If you’re raising $250,000 or less for your business, I recommend you consider using a convertible note or bridge loan to do it.
Here are the main things you need to know about bridge loans/convertible notes:
Q: What is a bridge loan (or convertible note)?
A bridge loan/convertible note is simply interim financing until the next round of financing can be obtained. The word “convertible” is often used since the bridge loan will “convert” into equity at your next round of financing. l
Q: Why use a bridge loan/convertible note versus selling stock?
- It typically costs you less than selling actual stock — You can get a bridge loan administered for a couple of thousand dollars or less.
- Fewer attorneys involved — Investors are less likely to ask their counsel to review it .because it tends to be a shorter document that is less complicated than a stock agreement.
- You don’t have to set your valuation yet — A bridge loan is simply a loan that will convert into equity later when a valuation is set (typically during a larger round of financing).
Q: During which stage of financing is a bridge loan/convertible note most useful?
I find them most useful during the initial seed financing rounds of fundraising such as taking on a small amount of money ($250,000 or less) from private angel investors or friends and family (as opposed to venture capital firms).
If you’re raising more than $250,000, or are raising money from medium to large venture capital firms, you are likely going to want to sell them preferred stock.
Q: How long should a bridge loan be for? (what should the length of the term be?)
It will typically be one year or less (it should be timed such that the maturity date of the bridge loan is due roughly around the time that another financing (or liquidity) event occurs for the company.
Q: What should the interest rate for a bridge loan be?
A: The interest rates for convertible bridge notes vary but tend to be around five percent greater than the Federal Reserve rate (one point of reference: California laws dictate that there should be a cap of 10% on the bridge note interest rate).
Q: What happens if you reach the maturity date of a convertible promissory note and there hasn’t been another round of financing or liquidity event (and your company doesn’t have the money to pay back the loan)?
In this event, you can:
1) Ask the investor to extend the maturity date
2) Convert the loan into stock based on a price you pre-determined or a price you determine at the maturity date.
Q: What is a conversion discount (or warrants) for a bridge loan?
A “conversion discount”(or warrants) is a future discount that you provide to your investor (the person giving you the bridge loan) in the event that you do raise another round of money or have a liquidity event.
The conversion discount generally ranges between 20% and 40%.
So, for example, let’s say you get your bridge loan and offer a 30% conversion discount and then later you raise a Series A round of venture capital at $1 per share. Your bridge loan investor would then receive one share of stock for each $.70 that he loaned you.
Q: Do you have an example of a convertible note/bridge financing term sheet?
Here’s one: Convertible Loan Term Sheet
Q: Are there any drawbacks to taking a bridge loan?
If you take a bridge loan and can’t pay it back at maturity then an investor can technically use that as an “event of default” which could lead to bankruptcy — the way around that is to accept the bridge loan from someone close to you who you trust to see you through such a scenario.
Additionally, to protect yourself, you can try to get language into the bridge loan which converts the loan into something else (no matter what).
Final Thoughts
If you want to read more about bridge loans/convertible notes (which are also called “convertible promissory notes”), a great resource can be found at Convertible Notes by Yokum Taku, an attorney at Wilson Sonsini Goodrich Rosati (WSGR) in California, USA.
I have worked with the WSGR law firm on one of my startups and highly recommend their services. In fact, one of their attorneys was so good, I eventually hired him as our general counsel!
My friend Jessica has designed products ending up in such places as Pottery Barn, SF MoMA and Barnes & Noble.
She also teaches Product Design in the Mechanical Engineering department at Stanford University.
Designer Jessica Zarin Kessin
I ran into her at our favorite San Francisco Mission coffee house recently and talked her into sharing her thoughts on the design process as it relates to business.
Q: Why is a product design process important for business?
Product design is a lot more than just the design of an object. It is a process for creative problem solving.
The design process can yield great products, but the process can just as easily help to create unique solutions to problems in any other area of business. The design process is a way to think, create and come up with new ideas.
Objects and solutions don’t just appear. It is a time consuming and detail oriented process. However, it can lead to great results, get you thinking out-of-the-box and you might even have some fun in the process!
There are design consultants of all sizes and types that can come in and facilitate this process for any of your needs. Each firm or consultant has a specific focus and their own process, I am going to discuss the basic process that I use.
