What You Should Know About The Convertible Note Purchase Agreement

A convertible note purchase agreement is one that binds investors to the same terms and conditions for a specific round of convertible debt financing. A convertible debt is simply one that can be converted to equity. A common trigger for converting debt to equity is when a company acquires a subsequent round of capital.

When Is A Convertible Note Purchase Agreement Used?

To put it simply, companies use a convertible note purchase agreement to issue convertible debt through a convertible promissory note. Companies raise convertible debts for a number of reasons. Some of them are:

• To postpone the need for a valuation of the company.
• To delay the issue of some types of equity and as a result, postponing the legal costs of issuing stocks and the possible dilution of founders’ control and equity.

What You Need For A Convertible Note Purchase Agreement

If a company wants to raise money through convertible debt, it needs three major documents: 1) a convertible debt term sheet, 2) a convertible debt agreement, and 3) a convertible promissory note. If you want to secure the debt, then you need to have a security agreement.

Convertible Debt Term Sheet

Just like other term sheets, you use a convertible term sheet to determine what you want from the agreement before it is drafted. They are for discussion purposes and are not binding. You should make sure your convertible term sheet has the following:

• The maximum and minimum amount of money you intend to raise with the proposed financing.
• The maximum and minimum amount of the convertible promissory note.
• The date of maturity for the convertible promissory note.
• The interest rate
• What would count as default of the agreement.
• How you plan to use the proceeds from the financing.
• How your company will make the payment.
• What happens in the event of a sale or liquidation.
• If the promissory notes are prepaid. If they are, what are the terms?
• A summary of representation of warranties from the company.

Convertible Note Purchase Agreement

This document would contain the terms in the convertible debt term sheet and it has to be signed by the convertible promissory note purchaser and your company. In addition to the above, the convertible note agreement should take care of the following:

• What is to be derived at closing
• Conditions for closing
• The representation of the warranties of the investors and company.
• Ancillary terms. These are terms you need to execute during conversion.
• Any other term that your attorney thinks you should add.

Convertible Promissory Notes

This is the instrument that creates the debt. Because you can convert the convertible promissory note to equity, it is a security. As a result, you have to follow all federal and state security laws. Just like every other type of promissory note, a convertible promissory note can either be secured or unsecured. If it is secured, it means that the debtor has pledged collateral for the debt.

Each convertible note purchase agreement is different. So, make sure you consult with an attorney to guide you through the process.