Chisos Investment Terms Explained (Part 2)

Over the past month we’ve had conversations with 50+ entrepreneurs exploring a potential investment from Chisos. These conversations have helped us learn what terms are important to an entrepreneur looking to raise money.

Given the unprecedented nature of a Convertible Income Share Agreement, the conversations have also helped us think through the different scenarios under which an entrepreneur may be looking to raise capital. We’ve talked with founders running successful, investor-backed businesses looking for a small slug of capital to purchase inventory or equipment. We’ve talked with bootstrapping founders looking to go full-time on their company. We’ve talked with other bootstrapping founders looking to extend their runway to show better growth and thus reduce future dilution before raising a larger round of capital. From small “lifestyle” businesses to the earliest stage startups, there is clearly a need for funding alternatives.

In this post, I try to further clarify our investment terms and lay out example funding situations to describe how a Convertible Income Share Agreement (“CISA”) would operate. If you have not already read Chisos Investment Terms Explained (Part 1), please read that first.

ISA Mechanics

The core feature of our investment terms is the Income Share Agreement (“ISA”). The ISA constitutes a period of time where a founder shares/pays a percentage of their income back to the investor.

If you strip out the equity features, the base premise of a Chisos CISA is 120 months of income share payments or a 2.0x repayment cap. Depending on the speed of repayment, the repayment cap can increase or decrease. To determine how the repayment cap moves, it helps to think of two countdowns:

The first countdown is the time passed since investment — this governs the repayment cap.

• If 1.5x the investment amount is repaid by month 60, the ISA liability is extinguished
• If the founder utilizes any deferment, this could extend payback past 120 months and up to 180 months. If payments are still due after month 120, the repayment cap may exceed 2.0x.

The second countdown is the number of months of repayment. A month is considered a repayment month if the founder earns over $3,333 ($40,000/yr) and makes the required payment.

• This countdown will never go above 120 months, but may be paused in the event of deferment. If 120 months of appropriate payments are made, the ISA liability is complete no matter what.

Examples

Positive Outcome Example

Alice earns $100,000 / year. Alice applies and qualifies for a $50,000 investment from Chisos, which includes a convertible equity claim on 5% of her new business. Alice can use this capital to pay business expenses and/or provide an income for herself while she works on her business.

Multiple outcomes can occur:

• Alice continues to grow her business without needing additional funding. Alice will continue paying down the ISA if she is earning an income above $40,000. In addition to the ISA, after year 10 or upon completion of the income share agreement, the equity claim will convert to shares of her company. The percentage equity claim will be reduced as the ISA is repaid (reduced 50% after 1.0x repayment, reduced another 16.7% after ISA is completely repaid. Chisos will always retain ⅓ of the original equity claim).
• Alice grows her business and decides to raise $3 million of additional capital in year 4. Between years 1–4 Alice will continue paying down the ISA if she is earning an income above $40,000. In this example, assume Alice has repaid 1.0x ($50,000) of the ISA when the $3 million is invested. Immediately before the new investment, Chisos’ equity claim, which has dropped 50% due to 1.0x ISA payback, converts in to 2.5% of equity shares. In an equity conversion outcome, the ISA payback cap drops to 1.0x. In this example, Alice has already paid 1.0x on the ISA, so the ISA liability is fulfilled.

Negative Outcome Example

Alice earns $100,000 / year. Alice applies and qualifies for a $50,000 investment from Chisos, which includes a convertible equity claim on 5% of her business. Alice can use this capital to pay business expenses and/or provide an income for herself while she works on her business.

The downside outcome:

• Alice starts a business that ultimately fails after 1 year. Alice will continue paying down the ISA if she is earning an income above $40,000. Her income may come from a salaried job or from a new company that she decides to start. The equity claim will expire worthless.
• In a situation where Alice returns to a job with a steady paycheck, it could make sense to take out a traditional, fixed-payment loan to pay off the ISA early.

We’ve built a simple spreadsheet tool to get a better sense of the ISA and equity conversion mechanics. Access the spreadsheet here and save down a copy to toggle the model inputs.

Please reach out with any questions. We are always happy to explore new financing scenarios.