What Terms Determine Whether a Convertible Instrument Is Repaid or Converted?
Short answer. The agreement's conversion triggers, maturity date, repayment terms, and election rights determine whether a convertible instrument becomes shares or remains debt. Check what happens if no trigger occurs, whether conversion is automatic, and how price and accrued interest are handled. Have counsel explain the terms in each possible outcome.
The written agreement determines whether a convertible instrument turns into shares or must be repaid. Focus on the conversion events, maturity date, repayment obligation, and any election rights held by the company or lender. The practical outcome depends on how these terms interact, especially if the expected financing or other trigger never happens.
Read the Conversion Conditions
Identify each event that can cause conversion. The source material describes triggers such as a future investment round, a revenue threshold, a public listing, or a sale of the business. The document should specify whether conversion is automatic, whether a party must elect it, and whether all or only part of the debt converts.
Check the required conditions for a financing round. The agreement may define a minimum amount raised, the type of security issued, or other requirements. If a transaction falls outside those definitions, the parties may disagree about whether conversion applies. The convertible loan terms founders should review include the trigger and conversion mechanics.
Check Maturity and Repayment Rights
Find the maturity date and determine what is due then if the instrument has not converted. Review whether the company must repay principal and interest, whether the lender can extend the term, and whether the lender has another conversion option. Confirm what default means under the agreement and what remedies follow. Do not assume an unsuccessful financing automatically extends repayment.
Interest treatment also matters. The documents should state whether interest is paid in cash, added to the balance, or included in the amount that converts. Check whether a conversion price is determined by a discount, a cap, or another formula. Have the finance team model the share count and cash due under each scenario so you can see the company's obligations.
Resolve Unclear Outcomes Before Signing
Ask for the agreement to address what happens if the company is sold, reaches a revenue target, raises a smaller round than expected, or has no qualifying financing before maturity. Confirm whether the lender has a choice among repayment and conversion, and whether the company has any corresponding right. Ambiguity around these outcomes can create a dispute precisely when the company has limited time and cash.
Review the instrument alongside any other notes, equity commitments, or financing documents. The conversion cap and ownership terms may affect dilution if the debt converts. Have your attorney review the contract and talk with your CPA about tax specifics. Make the repayment and conversion paths clear to the company, lender, and future investors.
Read next: What can a company negotiate if an investor wants to fund in stages?
In this model, financing is provided, and then, upon a trigger event, part or all of the debt is converted into equity.
Sources: The Single Family Office. Informational only, not financial, legal or tax advice.