The investor has the option to decide to convert their SeedNOTE into equity or get repaid in cash in a funding round, or Sale or IPO, or when the SeedNOTE reaches its Maturity Date. This article is then going to discuss each of these scenarios in detail and how to complete the conversion.
Repayment in cash:
To receive the repayment (in cash) of the initial investment amount of the loan (plus any accrued and outstanding interest), the Loan Note Holder will give the company a Redemption Notice before a Financing Round, Sale or IPO is completed, or on the ‘Maturity Date’ (whichever is earlier).
A Redemption Notice is a written notice sent by the Loan Note Holder to the company which expresses their intention to exercise their right to redeem. This needs to be given to the Company at least 5 days before the funding round, Sale, or IPO completion. The company should then expect to repay the Loan Note Holder no later than 30 business days from the redemption date, in case of a redemption.
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.
While a Loan Note Holder may issue a Redemption Notice to the company, 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.
In order to convert the SeedNOTE into shares, the Loan Note Holder needs to inform the company by serving a Conversion Notice. This is a two-step process by the Loan Note Holder:
First, a written notice to the Company to convert outstanding Notes must be given from the Loan Note Holder;
Next, the Loan Note Holder will then prepare relevant documents required to have the shares issued and allotted to them.
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. Meaning 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 Debt 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.
The Maturity Date set from the date of the agreement differs between jurisdictions:
In the UK, this is between 3 or 5 years
In Hong Kong, this is between 1 to 2 years
In Southeast Asia, this is usually more than 18 months
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.