What happens to the convertible promissory note if the maturity date is reached and there hasn’t been a financing?

April 29, 2007

The company could either (1) pay back the loan (which is unlikely since it is probably out of money), (2) ask the investors to extend the maturity date, (3) convert the loan into the last round of Preferred Stock (if any) at a pre-determined (i.e. last round) price (or price negotiated at the maturity date), or (4) convert the loan into Common Stock at a pre-determined price (or price negotiated at the maturity date). If the company can’t repay the note, then the investors could push the company into bankruptcy.

The typical situation when the maturity date is reached is for the company to talk to its investors and make sure that they don’t do anything drastic, like declaring an “event of default” on the note.

If there is already a series of Preferred Stock outstanding, then allowing the investors to convert at their option into the Preferred Stock is a good alternative, especially if the conversion price is agreeable to both the company and the investors.  As a practical matter, I think it is tougher to pre-negotiate a conversion price into common stock.

Sometimes aggressive investors will ask to control the board of directors or other things upon a payment default.

Comments

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  • John

    Yokum, you have put together an excellent resource, thank you.

    Quick question: once the Company has closed the Series A, 3 months later the Company finalizes a Bridge Loan, but the Series B never happens. What are the technicalities involved in converting the Note into Series A? Do you simply amend your articles to allow for more shares of Series A and issue the amount at the same Series A share price that you had 15 months ago? What if the COmpany cannot obtain Shareholder approval for the amendment of the Articles?

  • http://www.startupcompanylawyer.com Yokum

    You need to amend the articles (certificate) of incorporation to authorize additional shares of Series A and common stock (for conversion of the Series A), if necessary. The conversion price (or amount of discount, if any) is subject to negotiation. If the company cannot get stockholder approval to amend the articles (certificate), then you have a problem.

  • http://N/A Jason

    If the Company becomes highly successful quickly and opts not to raise Series A financing, what terms can be provisioned to duly reward Note investors for the risk?

  • http://www.startupcompanylawyer.com Yokum
  • Xavier

    Yokum, thanks for the great advice. I’m wondering if you can elaborate on my special case.

    I have a case where the maturity date is reached and the note contains a clause that says that if the company doesn’t pay the full amount + interest 10 days thereafter then it constitutes an Event of Default.

    Since then I have an offer to have the company purchased. I have spent quite a bit of time in pulling this deal together. What happens in this case? Can I convert the investor into shares of the acquirer as the note stipulates? They haven’t yet pushed a court to start bankruptcy filings so is this a possibility?

    I have an unfriendly investor who wants to take full ownership of the company and get the full benefits of the acquisition. Do we have a leg to stand on?

  • http://www.startupcompanylawyer.com Yokum

    @Xavier – It depends on what the document says. You need to consult with counsel. Many bridge loans are silent in this situation, which may be beneficial to the company.

  • dhillcrest

    We have investors in our LLC who's Promissory Convertible note is due. We have pre-negotiated to convert the note into member units upon maturity date. I have Unit Certificates. Do I just fill it out and send it off to them? Or is there some other paperwork?

  • dhillcrest

    We have two LLC's. One we would like to close but has two investors. Is it possible to offer to those investors to transfer their shares to our other company? Or do we just close and tell those investors they have lost their money?

  • http://www.startupcompanylawyer.com Yokum

    @dhillcrest – please consult with your own attorney. There is a lot more documentation to an LLC than what you describe.

  • http://www.startupcompanylawyer.com Yokum

    @dhillcrest – please consult with your own attorney. There is a lot more documentation to an LLC than what you describe.

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  • Jeff

    Yokum, have you ever heard of a convertible note where the borrower (issuer) has the power to cause the conversion and not the lender/investor?

  • http://www.startupcompanylawyer.com Yokum

    @Jeff – I don't think I'd agree to that as an investor. Possible, but certainly not common.