Important Terms in a Convertible Debt Term Sheet

The following are some of the common terms found in convertible debt term sheets:

– Interest, Payment Dates, and Maturity: The term sheet should set the interest rate and the dates on which interest shall be paid — typically, interest is capitalized into the principal. Additionally, a maturity date should be set, one that is far enough away that the company is confident it will be able to secure a further funding round or sell the company, but not so far away that it drives off investors; a default penalty can also be set in the event the note is not paid after maturity.

– Ranking, Permitted Indebtedness, Security, and Guaranty: The ranking of the debt being offered can also be set; for example, junior to existing indebtedness and senior to future indebtedness. It may also be preferable to state up front what future indebtedness the company can take on (to avoid the need to obtain the debt holder’s consent which may otherwise be required). The prospective not purchaser may also require the debt to be secured by a lien on the company’s asserts, or require the founders or another party to give a personal guaranty on the note.

– Conversion: Perhaps the most important term in a convertible debt term sheet, the company will want to explain how conversion will work, specifically what event(s) trigger conversion (typically a further round of financing of a certain minimum aggregate amount), what the principal and interest of the debt convert into (typically preferred stock), and how and at what price the debt converts (typically at the same price and terms as the further round, with a “discount” added in for the note holder). Additionally, often added is a redemption right in the event of a sale of the company, allowing a payoff of the outstanding debt in cash or liquid securities.

– Events of Default: Events triggering default may be listed; they may be triggered automatically, or or may be only triggered upon the affirmative vote by some majority or all of the note holders in the round.

– Additional Terms: Additional terms often seen in terms sheets include:

– Board seats and info rights: Professional angel investors may wish to protect themselves by requiring a seat on the board of directors, or the right to receive and/or inspect company records available to its stockholders

– Representations and warranties

– Covenants

– Confidentiality agreement

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