What happens if the company is sold after the convertible bridge note is issued and before the maturity date or the next round of financing?

May 1, 2007

Sometimes the convertible note is silent on this point, which would mean that the investor might simply get repaid the principal amount of the note plus interest upon a sale of company.  I think that investors generally should have the right to receive a return greater than simple interest upon a sale of company before the next round of financing.

Savvy investors will negotiate for one of the following (1) a fixed or floating rate of return greater than simple interest (either similar to the conversion discount or something like 1.2x to 2x the principal amount), or (2) the ability to convert the debt into common stock or preferred stock at some pre-determined price (in order to capture the “equity upside” in the sale).  There are some tricky tax issues for investors with regard to the concept of original issue discount, which I will leave for a later post.

I think it is generally unfair for a company to prepay the note without the consent of the investors in this situation, because this might eliminate the “upside” potential of the investors.

Comments

  • Pingback: Venture Hacks — [Hack] Make your debt attractive to investors

  • john DiLiddo

    what if the convertible note holder want 2X their their loan plus the conversion of the origional amount to the current PPM stock price if the company is sold to a third party before the note matures. Is this reasonable or excessive? They then get the benefit of both debt holders and equity holders .

  • http://www.startupcompanylawyer.com Yokum

    A 2x return plus 1x into equity is a very rich deal for investors.

  • jonchan

    What's the standard convertible note term addressing M&A events? Seems to me a fixed rate of return doesn't make sense because it doesn't account for the context of the M&A — i.e., what if it's a firesale? The alternative isn't great either but perhaps makes more sense — pre-negotiating a % ownership of the company at the time of sale.

  • http://www.startupcompanylawyer.com Yokum

    @jonchan – Probably conversion into common stock at a pre-set price or valuation. Alternatively, it could be a pre-set percentage of the company.

  • http://www.startupcompanylawyer.com Yokum

    @jonchan – Probably conversion into common stock at a pre-set price or valuation. Alternatively, it could be a pre-set percentage of the company.

  • Meg

    Any chance you completed that later post on original issue discount? I searched the site but couldn't find another post addressing it. I work in finance at a venture capital firm, and we have received payment on a bridge note that had a multiple liquidation preference. My gut tells me that the liquidation preference is not capital gain as it would be in a stock transaction, but I'm not sure where to find the answer. In case you're still monitoring comments, I would appreciate any pointers you could provide!