What am I buying when I invest in a startup?
It’s almost always one of two things.
- Convertible debt: a note that will convert into preferred shares during a future round of funding. Investments structured this way usually have valuation “caps.” If a note is “capped” at $10 million, and the next round values the company at $20 million, your shares convert at the $10 million valuation, giving you more shares than new investors get. Notes typically pay 2% to 8% interest.
- Preferred equity (shares): takes precedence over common shares in case of a negative liquidation event. Founders and employees are typically issued common shares.