Convertible Note: Early Sale

By Laura Duggan     Add your comments

Early Sale, Change of Control and other terms important to a Convertible Note

Considerations for a Convertible Note, continued

Early Sale, Change of Control

What happens if the company is sold before the note converts?

It depends on the terms of the notes. Typically, the notes will be repayable (plus accrued interest) on a sale or change of control. However, investors will also want to hedge their bets in these circumstances and require the option to convert on the pre-determined terms if the outcome would produce a better result.

Tip: Try and gauge the likelihood and value of the early exit. Also, ensure that a change of control represents a genuine liquidity event and not merely a recapitalization of the company.

Other Terms

Subordination and security

Should notes be secured or subordinated?

These are contrasting scenarios: if the notes are secured, investors will rank in priority to other creditors of the compant if there is an insolvency; whereas if the notes are subordinate, the investors will rank behind those creditors to whom the notes are expressed to be subordinate.

Most often, convertible notes are treated as quasi-equity and will be subordinated at least to monies owed to banks or other third party lenders.  However, if the notes are secured and the assets representing the collateral have real value, then the terms of the notes should reflect the reduced level of risk being taken by the investors.

Tip: Do not offer secured notes and suggest that the notes be at least subordinate to bank or other third party lenders.

Events of default

When do the notes go into default?

In most cases the notes will only go into default if the company goes out of business (including bankruptcy) or if the company fails to convert the notes into equity when required to do so.

Tip: Try to limit events of default so that you do not hand over the power to the investors to call the shots.

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