Private convertible notes are typically used as bridge facilities pre-valuation or between rounds. For high growth businesses, the general expectation is for funding rounds to be 12 to 18 months apart. Convertible notes typically have a 24- to 36-month tenor. This gives ample cushion, if the business is hitting its projections and the private markets are open. However, under choppy business or fundraising conditions (or both), convertible notes may hit maturity before conversion.
This situation should not be ignored. Amend-and-extend should be considered the minimum course of action. Management should provide a reasonable reassessment of whether and when a subsequent round (or repayment of the note) can be achieved. Time is of the essence. Every month of cash burn potentially reduces the amount available for (partial) repayment of the note, if it eventually comes to that. In some cases, relationship preservation may be viewed as more important than financial recovery, ie, forgive-and-forget. However, without question, managers handling “OPM” should take all prudent steps to minimize the downside.
Things That Might Be Missing from Your Non-Disclosure Agreement
Extended protection for long-term trade secrets: Trade secrets are IP rights without legal protection unless they are kept confidential. Some trade secrets (like the secret recipe for Coca-Cola) are potentially valuable forever. Therefore, a typical 2-year confidentiality term would not be appropriate.
“Underlying agreements” clause. Sometimes the contracts being disclosed are subject to their own specific confidentiality agreements. This might appear in major contracts with other parties not involved in your particular deal. This might include lease agreements, loan agreements, licensing agreements and joint venture agreements, to name a few. These specific confidentiality obligations need to be respected, especially if they are stricter than the terms of your typical NDA.
Language clause and foreign language versions: For international deals, contracts with parties from some countries must be made in the relevant national language to be enforceable. Dual-language contracts are a common approach, but then you need to specify which language governs if there is a discrepancy between the two languages.
Investors and advisers have been speculating that successful 2020 M&A deals will increasingly rely on earnouts to bridge the valuation gap. Earnouts are deferred consideration to sellers, based on a company’s achievement of agreed financial or non-financial metrics. The rationale is simple: all things being equal, business owners may be rightfully shy about an exit when asset prices are at historical lows. For many businesses, 1H 2020 performance will not provide an accurate picture of value, and the current environment makes reliable forecasting especially difficult. Earnouts can address this, keeping founders, management and new owners and investors properly aligned.