Convertable notes FAQs
Convertible notes are a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value.
Once a board has approved fundraising with convertible notes, they are a flexible financing instrument often used by startups, as they allow companies to raise funds without immediately establishing a valuation.
What are convertible notes?
Convertible notes are short-term debt that converts into equity, typically in conjunction with a future financing round.
In essence, the investor loans money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company.
After issuing a first round of convertible notes, companies may issue subsequent rounds.
What is in a Convertable note?
The resolution typically includes:
- Introduction and background: It generally starts with a preamble outlining the reasons why the company needs to issue convertible notes.
- Details of the Convertible Note Issue: It will specify the terms of the convertible notes, such as the interest rate, the maturity date, the conversion price, and any other terms that are applicable.
- Approval: The resolution itself is the formal approval by the board of directors to issue the convertible notes. It may specify that certain officers of the company are authorised to take all actions necessary to effect the issuance.
- Documentation: The resolution might include or be accompanied by the Convertible Note Purchase Agreement, which is the actual contract between the company and the purchasers of the convertible notes.
- Signatures: The resolution will be signed by the Directors to demonstrate their unanimous approval.
The required majority of directors of the company should sign the Written Board Resolution to Issue Convertible Notes.
Under the Companies Act 2006, the required majority for an ordinary resolution to be passed by written means is a simple majority of the total voting rights of eligible members.
Please also check the provisions of your Articles of Association.
Why do I need a convertible note?
A convertible note is important because it ensures that the board of directors has formally approved the issuance of the convertible notes.
It’s part of the company’s official record and may be required by investors, lenders, and regulators to demonstrate that the company has properly authorised the transaction.
What happens to a Convertible Note if the startup fails?
It largely depends on how the note was drafted. In cases where it is not guaranteed by any of the principles, it is taken as a regular debt. However, if the company has some money, it pays for the liabilities, and the remaining amount is distributed to the equity holders.
Most convertible notes do come with personal guarantees.
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