How Do the $150K BDC Convertible Notes Work?

Yesterday we covered a story about three startups from the Maritime provinces who received $150,000 in funding from the Business Development of Canada (BDC).

I mistakenly wrote that if those startups eventually fail then they’re not on the hook for repayment, which is not true at all. I asked the BDC’s manager of public relations, Shawn Selewski, to clarify what exactly happens if the startup does earn the money back in revenue, or if the business shutters. How does the BDC get its money back? After all, as Salewski clarified, “we are very much profit driven.”

The $150,000 convertible notes from BDC have been given to several high-potential startups from recognized tech accelerators throughout the country. Vancouver’s GrowLab, Montreal’s FounderFuel and Execution Labs, Moncton’s Launch36 and several other programs all award multiple or all cohort startups with the note. “It’s a key element of BDC’s Accelerator Strategy to support promising Canadian startups in their early, most fragile, stages. 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,” wrote Salewski.

The program was started in 2011 and today over 60 startups have benefitted from the investment money. It’s “convertible” because the funding is designed to be converted into shares upon the company’s first full funding raise. If the note isn’t converted to equity, then it is indeed repayable at the end of a two-year term.

So, what are the general terms of the investment?

BDC designed the convertible notes to be both “entrepreneur friendly and investor acceptable“, standardizing the terms and conditions of its notes across all its accelerator partners, so all companies are treated equally.

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.

These terms also fall within market norms, and do not disadvantage concurrent or future private and institutional investors. This is what “investor acceptable” means.

In many cases, BDC-backed accelerator graduates have leveraged a BDC VC convertible note to secure funding from angel investors with similar terms and conditions. The BDC’s willingness to provide the note ideally makes further investment less risky for private investors.

What are some of the differences from more traditional investments from other VCs or angels? The BDC doesn’t provide non-financial assistance, so they won’t be introducing startups into other VCs or helping it access new markets. And startups can only get one convertible note.

The money can be used for nearly anything pertaining to the company, but it can’t be used to repay debt.

And if the startup fails, or doesn’t have the money to repay the loan? “Much like with other VC deals, the start-up companies we are investing in aren’t personally liable for reimbursement,” wrote Salewski. “That being said, like any other investor, we would go after anything in the company (i.e. assets) to recover our money. So, the business is on the hook.”

Overall, the notes are pretty positive for the ecosystem, particularly when one asks to BDC what their expected rate of return on its convertible notes? They’re not traditional investment vehicles, wrote Salewski. “BDC VC wants to balance financial outcomes withpositive ecosystem impact. The goal is not necessarily to obtain the highest returns, but to help the most promising Canadian startups survive and grow. Later, some of these companies may become interesting investment candidates for BDC VC and other investors.”