By Al Wadyat CapitalPublished Updated 10 min read
Every early-stage instrument buys time. What separates them is which argument they postpone, how long the postponement lasts, and what it costs when the argument finally happens.
Choose the instrument that makes the next round possible, not the one that makes this round easiest. Those are different objectives and they frequently point in opposite directions.
The question behind the question
Founders usually arrive at this decision framed as a choice between speed and price: a convertible is faster, a priced round is cleaner. That framing is not wrong, but it hides the thing that actually matters, which is leverage.
Every instrument moves the valuation conversation to a particular moment. The only question worth asking is whether you will have more or less negotiating power at that moment than you do now. A company that expects to hit a hard, provable milestone in nine months should postpone. A company whose position is strongest today, because the market is warm or a competitor has just failed, usually should not.
The rest of this article is a description of what each instrument does with that postponement.
Priced equity
A priced round settles the valuation now. Shares are issued, ownership is unambiguous, and everybody knows where they stand. It is the most expensive instrument to execute — legal work, a shareholders' agreement, often a board seat — and the least ambiguous to live with.
Its underrated advantage is clarity for employees. Option grants against a known share price are a real incentive; options granted against a valuation that will be determined later by an unrelated conversion are a promise nobody can size.
Its underrated disadvantage is that it establishes a reference point. A high price set in a friendly market becomes a ceiling the company must grow into; a down round afterwards costs far more in morale and in anti-dilution mechanics than the original premium was worth.
- Best when: the milestone is already achieved, or the round is large enough to justify the process
- Postpones: nothing — the argument happens now
- Watch: preference stack, anti-dilution, and the consent list rather than the headline number
Convertible instruments and SAFEs
Convertible notes and their equity-side cousins defer valuation to a future qualifying round, usually with a discount, a cap, or both. They are fast, cheap and, used once with a clear purpose, entirely reasonable.
The standardised forms in wide use are published openly, and reading the actual document rather than a summary is worth the twenty minutes: the difference between a pre-money and a post-money version changes who bears dilution from subsequent notes, and that difference is invisible in a term summary.Sources for this passage: Y Combinator standard SAFE documents
The failure mode is repetition. One note is an instrument; four notes with different caps, discounts and maturity dates are a structure, and it is a structure that converts unpredictably at exactly the moment when a lead investor is deciding whether the cap table is clean enough to build on. Founders regularly discover at conversion that they own materially less than they believed.
A related trap is the maturity date. A note that matures before the company can plausibly raise creates a negotiation with existing holders under time pressure, which is the worst possible condition for it.
Revenue-based and other non-dilutive facilities
Where a company has predictable revenue, a facility repaid as a percentage of that revenue can extend runway without touching ownership. For a fintech with genuine recurring revenue this is often the most underused option available.
The cost is cash flow. Repayment starts immediately and continues whether or not the month went well, so the instrument suits companies with stable collection and margin, and punishes those whose revenue is lumpy or whose gross margin is thin.
It is also not a substitute for equity when the money is meant to fund discovery. Non-dilutive capital is excellent for scaling something that works and dangerous for financing the search for something that might.
Grants, programmes and strategic money
Grants and ecosystem programmes are genuinely non-dilutive and genuinely slow. They are worth pursuing when the timeline suits and worth ignoring when it does not; the common error is building a plan around one and discovering that the decision cycle is two quarters longer than the runway.
Strategic investment from a corporate or an infrastructure provider is a different animal again. The cheque may come with distribution, credibility or a customer attached, which is worth a great deal. It may also come with information rights, a right of first refusal or an implicit expectation of exclusivity that narrows every future conversation.
The test is simple: would you take this money at this price if the strategic benefit were removed? If not, the strategic benefit is the whole of the deal, and it should be written into the agreement rather than assumed.
Token instruments, and why they are not a shortcut
For blockchain companies there is a persistent belief that a token sale sidesteps the dilution question. In most jurisdictions it does not; it substitutes a securities question for an equity one.
Regulators internationally have converged on the position that the substance of the arrangement, not its technical form, determines whether an instrument is treated as a security, and the analysis is made market by market rather than once and globally.Sources for this passage: IOSCO
A token instrument sold before the network exists also creates an obligation that is difficult to renegotiate. Equity holders can agree to a restructure; thousands of holders of a future token right cannot practically be brought to the table at all.
None of this makes token financing wrong. It makes it a decision that belongs with the regulatory analysis rather than alongside it, which is why we treat it as a compliance question first and a funding question second.
How to actually decide
Model the cap table forward at least three rounds, including an option pool refresh at each one and the conversion mechanics of every instrument outstanding. Most bad instrument choices are obvious in that model and invisible without it.
Then apply three tests. Does this instrument leave the company able to raise the next round from somebody new? Would a competent lead investor look at the resulting structure and see something they can build on? And if the next milestone is missed by two quarters, what does this instrument do to the company then?
An instrument that passes all three is usually the right one, even when it is not the fastest or the flattering one. An instrument that fails the third test is a bet on the plan going well, and early-stage plans rarely do.