The SeedNOTE is a short-term debt instrument where investors can provide a loan to your company, which may be redeemed for cash or converted to shares.
The SeedNOTE (known as the Convertible Loan Note) gives investors the option to decide to convert their investment into equity or get repaid in cash in a funding round, Sale or IPO, or when the SeedNOTE reaches its Maturity Date. This article will discuss each of these scenarios in detail and how to complete the conversion.
Repayment in cash:
Outstanding Loans will be repaid within 30 days following the Maturity Date, provided that the Maturity Date does not fall between the date of the service of the notice before any proposed fundraising, Sale or IPO.
A Loan Note Holder cannot redeem the SeedNOTE whenever they want, and it’s not entirely at their discretion since it’s contingent on the maturity date, funding round date, Sale, or IPO. After one of these events occurs, they do have the right to insist on the loan being paid back. If the company cannot repay, it could get liquidated. This is an uncommon scenario but this is possible and it's why investors sometimes choose Convertible Loan Notes as they rank higher in priority than Equity instruments when the company gets liquidated.
There are specific instances that result in immediate redemption of the SeedNOTE. These are commonly known as ‘Events of Default’. Some examples of a default event are:
- when there is a material breach of terms in the SeedNOTE;
- when the company goes into administration;
- liquidation or dissolution of the company.
These examples are market standard but keep in mind that this is a clause in the SeedNOTE which is heavily negotiated between the investors and the company.
Once the SeedNOTE has been redeemed, it cannot be converted into Equity.
Conversion into Equity:
An alternative scenario is when the SeedNOTE converts to shares. Usually, when the company gains traction, it can prove more valuable for the Loan Note Holder to hold shares in the company instead of being repaid.
The SeedNOTE will convert into equity in these scenarios:
1: On a Funding / Financing Round
When selecting the terms of a SeedNOTE you specify an amount of investment that constitutes a new funding round. When you raise that amount, this will trigger the conversion of the SeedNOTE in that funding round. This means you will issue shares to the Loan Note Holder alongside the new cash investors.
When you convert a SeedNOTE in a funding round you will issue shares for the initial investment amount and any accrued interest, if there is a rate of interest set.
The price per share at which your SeedNOTE converts will be dependent on both the discount and the cap valuation you set when setting up the SeedNOTE. The discount means that your SeedNOTE will convert at that discount to the lowest price per share in the funding round. The cap valuation is the maximum valuation at which the SeedNOTE will convert in a future round. If you have both a cap and the discount, the SeedNOTE will convert at the lower of (a) the cap valuation; or (b) the valuation at the funding round including the discount.
As per the section above (Repayment in Cash), the Loan Note Holder actually has the option to choose to be repaid back in cash instead of converting to equity at the triggering funding round. If they want to be repaid back in cash, they would need to send a written notice 5 days before the completion of the funding round and ask to be repaid back in cash. If the Loan Note Holder doesn't send this notice or wants to convert to equity then you can convert them in your funding round alongside the other cash investors. Do note that if the SeedNOTE is redeemed for cash, the Loan Note Holder will not have the option to convert the SeedNOTE into equity.
When you know you are going to raise a new funding round that would trigger the SeedNOTE conversion then we recommend reaching out to the Loan Note Holder and asking if they want to be repaid in cash or converted to equity!
You can add your SeedNOTE’s to your funding round with a click of a button on SeedLegals - have a look at this step-by-step guide on how to convert a SeedFAST/SeedNOTE from the Convertibles Table on SeedLegals.
2: On a Sale or IPO
The SeedNOTE will convert into equity immediately before an exit event so that the Loan Note Holder can then sell those shares to the buyer, alongside the existing shareholders.
The process works exactly the same as if the Loan Note Holder were to convert in a funding round, detailed above. And the Loan Note Holder can choose to be repaid back in cash before the Sale or IPO event.
3: On the Maturity Date
On the Maturity Date (the date when the final repayment or conversion is due) one of three things will happen:
- The SeedNOTE will be converted into equity and the Loan Note Holder will have to inform the company by serving the Conversion Notice with reference to the 2-step process mentioned above.
- The SeedNOTE does not get converted but the company repays the loan after receiving the Redemption Notice from the Loan Note Holder
- The SeedNOTE does not get converted or repaid because the Loan Note Holder decides to extend the Maturity Date (a maximum of 12 months). This requires a separate written notice by the Loan Note Holder along with written consent from the company’s board as the interest of the loan will continue to accrue over the time extension.
If your investor has not asked for interest on the initial loan amount and they are not looking at redemption or repayment of the instrument, the SeedFAST or a funding round might be better suited to your investment needs. Feel free to jump on our live chat or reach out to the team to learn more!