Introduction

The last few years have seen a dramatic increase in the use of convertible instruments for early stage financings. The two primary means of effecting these financings are SAFEs (Simple Agreement for Future Equity) and Convertible Promissory Notes (“Convertible Notes”). The former typically utilizes established form agreements created by the Y Combinator accelerator. By contrast, Convertible Notes do not have a single established form, making review more time consuming and expensive. 

While Convertible Notes offer investors more protection than SAFEs, they still fall well short of the protections and “best practice” governance provisions of priced equity rounds, which also have industry-wide templates available such as that of the National Venture Capital Association. Until they are converted, both SAFEs and most current forms of Convertible Notes provide their holders with minimal control or fiduciary rights. More sophisticated investors have routinely “bulked up” their protection under Convertible Notes through the use of side letters and note purchase agreements that provided them with additional rights. 

The Angel Capital Association formed a task force of established early-stage investors and attorneys who routinely represent both founders and investors in early stage financings in order to streamline the use of convertible notes for companies which have decided to delay the offering of an equity financing. Its mandate was to create an enhanced model convertible promissory note that would combine common convertible promissory note provisions with “best practice” provisions often found in side-letters or note purchase agreements. The goal of the task force was to create a form document balancing the rights of founders and investors, and to include common alternative provisions for consideration. Drafts of a model term sheet and convertible note were shared with several leading angel groups for feedback. To the extent possible, the task force looked to industry data, including from Carta and the Angel Capital Association database, to analyze the market prevalence of various terms. 

The task force will update the model documents periodically to reflect changes in applicable laws and market terms, so please check the Angel Capital Association website to ensure use of the most current template.

Key Additions:

The proposed Convertible Promissory Note has several key additions that reflect provisions often found in the note purchase agreements and side letters required by early-stage investors. Many of these provisions have explanations and alternative provisions provided in footnotes. 

Included are:

1. Expanded Representations and Warranties – the goal is to focus on critical information that early stage investors want and that does not require significant time for the company to compile. An effort was made to avoid representations that are more relevant to later stage companies.
2. A Participation Right in Future Financings
3. Select Information Rights
4. A Most Favored Nations Provision as an option
5. A Board Observer Seat (optional, with an alternative for a full Board Seat noted)
6. A provision for compliance with the Corporate Transparency Act
7. Protective Provisions that require the approval of a majority of the noteholders with respect to select corporate acts while the notes are outstanding.

We hope that this form convertible promissory note will support the early-stage venture ecosystem by making this type of financing transaction more efficient (both from a cost and time perspective), establishing “best practice” industry standards, educating those using convertible notes and balancing the interests of the investor and the issuing company. 

Task Force Members:

• Chair: Elizabeth D. Sigety, Esq. – Fox Rothschild, LLP and Delaware Crossing Investor Group
• Mark Friedman – RTP Capital
• Dror Futter, Esq. – Rimon Law
• John Habbert – Queen City Angels
• Sonu Mirchandani – College of Business and Technology, ETSU
• Benamin David Novak, Esq. – Morgan, Lewis & Bockius LLP and Delaware Crossing Investor Group
• Clay Rankin – North Coast Ventures
• Ronald Weissman – Band of Angels
• And thank you to past task force members, David Sikes, Esq. of Goodwin Law and Joe Wallin, Esq. of Carney Law.