Why Entrepreneurs Should Avoid Convertible Notes, and Other Wisdom Gleaned From Raising $1M From Silicon Valley Angels


Last summer, our company AppMakr raised a $1 million angel round over 14 weeks and learned some big lessons in the process. Luckily, Brendan Baker, an MBA student at Oxford University, took an interest in our raise and documented the process, creating a visual infographic of our efforts (see below). His infographic illustrated pertinent trends in the raise period and allowed us to draw some inferences that would’ve otherwise gone unnoticed, which I’ll describe here in detail.

One of the most striking facts to emerge from Brendan’s infographic was what I call “Daniel’s Rule of 10.” It turns out that I could sniff out eager and willing angels only through connectors who made at least 10 introductions. Or to put it another way: Don’t waste your time talking to anyone who offers to make an introduction to only one angel. Focus on people who can make at least 10 solid introductions. The visual representation of this is especially striking because it’s impossible to know ahead of time who will follow through for you, so applying a rule like this could radically change the way you raise a round.

For the entrepreneur, every lead you get is golden. Follow up on every opportunity as thoroughly as possible, but keep in mind the Rule of 10. Passing on what appear to be great leads because you haven’t gotten enough introductions from the referrer may seem crazy, and I’d guess that my data set is too small to be statistically significant. But having spoken to hundreds of potential angels, and seeing as how only 8.47 percent of the angels I spoke with ended up funding us, what I can say for a fact is my Rule of 10 held true for our raise, and that’s a powerful enough inference for me to minimize my efforts on referrers who only make one intro, so I can focus on those who are willing to make at least 10 intros. Having said that, use my Rule of 10 at your own risk!

Additionally, the data showed that timing was a key component. We originally started our raise over the summer, though I heard it wasn’t an ideal time. It’s not. The season is a poor choice primarily because it’s difficult to get on the calendars of prospective investors in between their vacations. That long lead time proves incredibly distracting and has a compound effect: I was never able to be as focused as I wanted to be on the more immediate meetings because there was always a meeting with a prominent prospective investor scheduled for several weeks in the future.

Anatomy of a Seed Round - Graphic by Brendan Baker. For a full-size PDF version go to http://go.danielodio.com/seed_infographic

As it turns out, spring is the absolute best time to go out for a raise, with fall ranking second best. The summer and the holidays are very difficult and not worth the delays and distraction. It’s better to hunker down and shoot for spring if you can control your burn, or better yet, raise the spring before you have urgent cash needs, if you can plan that far in advance.

Nailing your pitch is just as important as timing. Our pitch was still in flux in our first round of meetings, but with many of these investors, you only get one shot. We iterated quickly (as startups tend to do) and hit on some core concepts that have since become key to our business, but iterating during your pitching process is far from ideal. You want to have your pitch down cold and supplement that with supporting data and a deep understanding of the competitive landscape before you start pitching.

We ended up raising our $1 million through a convertible note (a loan that only converts into equity when you do a future raise), as many entrepreneurs are doing these days. Convertible notes have become popular due to their supposed speed and ease of execution. But I don’t recommend them, and if I were to raise our seed round again, I’d do it as a priced equity round.

Some may see this as a pretty bold statement, as convertible notes are seen as very entrepreneur-friendly. However, there is a cost to everything, and notes are no exception. It’s a bit hard for me to imagine what our world would look like had we done an equity round, but I know a few things are certain: There are open-sourced seed round legal documents that can minimize or eliminate any … Next Page »

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Daniel R. Odio (http://bio.DanielOdio.com) is the CEO and co-founder of PointAbout, which launched the leading do-it-yourself mobile app creation platform, AppMakr.com, in 2010. Daniel specializes in social media and mobile innovations and will speak at “Cliff Notes on Raising Your First $1 Million Through AngelList” on April 12 in McLean, VA. Details at http://go.DanielOdio.com/first1MM. Follow @

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11 responses to “Why Entrepreneurs Should Avoid Convertible Notes, and Other Wisdom Gleaned From Raising $1M From Silicon Valley Angels”

  1. Susan says:

    Excellent information, Daniel.

    Our team members are ex-MySpace/Fox Interactive Media employees and we are just finishing the first Facebook game (eVille) on our Extrafeet platform and a couple of months from the completion of the iPhone companion version – think Foursquare meets Mafia Wars – http://apps.facebook.com/evilleapp.

    We’ve talked to dozens of one-off investors with no luck. We are now revising our pitch and working with a “10 or more” adviser to set up meetings for potential seed funding in SFO and Seattle before the end of May.

    I’ve always felt you are pointed toward the information you need when you need it, and while reading the article I thought you were talking directly to me.

    The “over the summer” issue makes sense and at the same time is quite distressing. We are bootstrapping now to such a degree that I think cardboard will be our next food of necessity :-)

    Any chance I could get a copy of the Cliff Notes presentation?

    Thanks in advance.
    Chief Herder of Cats

  2. DROdio says:

    Susan, absolutely, materials sent.

    Also there’s a 2 hour video on raising your first $1MM from a panel yesterday you might like at http://go.danielodio.com/first1mm

    Good luck!

  3. Daniel

    Your rule of 10 is right on. I raised $3m from 23 angels to launch http://www.circlebuilder.com. 23 wrote checks from close to 250 introductions over 3 years.

    I disagree about taking straight equity for your first initial investment. In taking straight equity, you need to set a valuation. For many pre-revenue, prototype or pre-launch start-ups it is very difficult to do. The investor will want a low or the lowest valuation and the founder (s) will want a higher valuation. This puts the investor and founder out of alignment from the get go. We have successfully used convertible promissory notes and warrants to date.

    Howard Brown
    Co-founder and CEO
    CircleBuilder Software LLC

  4. Howard, thanks for the note.

    I don’t disagree with your points re: hard to value a small company.

    I’m just saying this: There’s a cost to everything. And convertible notes are held up as the “solution,” but there’s a cost to them too.

    And after going through that cost, I would try it the other way next time. Because the cost feels a bit like “easy now, 10x harder later”. Yes the note pushes the valuation issue out till later. Yes the note is faster and easier to do. BUT you end up with investors that have mis-aligned interests and aren’t as motivated. So which cost is greater? It’s not an easy ‘yes’ like so many people make it out to be.

  5. Nic says:

    What strikes me from the infographic is how useless middlemen appear to be! Am I reading this right? What defines a middleman in your market? An d could you explain the brackets on the right of the infographic,i.e. What is ‘New School’ versus ‘Old School’? (I think we know what timewasters are)