Waves splashed in the startup world recently when Montreal-based indie game accelerator Execution Labs joined BDC Venture Capital's convertible note program. That's because it's just the sixth accelerator in Canada to join the program, which offers $150,000 convertible notes to select graduates of Canada's top-rated accelerators. (The other five are FounderFuel, Communitech Hyperdrive, Extreme Startups, GrowLab, and Launch36.)
Everyone cheered at the news, but it seems that few actually understand exactly what BDC's convertible note program is. So we reached out to BDC to settle the score once and for all.
In 2011, BDC Venture Capital created the program, which it describes as a "key element" of its Accelerator Strategy to support promising Canadian startups in their early stages. To date, almost 60 early-stage tech startups across the country have benefitted from the program. And this number stands to grow significantly over the next few years as BDC VC looks to its partners to help build its network of leading Canadian technology accelerators.
"The program provides seed funds to help fill the gap that many startups face between their first financing phase (funding by founders, family and friends) and their first full round of investor financing," explained Dominique Bélanger, BDC Venture Capital's vice president of strategic investments and initiatives, to Techvibes. "Convertible notes are short-term loans designed to be converted into shares later in the company’s life—usually when it raises its first full round of investor financing. BDC VC issues notes of $150,000 each, which—if not converted into equity—are repayable at the end of a two-year term."
According to Bélanger, only "venture-ready" Canadian startups that graduate from a participating accelerator can be selected. And that's where people start to get lost—just what does venture-ready mean?
"A 'venture-ready' startup has developed a solid product with significant early traction," says Bélanger. "Its leaders are capable entrepreneurs eager to build a market-leading company. Other factors considered include the firm’s business model and investor or fundraising traction."
As for the terms of the notes, Bélanger says his team designed the program to be both entrepreneur friendly and investor acceptable. Michael Mahon, BDC Venture Capital’s director responsible for the program, filled us in on some of the program’s terms.
"The notes are entrepreneur friendly because their interest rate, discount rate (the conversion premium accorded when the loan is converted into equity) and valuation cap (used to calculate the number of shares the note will convert into) are often more favourable than the terms and conditions typically offered to companies at this development stage," notes Mahon. The "investor acceptable" part is achieved by having terms that "fall within market norms, and do not disadvantage concurrent or future private and institutional investors," he adds.
There are other things for startups to consider when being offered a note—it's not just $150,000. For example, BDC VC provides non-financial assistance, such as connecting a company with other investors and helping it access new markets. Though the convertible note does not guarantee follow-on investment from BDC VC or any of its funds, recipients become part of BDC’s extended network of convertible note alumni which BDC VC actively promotes with its partners such as the C100, the Canadian Technology Accelerator program in the United States, and other startup-enabling organizations BDC works closely with.
As for the actual money portion, startups can use the $150,000 as general working capital, to develop the company’s principal technology, to hire the core team, to develop an intellectual property strategy, for business development or for general corporate development—but they cannot use it to repay debt.
It's important for startups to remember that a convertible note is not free money, warns Mahon. "BDC VC expects to convert a note into shares within two years," he says. "If that doesn’t happen, BDC VC will work with the company to see how the loan (including the nominal interest) can best be repaid."
In the end, BDC VC's objective with its convertible notes program is to balance financial outcomes with positive ecosystem impact. "The goal is not necessarily to obtain the highest returns," Dominique Bélanger affirms, "but to help the most promising Canadian startups survive and grow."