Q: What are examples of when design processes should be applied in a business?
A creative process can be applied anywhere. I use the process to help me when I am stuck or need inspiration in any area of business….it does not have to be design related.
As the founder of a toy company, I have used this process (or parts of this process) to plot the overall direction of the marketing, branding and the general trajectory of the company. Of course, I also use it to design toys!
With clients, I often map out the process to show them exactly what I am doing for them. It also helps to keep them involved.
As an external consultant, I cannot design in a vacuum. We all need to work together as a team. Especially in the Analysis and Definition stages, I can lead the process, but the trajectory ultimately needs to come from the client.
Being a designer is not a solo job.
Q: Do you have a design process diagram you could share with us?
Design Process Model
This is a basic representation of the process that I use. It is an adaptation of the design process that Don Koberg and Jim Bagnall describe in The Universal Traveler.
Q: Would you explain each of the six steps of your design process model in more detail (I’m especially interested in the ideation phase)?
As shown in the diagram above, design is a process.
Step 1: Analyze
To design an object you need to understand the area surrounding that design. Why are you designing this object? What is the need or problem that you are trying to solve?
What else is out there? What is your competition? Why is your competition not filling the need? Who is going to use it? Where is it going to be sold?
The list goes on and on….
You can do this in a number of ways. Market research, talking to primary or secondary users, formal interviews, market surveys and observation are a few of the methods.
Why don’t we pick a need and walk through an example together. Let’s say you were annoyed that your bike seat got wet in the rain and you wanted to design a cover for it. How would we go about doing this?
First we would look at stores, catalogs and bikes we see around to see what other solutions exist. We might talk to bike commuters, people who worked in bike shops or kids who ride to school.
We might see how others are solving this problem or are you the only person who has this specific problem….if it is just you, your product might not be such a huge success and we might want to just make one.
This is also the phase when you should question your mission and try to look at it from a new perspective entirely.
Is a bike seat cover really the answer, or do we really need to create a new form of transportation that is rainproof? Or should we really be creating a way to stop rain all together? Would waterproof pants solve the problem instead?
Is the bike seat cover really the best solution to your problem or is it just the first thing you thought of? Take a moment to explore other directions. We might end up back where we started, but we should take time to consider this.
Step 2: Define
Once we have analyzed the marketplace and environment that we are designing into, we need to define the goals. What are the specific design principles where we will not compromise? Who are we designing for? What qualities does the product need to have?
Is our bike cover for bike cover for tri-athletes that have very high-end bikes? Is it for college kids with no money? Is the price important? Are your users eco-conscious and do we need to consider that? Is aesthetics an important factor? Is convenience important?
Does it need to stay attached to the bike so it doesn’t get lost? Are our users somewhere where it might get stolen and does it therefore need to lock?
The list goes on, but the designs that emerge will be vastly different based on the answers to these questions. This is especially important when designing with a team. If everyone is not going down the same path, we are going to have major problems.
(This is why when I design for a client group, their involvement is imperative!)
Once we list out all our design criteria and everyone agrees to them, we are ready for the ideation phase!
Step 3: Ideation
Ideation is also known as brainstorming. This is where you should go big and not be afraid to get a bit wild. The ideation phase is a divergent phase. We go wide, looking for quantity over quality…yes, quantity, not quality!
There are a number of different brainstorming techniques that you can use. But the main rules of brainstorming remain the same.
RULES OF BRAINSTORMING:
- Defer judgment -Don’t edit yourself of others. No idea is stupid!
- Encourage wild and crazy ideas (Maybe we should all move to the moon and bounce to work instead of biking?)
- Build on other people’s ideas. Steal, Steal, Steal!! Take other people’s ideas and leapfrog off them. There is no claiming credit in a brainstorm; it’s all about working together!
- Stay focused on the topic. Your ideas can get wacky, but keep generally focused on bikes and rain.
- Have one conversation at a time. If you are brainstorming in a group, let other finish their thought. Jot yours down so you wont forget them in the meantime.
- Be visual. Drawing conveys ideas; you don’t have to be Rembrandt, stick figures are great!
- Go for QUANTITY!!! (We make our students come up with at least 100 ideas before they can pick one to work on).
