Structuring Convertible Debt: Key Triggers, Valuation Terms

Due Diligence, Determining Priority vs. Other Creditors and Equity Holders

Recording of a 90-minute premium CLE webinar with Q&A

Conducted on Wednesday, August 26, 2020

Recorded event now available

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Program Materials

This CLE webinar will provide corporate finance counsel with guidance on structuring convertible notes for seed-stage financing. The panel will discuss upfront due diligence, term sheet negotiation, and critical terms, including the discount rate, valuation cap, and triggers for the conversion from debt to equity.

Description

Convertible note financing is the most common form of seed-round funding for startup companies, in part because it does not force the issuer and investors to determine the value of the company at the time of the transaction. Conversion terms govern when the note converts to equity and how much will be paid to the noteholder upon conversion.

There are typically three events that might trigger a conversion: subsequent issuance of equity (often preferred) that meets an agreed minimum threshold, sale of the company or substantially all of its assets, and maturity of the note. All of these triggers and the options available to the noteholders in each event must be negotiated in the term sheet and reflected in the documents.

Since valuation is not determined upfront, the parties must agree on a framework for the valuation of equity shares upon conversion. Critical terms include the discount rate, or valuation discount the convertible noteholder receives relative to investors in the subsequent financing round; the valuation cap, the price at which the notes will convert into equity; and the interest rate, accruing to the principal invested and increasing the number of shares issued upon conversion.

Listen as our authoritative panel analyzes the nuances and crucial negotiating points for convertible notes. The group will discuss conversion triggers, components for evaluating equity shares upon conversion, due diligence, and other terms to consider in a convertible note financing.

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Outline

  1. Advantages of convertible debt as seed-stage financing
  2. What to address in the term sheet
  3. Due diligence before closing
  4. Conversion triggers
    1. Issuance of equity
    2. Sale of company or company assets
    3. Maturity
  5. Factors in determining equity value at the conversion
    1. Discount rate
    2. Valuation cap
    3. Interest rate under the note

Benefits

The panel will review these and other key issues:

  • Without an accurate valuation, how should an investor determine an appropriate amount of seed-stage financing to provide a startup company?
  • When is the right of conversion to equity exercised?
  • What is the typical discount rate, and how is the valuation cap determined at the time of the convertible note transaction?
  • What is the priority of the convertible note vis-a-vis other creditors and equity holders of a startup?

Faculty

Di Bacco, Kristine
Kristine M. Di Bacco
Partner
Torys

Ms. Di Bacco provides strategic counseling to emerging and high-growth companies primarily in the consumer and...  |  Read More

Teichman, Josh
Josh Teichman
Attorney
Torys

Mr. Teichman's practice focuses on corporate law, with an emphasis on private equity and venture capital...  |  Read More

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