To start, a convertible note is a debt instrument that converts into equity. Importantly, before the conversion takes place, the convertible note is a debt of the company. Basically, this means it has a due date on which the debt has to be repaid. This is called the “maturity date”. Interest accrues during the period that the debt is outstanding.
In a nutshell, a convertible note entitles its holder to convert the money paid for the notes into equity of the company at a discounted price. After the conversion, the holder of the convertible notes will become a shareholder of the company.
Essentially, these can offer both the business and seed investors leverage in pursuing major fundraising benefits.
Step 1: Create a Term Sheet
Aterm sheet is a non-binding record of the major terms discussed between the company and the investor. You may create a term sheet for a convertible note to facilitate discussion. However, it is not absolutely necessary. Additionally, you may consider entering into aConfidentiality Agreement. This is useful during the negotiation process to protect the confidential information of your company.
Create aConvertible Note Instrument, to execute as a deed. Then each investor will issue aConvertible Note Subscription Letter to the company. This only sets out the principal amount. The benefit of using this approach is that once you create the Instrument, notes can be subscribed by multiple investors at multiple times using a short and simple document.
Step 3: Shareholder approval
Issuing a convertible note requires approval by the shareholders of the company. You should prepare (or instruct your company secretary to prepare) the relevant minutes for the shareholders meeting approving the creation and issue of the convertible note.
Step 4: Issue convertible note
Upon the investor paying the principal amount to the company, the company must issue aConvertible Note Certificate to the investor. This certificate needs executing as a deed.