Convertible Debt Financing

Let's talk about convertible debt financing for an emerging technology company. These transactions are common for technology companies. Usually, they come into play as part of a first external round of financing from investors, in-between priced rounds for a company, and just prior to a strategic or sales transaction for the company. Our focus will be on the term sheet for the convertible debt financing.

Term Sheets are Surprisingly Simple

The first thing a person notices with one of these term sheets is how relatively simple they are. There are usually only one or two pages. Compare that to a Series A financing where there is usually 5-10 pages or more. One reason that convertible debt term sheets are so short is that the transaction is structured so that convertible notes convert into the security issued in the next round, entitling the note holders to not only the rights and the benefits associated with that new security, but also with the accompanying representations, warranties, covenants, and other obligations that come with its sale.

With that in mind, it is customary to defer all that detail to the subsequent financing. As a result, the documents associated with convertible debt funding for an emerging technology company are some of the simplest and straight-forward financing documents to prepare and negotiate. Let's get into the terms of the term sheet. There are two types of terms to consider - financial and procedural.

Common Financial Terms

The financial terms are the economic incentives for entering into the transaction. As you would expect, they include the interest rate and a discount percentage of the security price in the next financing. Sometimes, instead of a discount, one sees warrant coverage. Warrant coverage is the right to purchase a certain number of shares in the future at a set price. The warrant can be exercised when the value of the stock has increased.

Common Procedural Terms

Let's consider the conversion process. There are different conversion types:

Automatic: occurs upon a "Qualified Financing." Voluntary: occurs upon the consent of the company and the note holders.

Our experience with emerging technology companies is that the Qualified Financing threshold is usually set at no less than 2 times the amount of the money raised as part of the convertible debt offering. Other common procedural terms typically include:

• Deadline for participating in the offering
• The maturity date of the notes
• Initial closing date
• Minimum investment
• and other miscellaneous terms

It is also important to enable the waiver of terms and the amendment of documents by the consent of the company.

What are the Takeaways?

• The term sheet should be short and sweet
• The key financial term is the discount or warranty coverage

• "Qualified Financing"
• Amendment of all notes by a subset of the note holders

To learn more about convertible debt financing for technology companies, contact Eurasian Capital, LLC.