Structuring Convertible Debt: Key Triggers, Valuation Terms

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.