SUPPLIES:
- Big paper or a white board
- Comfy chairs
- Caffeine and snacks
- Items for inspiration. (In our scenario, we might have a bike, an umbrella and any existing seat covers on the table for inspiration.)
- Open minds!
- In a group, it also helps to pick a facilitator to lead the brainstorm.
There are a number of techniques people use to brainstorm from listing, to different uses of perspective. Any technique is fine as long as it gets creativity flowing. My favorite technique is mind mapping.
Mind mapping is the equivalent of a writer’s free-writing. Mind mapping is simple, you write a topic or question in the center of a paper. Then as quickly as you can, branch out and write or draw ideas. Topic areas will naturally form as you branch off each other.
Q: Do you have any mind map examples you could share
Sure, here’s one example of mind mapping:
Mind Map Example
When I mind map with a partner, we both write as fast as we can, when we see our writing start to slow down, we rotate the paper and start to branch off of each other’s ideas. We keep rotating until the paper is full.
Now that you have a huge stockpile of ideas, it’s time to converge again.
Q: Ok, sorry to interupt. What’s the next step in the design process?
Step 4: Select
Don’t forget to look back at those design criteria from the define step. With those in mind, we will pick 3-5 ideas that we like from the crazy brainstorm. There should be some really fun ideas that don’t fit the criteria, but hopefully we can find a few that could.
The selection process can be as formal or as informal as we want. We can pick based on our favorites, we can hold a team vote, or we can use a more formal decision matrix. (I wont go into the details of that here, but it’s an mathematical way to make a decision.)
The decisions might be made due to cost, or manufacturability or just how cool the idea is. Whatever direction we choose, we need to make sure we all know why we are choosing it. All these reasons are valid as long as we understand our motivations.
After one more check to make sure everyone agrees on the concepts and to make sure all the criteria can be met, we are ready to implement!
Step 5: Implement
Now that we have a direction (or a few) it is time to implement our ideas.
Designer will consider implementation anything from sketching to prototypes. The quicker or faster we can prototype something, the faster we will be able to evaluate it and move on.
A designer’s motto is “Fail Early, Fail Often!” Test all the crazy ideas; just don’t invest a lot of time or money to do this. Ugly prototypes out of foam core or cardboard are great!
If we are testing our bike seat cover, maybe we spend 30 minutes with a garbage bag and an empty soda bottle to test a concept. All we are doing is seeing if this concept is worth moving on to a more advanced prototype.
There is no point in wasting time or money on something that we can prove wont work with 30 minutes and stuff we found lying around the office.
We build to learn. The first idea might inspire our second and we will certainly take what we learned with us.
Don’t fall in love with any of the ideas! This will cost time, money and heartache. Test it and move on if it doesn’t work.
Step 6: Evaluate
Now it’s time to debug the prototype. Take a step back and evaluate it with a fresh set of eyes. After we do this a few times, and we think we have something good, we are ready to get some feedback!
It is time to take our prototype out for a test run! The point at which we can do this depends greatly on what we are making, but the earlier the better. Get it in front of users and get feedback!
People often think they can judge a design themselves. Unless you are creating something that is only for your use, get other people to tell you what they think. They will think of things we never could.
Maybe our design only works for tall people, or people that have both hands free at that moment. Maybe there is a social stigma that we are not aware of for some users. Testers will be honest. We will take their feedback and go iterate.
Iterate
The design process is iterative. We will cycle through this process many times in the creation of a product.
Express-Test-Cycle is another way to look at this phase of the process. Express or build your idea, test it and then iterate!
Source: Experiences in Visual Thinking by Robert McKim
We will do this on a macro and micro scale. The same process we just went through for the overall design will work for the details. For example, we might do an entire mind map and implementation on how one hinge is going to work in our overall bike cover design.
Ideate and iterate at ever stage and for every part! Our final results will rarely resemble where we started. (If it does, we are probably not working the process correctly.)
Q: What are some design tips that most non-designers wouldn’t be aware of?
Come up with crazy ideas. Don’t be afraid to get silly. They might seem ridiculous, but they can also spur other ideas that may in fact be great.
Remember when we were 5 years old and imagination was endless? Try to recapture that part of yourself! It’s still in there!
