Interesting convertible note question

Posted on 10. May, 2007 by jon in Building eduFire, eduFire News

So we’re finalizing our convertible note right now and there’s one sticking point we’re trying to figure out. One of the provisions of our note is that the majority interest holders in the note have the right to waive a provision of the note. Let me give an example of how this might play out (entirely hypothetical). Let’s say we have the following note holders:

Bob – $200K
Mary – $150K
Sam – $50K
Natasha – $100K

Let’s say that at the end of the term of the note we haven’t raised our Series A financing yet (unlikely but possible :)). Some of the note holders are fine with setting a valuation on the company at that point and converting the note to equity. However, let’s say that Sam is against this. There are two possible scenarios that emerge:

#1 – With our current amendment in place the note holders vote on the conversion and since Sam is in the minority the note converts to equity.

#2 – If we remove the amendment then we’re unable to change the terms of the note unless everyone agrees to it. Under that circumstance Sam’s disagreement means that the note does not convert.

As the entrepreneur scenario #1 is the most favorable because it leaves more flexibility for the company to do what is in its best interest and the interest of the majority of the note holders. However, as an investor I can see why #2 might be preferable to #1.

I’m sure there’s a way to preserve the flexibility while being fair to all of our investors. We’ll be discussing this with our lawyer soon and posting a follow-up. In the meantime feel free to comment away.

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  • jon
    We ended up going with a 2/3 majority to be able to amend terms of the note. We feel that this gives adequate flexibility to make changes that could more easily lead to a Series A while at the same time decreasing the likelihood that one or two note holders could dictate their interests on the rest of the group.
  • i'm not an expert, but you might check out discussions by Brad Feld and Josh Kopelman on these topics. they have a bias, but their writing is educational.
  • brad and josh's writings have been super educational for us, and a big help. at the same time, there's very little out there written from the entrepreneur's perspective, which is what we're trying to provide.

    thanks for stopping by, dave!
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