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Overview

The Series Seed Convertible Note Term Sheet outlines the principal terms for a debt-based seed financing. Unlike equity financing, investors initially receive debt (promissory notes) that later converts into equity under specified circumstances.
This term sheet is an expression of intent only and does not express the agreement of the parties. It is not meant to be binding except as specifically noted, and is meant to be used as a negotiation aid.

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Document Information

Source: Cooley LLP Series Seed
Format: Available in .md
Documentation Generator: cooleygo.com/seednotes/

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Why Convertible Notes?

Convertible notes offer several advantages for seed-stage companies:
Notes can be issued more quickly than equity securities because they:
  • Don’t require a valuation discussion upfront
  • Avoid amending the certificate of incorporation immediately
  • Require fewer legal documents
  • Don’t require stockholder approval
Valuation is determined at a later equity financing round when the company has more traction and data, potentially resulting in a fairer valuation for both parties.
Useful as a bridge to a larger priced equity round, allowing companies to raise capital quickly while preparing for a more substantial financing.

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Key Terms

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Basic Structure

The total amount to be raised, either:
  • Specified amount (e.g., “Up to $500,000”)
  • Unspecified with identified investors
Multiple Closings: Amounts may be funded in multiple closings, allowing the company to bring in investors over time.
The date when outstanding principal and unpaid accrued interest become due and payable.Timing Options:
  • Specific date (e.g., “December 31, 2026”)
  • Duration from initial closing (e.g., “18 months from initial closing”)
Payment Trigger: Due upon request of Majority Holders made on or after the Maturity Date
If notes are not converted or repaid by the maturity date, they become due and payable, which could create financial pressure on the company.
Annual interest rate on outstanding principal, typically:
  • Range: 2-8% per annum
  • Simple or compounded annually
  • Accrues from date of note issuance
Calculation: Based on 365-day year for actual days elapsedExample: 100,000noteat5100,000 note at 5% simple interest for 12 months = 5,000 interest

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Conversion Mechanics

Qualified Financing Definition: An equity financing where the company sells equity securities with aggregate proceeds of not less than a specified threshold (commonly 500,000to500,000 to 1,500,000), excluding conversion of notes.Conversion Formula Options:
  1. Discount Only: 
    Conversion Price = Qualified Financing Price × Discount Percentage
Example: $1.00 per share × 80% = $0.80 per share
  2. Cap Only: 
    Conversion Price = Valuation Cap / Fully-Diluted Shares
Example: $5,000,000 cap / 10,000,000 shares = $0.50 per share
  3. Discount AND Cap (investor gets better of two): 
    Conversion Price = Lesser of:
(a) Qualified Financing Price × Discount Percentage
(b) Valuation Cap / Fully-Diluted Shares
Automatic Conversion: Upon a Qualified Financing, principal and accrued interest automatically convert into the securities sold in that financing.
The company may have the option to convert notes into a newly created series with identical rights to the Qualified Financing securities but at the discounted conversion price.
If the company raises equity that doesn’t meet the Qualified Financing threshold:Majority Holders Option: Holders of majority of outstanding principal may elect to treat the financing as a Qualified FinancingIndividual Holder Option: Each investor may individually elect to convertThis gives noteholders flexibility to convert even in smaller rounds.
If notes remain outstanding at Maturity Date:Automatic Conversion (if specified):
  • Converts without further action
  • Into common stock or newly created preferred stock
  • At conversion price based on predetermined valuation
Optional Conversion (if specified):
  • Majority Holders or individual Holder may elect to convert
  • Or may elect to demand repayment instead
Conversion Price Formula:
Conversion Price = Valuation Cap / Outstanding Common Shares

Example: $4,000,000 cap / 8,000,000 shares = $0.50 per share
Share Count: May be calculated as of maturity date or as of note date
If the company is acquired before notes convert:Option 1: Cash Repayment:
  • Outstanding principal + accrued interest
  • Optional: Additional repayment premium (commonly 50-200% of principal)
Option 2: Conversion to Common (if provided):
  • Investor may elect to convert to common stock
  • Using predetermined conversion price
  • Allows investor to participate in acquisition proceeds
Change of Control Definition:
  • Merger or consolidation (where company is not surviving entity)
  • Transfer of more than 50% of voting power
  • Sale of substantially all assets

