What type of financing forces an automatic conversion of the promissory note into Preferred Stock?

April 29, 2007

Typically, the convertible note should automatically convert into Preferred Stock upon a “Qualified Financing.”  The “Qualified Financing” is usually defined as a financing raising a certain amount of money (including or excluding the amount of the convertible notes).

The size of the Qualified Financing is typically set high enough to make sure that the financing legitimately sets a valuation for the company.  A Qualified Financing set at a very low amount (such as $500,000) might be questionable at setting a valuation on which the conversion price is based.  A Qualified Financing is usually set at some amount the company would legitimately need to raise after hitting the milestones that the bridge financing provided.  I think that it probably should be at least $1 million of new investor money or greater.

Other tweaks to the definition of Qualified Financing may include limiting it to a financing involving a VC.