What is a security interest in connection with a convertible note?
May 9, 2007
A security agreement creates a security interest in certain company assets. This allows the investor to take certain actions upon non-payment of the loan. The investor (or a collateral agent acting for the investors) may take possession of and sell the collateral and apply the proceeds to the repay the debt. If the proceeds of the sale exceed the amount of the debt, the company is entitled to the excess.
In order for the rights of the investor to become enforceable against third parties with respect to the collateral, the holder must “perfect” the security interest. Perfection is typically achieved by filing a document called a UCC financing statement with the secretary of state where the corporation is located. The investor will not be able to enforce its rights in the collateral against third parties, such as other creditors who claim a security interest in the same collateral or a trustee in bankruptcy, without “perfecting” the security interest.
Security interests are rare in seed stage convertible note bridge financings and not particularly common in bridge loans for venture backed companies, unless the loan is particularly risky, such as in connection with a bridge to a sale of company when the company is running out of money.