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Additional Provisions

If the company issues other convertible debt with more favorable terms:
  1. Notice Requirement: Company must notify existing noteholders within 30 days
  2. Documentation: Provide copies of all new debt documentation
  3. Election Period: Holders have 5 days to elect to receive new terms
  4. Amendment: Company must amend existing notes to match new terms
MFN provisions protect early investors from being disadvantaged if the company later issues debt with better terms.
Standard Terms: Company may not prepay notes without consent of Majority HoldersRationale: Prevents company from forcing repayment when investors prefer to maintain their conversion option
Notes are typically unsecured obligations, meaning:
  • No collateral pledged
  • No liens on company assets
  • Subordinate to senior bank debt
In bankruptcy, unsecured noteholders rank below secured creditors but above equity holders.

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Maturity Conversion Terms

If notes convert at maturity into a newly created series of preferred stock:
Liquidation Preference: Original purchase price prior to common stock distributionConversion Rights: 1:1 to common stock at holder’s option, subject to adjustmentsAutomatic Conversion: Upon IPO or consent of majority of preferred holdersVoting Rights: Equal to common stock on as-converted basisProtective Provisions: Majority consent required to:
  • Adversely alter rights of the series
  • Change authorized number of shares
Market Stand-Off: 180-day lock-up following IPO (if officers/directors similarly bound)
May include:Pro Rata Rights: Right to purchase proportionate share of future offerings
  • Terminates at IPO or after 7 years
Information Rights:
  • Annual unaudited financial statements
  • Quarterly unaudited financial statements
  • Terminates at IPO

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Documentation

Documents will be prepared using forms available at https://cooleygo.com/seednotes/, which are substantially similar to the automated document generator forms.
The note financing package includes:
  • Convertible Promissory Note (for each investor)
  • Board Consent (approving note issuance)
  • Investor Questionnaire (for securities law compliance)

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Comparison: Discount vs. Cap vs. Both

FeatureDiscount OnlyCap OnlyDiscount + Cap
Investor BenefitModerateModerate-HighHighest
ComplexitySimpleSimpleMore Complex
Upside PotentialLimitedCan be significantMaximum
Common UsageLess commonCommonMost common
Assumptions: 100Knote,20100K note, 20% discount, 5M capScenario 1: Qualified Financing at $10M valuation
  • Discount only: 20% discount on 10M=10M = 8M effective valuation
  • Cap only: $5M cap (better for investor)
  • Discount + Cap: $5M cap applies (investor gets better deal)
Scenario 2: Qualified Financing at $4M valuation
  • Discount only: 20% discount on 4M=4M = 3.2M effective valuation (better)
  • Cap only: $5M cap
  • Discount + Cap: Discount applies (investor gets better deal)

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Common Negotiation Points

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For Companies

  • Lower discount percentage (15-20% is typical)
  • Higher valuation cap or no cap
  • Higher Qualified Financing threshold
  • Longer maturity date
  • No repayment premium on change of control

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For Investors

  • Higher discount percentage (20-25%)
  • Lower valuation cap
  • Both discount and cap
  • Shorter maturity date
  • MFN protection
  • Repayment premium on change of control

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Advantages and Disadvantages

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Advantages for Companies

  • Quick to execute (no valuation negotiation)
  • Less dilutive initially (debt vs. equity)
  • No immediate impact on cap table
  • Board-only approval (no stockholder consent)
  • Lower legal costs

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Advantages for Investors

  • Discount to future round price
  • Downside protection (debt instrument)
  • Interest accrual
  • Ability to participate in upside via conversion
  • Senior to equity in liquidation

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Disadvantages

  • Creates debt obligation that may become due
  • Can complicate future equity rounds
  • May result in unexpected dilution if cap is low
  • Interest accrues, increasing conversion amount
  • Complex cap table if many notes outstanding

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Best Practices

Keep track of all outstanding notes, interest calculations, and conversion triggers. Multiple tranches of notes with different terms can create significant complexity.
  1. Document everything: Maintain a detailed schedule of all notes, terms, and accrued interest
  2. Plan for conversion: Model various scenarios to understand potential dilution
  3. Coordinate terms: Try to keep terms consistent across multiple investors
  4. Consider timing: Ensure maturity date provides adequate time to raise equity round
  5. Communicate clearly: Keep noteholders informed of company progress and financing plans

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Additional Resources

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