Only positive energy and positive comments are allowed during a brainstorm. Don’t edit yourself or others. There is no such thing as a stupid idea.
Come up with as many ideas as you can…narrow them down later.
Don’t fall in love with any one idea. This will make it easier to test them objectively and move on if necessary.
Q: Let’s put me on the spot: do you have any blog design tips for Purchase.com?
Yup! Invite friends over and do a brainstorm! (I am happy to come facilitate.)
Q: What are you favorite books about the design process?
The books that we often recommend to our students are:
Another good book is Back of the Napkin by Dan Roam (This is a more recent book. It does a great job at showing non-designers how to use visual thinking techniques.)
Q: Thanks, Jess. If someone would like to learn more about you, or get in touch with you, what should they do?
I am always happy to talk about design. I am available at jkessin@yahoo.com if anyone wants to reach me.
Amazing value, Jessica — see ya at the coffee shop!
I’ve been thinking about mission statements lately and I’m real impressed by Johnson & Johnson’s credo (they call it a corporate credo instead of mission statement).
I know J&J people, and they’re truly proud of their credo!
Why is a corporate credo important? Read this article on how it helped guide (and some argue save) J&J during the Johnson and Johnson Tylenol Crisis of 1972.
The Tylenol Crisis put J&J on the map as a leader in PR crisis management.
If you want a great book on credo and mission statement examples, try Say It And Live It by Patricia Jones and Larry Kahaner (the article above is excerpted from the book).
Say It And Live It includes credos and mission statements from such business leaders as UPS, IBM, Kellogg’s, Citicorp, Hallmark Cards, Reader’s Digest, Boeing, Southwest Airlines, UPS, Xerox and Ben & Jerry’s.
Oh, and I almost forgot, here’s J&J’s Credo:
We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality.
We must constantly strive to reduce our costs in order to maintain reasonable prices.
Customers’ orders must be serviced promptly and accurately. Our suppliers and distributors must have an opportunity to make a fair profit.
We are responsible to our employees, the men and women who work with us throughout the world. Everyone must be considered as an individual. We must respect their dignity and recognize their merit. They must have a sense of security in their jobs.
Compensation must be fair and adequate, and working conditions clean, orderly and safe. We must be mindful of ways to help our employees fulfill their family responsibilities.
Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified.
We must provide competent management, and their actions must be just and ethical.
We are responsible to the communities in which we live and work and to the world community as well. We must be good citizens – support good works and charities and bear our fair share of taxes. We must encourage civic improvements and better health and education.
We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.
Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed and mistakes paid for.
New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.
You can put all your eggs in one basket (just watch the basket!)
We’ve all heard the saying that you shouldn’t put all your eggs in one basket. While sometimes wise, I think there are many exceptions.
Mark Twain wrote that you should “put all your eggs in one basket and watch that basket.” I agree in many circumstances, including for business.
If you are super-selective and focus on one business (whether as investor or founder or employee) at a time, you can reap huge rewards. Look at Bill Gates of Microsoft (who loves using the word “super” by the way) — he invested purely in Microsoft for 30 years.
I had the good fortune of meeting Bill Gates a few times and I recall how reporters and other people were highly critical of the fact that he was reinvesting his Microsoft profits in Microsoft and not, for instance, in Philanthropic endeavors.
He told me that he believed his most valuable contribution at that time was focusing on Microsoft and that he would later focus on investing his money elsewhere.
Well, in 2000 Bill and his wife Melinda French (who I also had the pleasure of meeting once) created what is now the largest charitable foundation in the world and Bill turned his focus to investing in creating value elsewhere (specifically, helping solve many of life’s diseases).
So, Bill had his Microsoft basket for 30 years and now has his Foundation basket.
Similarly, Warren Buffett, who has created more wealth investing than anyone to date, has focused primarily on one business — Berkshire Hathaway — most of his life.
If the stock in Berkshire were to tank, Warren’s net worth too. But it probably won’t, because Warren is watching his one basket!
It’s no coincidence that when Warren finally decided to put his eggs (his money!) in a second basket, he chose to put them in the Bill and Melinda Gates Foundation basket – one that he trusted would be watched closely for years to come by his younger friends Bill and Melinda.!
