A debt instrument that could be converted into equity under predetermined conditions is a convertible note. It includes a discounted fully diluted price per share. At the equity financing, it declares a minimum fund to be raised.
A convertible note is interest-bearing which shall be converted into equity and has a maturity date. However, creating a convertible note template for such conversion is crucial to make sure everything runs smoothly and effectively.
But, what is this convertible note agreement? Is it even necessary for your company?
What Is a Convertible Note Agreement?
A convertible note agreement is a legal document that allows an investor to convert a debt instrument into equity under certain circumstances by subscribing for a convertible note.
The party shall convert into equity under this agreement in the following conditions:
- Company’s financing exceeds a certain minimum amount.
- A liquidity event incurs change of listing or control.
- If neither of these two happens on a predetermined maturity date.
For issuing convertible notes to raise funds, the party could use the convertible note instrument or convertible note subscription agreement.
In case the company has only one investor or a few investors who subscribe for the note, using a convertible note subscription agreement is advisable.
How Does a Convertible Note Agreement Work?
There are several ways to use convertible debt note templates. Here a different price mechanism shall be applied and the security of money is intact as if no equity is paid, the investors shall gain their money back.
Moreover, the parties shall create their own convertible notes agreement as per their company's mechanism with the help of convertible note sample agreement. This agreement works as proof of approval at both shareholders and board level.
The parties shall include everything discussed in the meeting in the agreement. The convertible note shall be in sync with the Articles of Association for the validity and reliability of the execution of the deed and consulting the secretary.
This agreement is a clear indication for each investor how much convertible note he will subscribe to and the responsibility of payment. A separate letter is executed to each investor.
Lastly, the letter shall be signed by the company to come into execution.
What Are the Features of a Convertible Note Agreement?
Before agreeing upon a convertible note agreement, the parties shall consider a few features. Some of them are as follow:
- Discount Rate: In case an investor bore an additional risk by investing earlier or investing more, the compensation is provided as a valuation discount relative to other investors at the financing round.
- Valuation Cap: The reward given to the investor for taking an additional risk is a valuation cap. It accurately caps the price of the investor’s note which will be converted into equity. In short, the investor with convertible notes gets equity-like upside in case the company takes off.
- Interest Rate: As the investors’ money is borrowed by the company, convertible notes provide interest as well. However, the interest is not paid in cash but instead accrues to the principal invested which in turn increases the number of issued shares.
- Maturity Date: The convertible notes agreement should also include the maturity dates. It is mentioned at what date the note is due and the company needs to repay it.
- Pre-payment Terms: In case the company wants to prepay the accrued interest, it is imperative to take the approval of the majority holders.
- Documents: The counsel of the company documents every transaction with the help of the Note Purchasing Agreement, Investor Questionnaire, and Convertible Note (this document).
- Note Purchase Agreement: The agreement includes all the details of representations, covenants, and warranties of the company which shall be provided in conjunction with this agreement.
The convertible note agreement shall come under effect only if agreed and signed by the majority of the shareholders. After that, every investor shall adhere to its terms and conditions.
Moreover, the purchase and sale of the notes shall be carried out only if the company and the purchasers mutually agree in writing or oral. Furthermore, the party can form their customized agreement by taking reference from CocoSign.
We have a wide range of relevant and lawful templates which are updated constantly. Our experts' team is also available to resolve any convertible or other agreement related query.
Convertible Note Agreement
This term sheet summarizes key terms of a proposed convertible note issuance, for discussion purposes only. It is non-binding and is not self-executing. No party has any obligation with respect to the proposed note issuance unless and until it signs a definitive agreement governing such transaction. Any party may end discussions at any time for any reason or no reason at all. [Notwithstanding the foregoing, the parties hereto agree to be bound by the provisions contained in the paragraphs entitled “Confidentiality”, “Governing Law”, “Exclusivity”, and “Expenses”.]
Issuer: [ISSUER], a Delaware corporation (the “Issuer”)
Purchaser: [PURCHASER], a [DESCRIBE ENTITY OR ENTITIES] (the “Purchaser”)
Issuance: Convertible promissory note due [YEAR DUE] (the “Note”)
Principal: [Up to] $[PRINCIPAL AMOUNT]; the Purchaser will pay face value for the Note.
Target Closing Date: On or before [TARGET CLOSING DATE], [or as soon as practicable after satisfaction or waiver of all closing conditions] [to occur simultaneously with signing the definitive documentation]
[ANNUAL CAPITALIZED INTEREST]% per year, capitalized into the Note’s principal.
2% per year default penalty.
Payment Dates: [Quarterly, in arrears [beginning on [START DATE]]] [Upon maturity]
Maturity: Unless converted, the Note matures on the [NUMERAL (FIRST, SECOND, ETC.)] anniversary of the closing date.
Use of Proceeds: Proceeds from the Note issuance must be used [for general corporate purposes].
Ranking: [[SENIOR / JUNIOR / SUBORDINATED]] [[SECURED / UNSECURED]] ranking.
[Permitted Indebtedness: (i) Mechanics’ liens and obligations to trade creditors, (ii) existing indebtedness [[DESCRIBE]], and (iii) [Unsecured] indebtedness from a commercial bank or comparable lender [for (describe purpose)] in an amount not to exceed $[[MAX INDEBTEDNESS]].]
material legal judgment against the Issuer [, including [final and unappealable] invalidation of key patent claims by a court of law]
default under a material contract
[Closing Conditions: The parties’ obligation to close will be contingent on customary conditions for a financing of this type, including [satisfactory completion of the Purchaser’s due diligence] [regulatory approvals] [third party consents] [the Purchaser’s obtaining third-party financing in an amount sufficient to fund the purchase price and on terms satisfactory to it].]
Registration Rights: The holders of shares of stock issued upon the Note’s conversion will have customary registration rights, including the right to piggyback on any registration of shares from the same class of equity by the Issuer
Transferability: The Purchaser may not transfer the Note [, except [to its affiliates and] in compliance with applicable state and federal securities laws.]
[Documentation: The [Issuer’s counsel] will prepare initial drafts of definitive legal documentation for review and comment by the [Purchaser’s counsel]. The definitive documentation [will combine the loan agreement terms, the convertible note [, and the security agreement] in a single document] [will consist of a note purchase agreement with attached forms of the note[s] and security agreement to be executed on closing].
Governing Law and Jurisdiction: [This term sheet and the definitive documentation shall be governed by and construed in accordance with the laws of New York State applicable to transactions signed and to be performed solely within such state.
Confidentiality: [This term sheet is Confidential Information within the meaning used in the confidentiality agreement, dated [CONFIDENTIALITY AGREEMENT DATE], between the parties hereto.]
[Except as otherwise required by law, the Issuer will not disclose the existence or terms of this term sheet or any of the matters referred to herein (“Confidential Information”) to any persons other than its executive officers, directors, accountants and attorneys, and shall inform all recipients of Confidential Information that they may not disclose it to third parties. The Purchaser is responsible for all such recipients’ conduct with respect to the Confidential Information. The Issuer may seek injunctive relief, in addition to other remedies, to enforce this provision.]
Exclusivity: During the period commencing on the date hereof and continuing for 90 days, neither the Issuer, nor any of its respective affiliates, agents, principals, attorneys, or other representatives shall directly or indirectly contact, solicit, encourage or negotiate with any person or entity other than Purchaser with respect to any transaction involving the purchase of equity interests of the Company, or substantially all of its business and assets (a “Competing Transaction”). If Seller receives or becomes aware of