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When negotiating convertible notes, parties typically focus on the terms of conversion upon an equity financing, most notably the discount and valuation cap.  This is understandable inasmuch as the not-so-hidden secret of convertible notes is that no one wants the notes to ever get paid.  The investors are not seeking interest on their investment.  The goal is for the company to attract venture capital investors in the near future, do a priced round and then to have the notes convert into that round at a discount.

Not enough attention, however, is paid to what happens upon maturity, assuming a qualified financing, non-qualified financing or corporate transaction has not occurred that would result in conversion prior to maturity.  As a general matter, three possible scenarios could occur upon maturity of a convertible note: conversion into common, repayment of the note and extension of the maturity date. 

A recent case in Delaware involves a dispute between a company and its convertible note investors over the noteholders’ rights upon maturity.  The case serves as a cautionary tale to investors and companies alike as to the importance during the negotiation process of paying close attention to what happens upon maturity. At the risk of getting tedious, the background details are worth reviewing.Continue Reading Beyond the Discount: Why Maturity Terms Matter in Convertible Notes

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In the world of early stage investing, there exists a range of structures from the most founder friendly to the most investor friendly. 

The most investor-friendly structure involves some type of a priced round in which the investor receives shares of a class of preferred stock with a negotiated set of enhanced economic, management and exit rights.  These rights and other terms are memorialized in a group of governance documents and agreements among the company, the investors and the founders.

On the other hand, the most founder-friendly investment structure is the simple agreement for future equity, or SAFE, which is similar to a convertible note but notably lacks an interest component and a maturity date.  Next along the range of investor friendliness is the convertible note, which contains several investor protections, including interest, maturity, some reps and warranties and (sometimes) security.  In the real world, however, more sophisticated investors routinely augment their protection under both SAFEs and convertible notes by negotiating side letters that provide them with more enhanced rights.

Documentation for priced rounds and SAFEs have benefited from standardization.  The National Venture Capital Association website open sources a set of standard Series A documents which are a convenient starting point for initial VC rounds.  Ted Wang of Fenwick & West developed a set of standard Series Seed documents in 2010 for use in lower dollar amount priced rounds.  Gust Launch, a SaaS platform for founding, operating and investing in startups open sources a slightly more elaborate set of Series Seed documents.  And Y Combinator, which created the SAFE, open sources its several varieties of the SAFE on its website.  Only convertible notes have lacked standardization and the efficiencies that come with it.Continue Reading Planting Seeds:  New Standard Convertible Note Could Disrupt Angel Investing

SEC

Identifying potential investors is one of the most difficult challenges facing early-stage companies.  The range of amounts sought at this stage is typically greater than what could be provided by the founders and friends and family, but below what would attract a VC or a registered broker-dealer.  The problem is even more acute in geographic…

Judge Analisa Torres’ greatly anticipated Order in the SEC’s lawsuit against Ripple is a split decision.  The Order basically finds that Ripple’s digital token XRP is a security when sold privately to individuals and institutional investors pursuant to purchase agreements, but is not a security when sold on a digital asset exchange where sellers don’t know who’s buying and buyers don’t know who’s selling.[1]  Although the Order should be perceived as at least a partial victory for crypto, it perversely upends a fundamental tenet of the securities laws which is that the laws are designed to protect those who cannot fend for themselves.  Moreover, the finding that digital tokens sold anonymously on digital asset exchanges is not a security also seems to contradict the “fraud on the market” theory of securities liability.Continue Reading Parting the Crypto Sea:  Ripple’s XRP Ruled to be a Security When Sold to Private Investors, But Not When Sold on an Exchange

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The anti-child trafficking thriller “Sound of Freedom” just opened in theatres on July 4th.  Based on a true story, it stars Jim Caviezal as former Homeland Security special agent Tim Ballard who quits his job with the agency and embarks on a mission to rescue children from traffickers in Latin America.  Another true story relating to the film is that the cost of marketing it has been funded through an equity crowdfunding campaign under Regulation CF.  What makes it even more interesting is that the investment instrument issued in this crowdfunding offering was not your typical stock, convertible note or SAFE, but rather something called a revenue participation right.Continue Reading Revenue Participation Rights as a Crowdfunding Instrument Alternative

A major theme of this Blog has always been ongoing legislative, regulatory and market initiatives to reform capital markets by targeting unreasonable or outdated impediments to capital formation to make it easier for early-stage companies to raise capital.  These impediments are not always obvious or direct.  One such indirect impediment has been the venture capital adviser exemption under the Investment Advisors Act of 1940, the eligibility requirements of which disincentivize VC investment in secondary transactions and in other VC funds, thereby unnecessarily hampering liquidity in the innovation ecosystem.  If a new piece of proposed legislation passed by the House Financial Services Committee becomes law, however, this impediment will be eliminated.Continue Reading Proposed Reform of Venture Capital Fund Advisor Exemption Will Boost Startup Investment and Founder Liquidity

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FTX

“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” Such was the lament of John Ray, the legendary restructuring executive tasked with the unenviable assignment of serving as the caretaker CEO of bankrupt FTX Trading Ltd.  As the criminal and civil cases by the DOJ, SEC and CFTC against FTX founder and former CEO Sam Bankman-Fried play out in the courts, what does the “complete failure of corporate controls” at FTX teach us about corporate governance, unchecked founder control and the importance of proper oversight?Continue Reading FTX, Sam Bankman-Fried and the Risk of Unchecked Founder Control

Just last week, special purpose acquisition company The Music Acquisition Corporation (“TMAC”) called a special meeting of its stockholders.  It wasn’t the special meeting it originally envisioned.  TMAC was launched in February 2021 by long-time Geffen Records President Neil Jacobson to acquire a music business with the $230 million of SPAC IPO proceeds it raised. …

Two startups with competing, equally compelling technologies at the same stage of development are pitching venture capital investors for Series A funding.  One startup is led by a serial entrepreneur founder, the other by a novice.  Assume each will get funded.  In all likelihood, the deal will happen quicker and the amount funded and pre-money…

Last month, the Securities and Exchange Commission passed sweeping reforms of the rules governing exempt offerings (the “2020 Reforms”) to make it easier for issuers to move from one exemption to another, to bring clarity and consistency to the rules governing offering communications, to increase offering and investment limits and to harmonize certain disclosure requirements…