What happens to the convertible note if it hasn't converted by the maturity date?
Takeaway: Usually, the company and the investors will agree to extend the maturity date. But the investors don’t have to do this - they can call the notes and force the company to repay them.
Convertible promissory notes have become a popular financing instrument for startups, providing both founders and investors with flexibility and potential returns. However, there may be situations where the maturity date is reached, and no financing event has occurred for the note to convert into equity. In this post, we will explore what happens when a convertible promissory note reaches its maturity date without conversion, and the possible outcomes for both the startup and the investor.
Convertible Promissory Notes: A Quick Recap
Convertible promissory notes are short-term debt instruments that allow investors to lend money to startups with the expectation that the loan will convert into equity during a future financing round. This conversion typically occurs at a discount or cap on the conversion price. The note has a maturity date, which is the deadline for the startup to repay the principal amount and any accrued interest or convert the debt into equity.
Reaching Maturity Without Conversion
When a convertible promissory note reaches its maturity date without a qualifying financing event, the note essentially becomes due, and the startup is obligated to repay the principal and any accrued interest to the investor. However, several possible outcomes can unfold, depending on the specific terms of the note and the negotiation between the parties:
Extension of Maturity Date: Both parties can mutually agree to extend the maturity date, providing the startup with additional time to secure a financing round that triggers conversion. This approach may benefit both parties, as the investor can maintain the potential for equity conversion, while the startup gains more time to increase its valuation and secure funding.
Repayment: The startup can repay the outstanding principal and accrued interest to the investor, effectively ending the investment relationship. This scenario may be less desirable for both parties, as the investor would not benefit from potential future gains in the company's value, and the startup would need to allocate funds for repayment instead of focusing on growth.
Debt-to-Equity Conversion: The investor and the startup may agree to convert the note into equity at the maturity date, even without a financing event. This conversion could be based on a pre-agreed valuation or a negotiated valuation at the time of conversion. This scenario allows the investor to become an equity holder and share in the future growth of the company, while the startup avoids the need to repay the loan.
Debt Restructuring: If the startup is unable to repay the loan or secure an extension, both parties may choose to restructure the debt. This could involve modifying the terms of the note, such as changing the interest rate, extending the maturity date, or adjusting the conversion terms.
Legal Implications and Negotiation
It is crucial for startups and investors to be aware of the legal implications of a convertible promissory note reaching maturity without conversion. The note's terms and conditions, along with applicable laws and regulations, will guide the negotiation process and determine the available options.
Startups should seek legal counsel and work closely with their investors to find a mutually beneficial solution. Open communication and a willingness to negotiate can help both parties navigate the challenges of a convertible promissory note reaching maturity without a conversion event.
Conclusion
The maturity of a convertible promissory note without conversion can pose challenges for both startups and investors. By understanding the possible outcomes and engaging in transparent communication and negotiation, both parties can work together to find a solution that aligns with their long-term goals. Startups should be proactive in addressing the potential issues associated with the maturity of convertible promissory notes, ensuring they are prepared to navigate the complexities and achieve the best possible outcome for all stakeholders involved.