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.
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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.


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