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Why Convertible Debentures offer startups an attractive way to raise funds

Woodbridge corporate and securities lawyer, Joseph Chiummiento, of Core Lawyers, helps you understand raising money by using convertible debentures.

When you or your company raises money from investors, the basic premise is that you are receiving funds in exchange for something you are giving to the investors.  In legal language, you/the company is giving “securities” or an interest in the company to the investor.

What is a Convertible Debenture?

A convertible debenture is one mechanism a startup or early stage public company can use to raise funds and is generally more favoured by investors.  It is a loan to the company that is convertible into shares of the company at a later date and typically at a set price.  The debenture also usually requires the company to pay an interest rate on the amount of the loan.

Well–known investors such as Warren Buffett, Bill Gates and others are known to use convertible debentures as ways to help capitalize companies looking for funding to build out their business and growth plans yet minimize their risks.

How to Structure a Convertible Debenture

As a general rule, convertible debentures are contracts and for the most part are negotiable once it has been determined both parties are in agreement with moving forward.  As a company or investor, these additional considerations should be discussed with your legal counsel:

• Is there a mechanism in the contract that can “force” conversion to shares so that the company doesn’t have to pay the funds back and can convert it to equity?
• Is there a right to extend the term in the event the market changes or the timelines for milestones are off?
• Is there a cure provision allowing a set time to manage default in repayments of interest or the loan?
• If your company is a public company, what do the securities laws and regulations require with respect to the exercise price – such as current market price, discounts to market price and related disclosure issues needed for news releases.
• Are the investors accredited investors?
• What filings are required with the Ontario Securities Commission for both private companies and public companies to comply with applicable laws?

Be sure to discuss these and any other questions you have with your advisors.

A Note of Caution

As a company raising money via convertible debenture, you have to remember that a convertible debenture is a loan and has to be repaid as a debt of the company. If not repaid, the debt holder can take action to recover the debt and that could include seizing the assets of the company.  If you are a tech company that means your source code or intellectual property (ie. your creation) could be open to seizure.  A mining or energy company could lose its interest in the mining or oil & gas property.

Understanding both, the opportunities and the risks, when negotiating for a convertible debenture is crucial to ensure your money raising efforts are benefiting your emerging business not just in the near-term but also in the future.

Feel free to get in touch with me directly to discuss your situation or any questions you may have about raising money for your business.