neumannsol.com

Excellent articles on the topic:

Angels: Don’t Use Convertible Debt to Fund Startup Ventures

5 Reasons Convertible Debt Sucks

David Rose’s Angelsoft Blog lays out the reasons, along with some exceptions.

Here are some of the key points:

• The primary reason, of course, is economic: the angel is investing at an earlier, riskier stage and therefore should expect a higher return than the VC, who is coming in when some of the risk has been removed, and after the entrepreneur has made the company more valuable using the angel’s money. For the angel to wait until the next round to value the company results in exactly the opposite: he or she takes the early stage risk and ends up with later stage valuation: a lose/lose proposition!
• From the side of the entrepreneur, doing a convertible debt round correctly is complicated, creates a perverse incentive for the angel investor to work against the company, and ultimately doesn’t make a big difference for the entrepreneur.
  
• Most of the time, the founder is in a much better situation to negotiate favorable (or reasonable) terms with friendly angel investors with professional VCs My recommendation is to use the opportunity to negotiate favorable terms with angel investors and these will likely become precedent for future rounds.
  
• The biggest problem with convertible debt is that it aligns the interest of your angel investors with future VC investors and against you! Because the debt converts into equity at a price equal to or slightly discounted from what the VCs pay, the lower the price the more the angel investors will own. And often times, the angel investors will have the relationships and connections to VCs (and hence know them better than you do) so it is in your interest to get your angels on your side of the table.
  
  • One final comment against using convertible debt for angel rounds: Convertible debt creates misalignment between entrepreneurs and their angel bridge investors. Angels would prefer to see VCs invest at a lower valuation as the angels convert their bridge debt to equity (increasing the angels’ ownership fraction) while entrepreneurs seek VC investment at a higher valuation (maintaining more ownership for the entrepreneurs). Under these circumstances, angels may be less motivated to undertake activities that could increase valuation prior to the subsequent funding. Misalignment of entrepreneurs and investors is simply a bad practice.

This is just awesome

As seen on nudges blog and indexed blog.

Recent articles in the WSJ and FT about Market Bubbles and the recent chatter about Fed taking more activist approach about controlling/reducing the likelihood of bubbles.

WSJ article: Bernanke’s Bubble Lab

Manias can persist even though many smart people suspect a bubble, because no one of them has the firepower to successfully attack it. Only when skeptical investors act simultaneously — a moment impossible to predict — does the bubble pop.

…

The insights of bearish investors “are more likely to be flushed out through the trading process when the market is falling, as opposed to when it’s rising,” Mr. Hong and Harvard’s Jeremy Stein write. They say this explains why prices fall more rapidly than they go up. Over 60 years, nine of the 10 biggest one-day percentage moves in the S&P 500 were down.

When a lot of borrowed money is involved — as it often is in a bubble — once prices peak, the speed of their fall is intensified as investors sell urgently to pay down debt. That pattern offers a strong argument, in Mr. Hong’s view, for government to restrain bubbles and the borrowing that fuels them.

…

Under the Hayek view, bubbles don’t make sense. As soon as some group of traders irrationally pushes prices way up, more-rational traders should take advantage of the mispricing by selling — bringing prices back down. But the tech boom reinforced an oft-quoted warning from John Maynard Keynes: “The market can stay irrational longer than you can stay solvent.”

FT article: Fed looks at ways to fight asset bubbles

My friend, Victor introduced me a book on Value Investing by Seth Klarman.

There was an article in BW on the book about 2 years back:

http://www.businessweek.com/magazine/content/06_32/b3996085.htm

I quote from the Seth Klarman’s book:

Value Investing is about …

“always buying at a significant discount to underlying business value, and giving preference to tangible assets over intangibles”

“By replacing current holdings as better bargains come along. By selling when the market price of an investment comes to reflect its underlying value and by holding cash, if necessary, until other attractive investments become available.”

Underlying Value = “that’s shorn of intangible assets such as goodwill. “Since investors cannot predict when values will rise or fall valuation should always be performed conservatively, giving considerable weight to worst-case liquidation value as well as to other methods.”