Zarco, 胡安•雷蒙•扎尔科, Silicon Valley Ventures Growth Partners llp, Hygieia Healthcare Technologies Company, AllRest Technologies LLC, Crimson Growth Partners LLP,, is an experienced as CxO, General Counsel and Secretary to public and private companies with global operations. Established track record of producing practical, revenue-focused solutions. As Counselor and Secretary, demonstrating vision, integrity, and sound business judgment, to CxOs. Managed complex, strategic transactions, M&A, contracts support, PE Financing, IPO, SEC compliance, Corporate/HR governance, IP licensing, Budgeting, Staff, outside counsel management, International market access strategies, Domestic & foreign government relations and advocacy. Creative in designing and implementing market access strategies. Practices law beyond conventional model with low-overhead and project-based fees. Effective at managing departments, formulating marketing strategies, balancing budgets, and implementing cost-saving measures. Extensive in-house and private practice experience, advising clients on commercial, corporate, international business, and technology law and policy.; For Sprint, he managed iDen international development in Southeast Asia, Middle East, and Africa, and contractual issues with Verizon. In Private Equity, he worked with Pegasus in vetting international investment deals and interim President for portfolio companies, such as Data Foundation, a data storage company, handling marketing, strategy, fund raising, and accounting. Before Pegasus, Mr. Zarco, as CLO and V.P. of Corporate Development, played a principal role in the structuring, international expansions for 2 telecom companies, U.S. Cable Group and Viatel, Inc. in financing and M&A deals exceeding $200 million. Mr. Zarco earned a J.D. from NYU Law School, M.B.A. from Cornell, and B.A. from Williams College; is fluent in Spanish, Portuguese, French, and German, with working knowledge of Russian, Arabic and Japanese.
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