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What is a Convertible Note Subscription Agreement?
A Convertible Note Subscription Agreement is a contract for an investor to subscribe for convertible note, which is a debt instrument that converts into equity under predefined conditions.
The conditions for convertible note to convert into equity under a Convertible Note Subscription Agreement are a qualified financing, at a liquidity event, or on a maturity date.
To raise funds by issuing convertible notes, either a Convertible Note Subscription Agreement or a Convertible Note Instrument can be used. If a company has one (or very few) investors subscribing for the note, a Convertible Note Subscription Agreement may be used.
Contrary to a Simple Agreement for Future Equity (SAFE), a convertible note created under a Convertible Note Subscription Agreement is interest-bearing, has a maturity date, and specifies a minimum amount of funds to be raised at the equity financing.
- a qualified financing (i.e., a subsequent fundraising by the company which exceeds a certain minimum amount): the note will be converted into the same class of equity issued by the company at the qualified financing (typically preferred shares with additional rights compared to common equity);
- a liquidity event (i.e., a change of control or listing): the note will be converted into ordinary shares right before the liquidity event; or
- if neither of the above happens, on the maturity date (i.e., the due date of the debt): the note will be converted into shares, typically ordinary shares.
- a discount to the fully diluted price per share – compared with the price paid by investors in the qualified financing or the reference price for the liquidity event; and
- a cap on the fully diluted price per share at which the conversion will occur. In the documentation you will find in the Zegal app, this cap is expressed as a cap to the post discount pre-money valuation at the conversion event.
Key terms explained
Steps to create a convertible note and get investors to invest
Step 1: Initial negotiation
Step 2: Creation of the convertible note
Step 3: Subscription by investors
Step 4: Completion of subscription
Key points included
- Principal amount to be subscribed by the investor;
- Interest rate;
- Maturity date;
- Discount rate;
- Valuation cap;
- Qualified financing amount;
- Additional optional clauses such as restrictions on dividend payments prior to conversion or pro rata rights; and
- Nature of shares into which the note converts depending on the conversion event.