Convertible Note Cheat Sheet

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Updated September 19, 2022
Angel Investing

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important When negotiating a convertible note financing, focus on the following elements of the term sheet:

  • What is the valuation cap?

  • What is the conversion discount? (10% to 20% typically.)

  • What is the repayment premium in the event of a sale before conversion?

  • What defines the qualified financing?

  • What happens if the company does not achieve a qualified financing?

  • Do you have the right to participate in any financings which are not qualified financings?

  • Is there an optional conversion provision that is at your option, or the company’s option?

  • Do you have or want a most-favored nations clause?

  • Will interest be paid in cash or stock or a combination of cash and stock? (Although this is less common, if you are being paid a considerable amount in interest because you are making a sizable investment, this is something you could ask for.)

danger Provisions to watch out for in a convertible note financing:

  • Make sure that in the event of the sale of the company the company can’t just return your principal and interest. You are investing in a note for the potential equity upside, not interest.

  • You will usually want a valuation cap that is acceptable to you (not too high).

  • A mandatory conversion paragraph that doesn’t convert you at the lower of the discounted price or cap.

  • The lack of a change of control payment provision.

  • A mandatory conversion paragraph that does not contain a sufficiently sized round to justify your forced conversion.

  • The lack of an optional conversation paragraph, giving you the option to convert into equity either (i) when the company closes a financing round that does not meet the definition of a qualified financing, or (ii) after the maturity date, at a specified valuation (for example, the cap).

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