{"id":179867,"date":"2023-03-01T03:32:05","date_gmt":"2023-03-01T03:32:05","guid":{"rendered":"https:\/\/legalvision.co.uk\/?p=179867"},"modified":"2025-07-02T00:38:32","modified_gmt":"2025-07-01T23:38:32","slug":"due-diligence-convertible-note-term-sheet","status":"publish","type":"post","link":"https:\/\/legalvision.co.uk\/startups\/due-diligence-convertible-note-term-sheet\/","title":{"rendered":"Due Diligence When Reviewing a Convertible Note Term Sheet"},"content":{"rendered":"\n<p>If you want to raise capital for your business, convertible notes are an attractive option because they combine features common to both <a href=\"https:\/\/legalvision.co.uk\/startups\/raise-finance-debt-equity\/\">debt and equity<\/a>. In practice, your business and the outside investors will negotiate the terms of the convertible note financing. The negotiated terms will then be included in the convertible note term sheet. This article examines critical due diligence considerations when reviewing a convertible note term sheet prepared by a potential investor.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Convertible Notes<\/h2>\n\n\n\n<p><a href=\"https:\/\/legalvision.co.uk\/startups\/what-happens-when-convertible-note-converts\/\">Convertible notes<\/a> behave like a loan from an investor to your business when you first execute the convertible note agreement. According to the convertible note term sheet, the investor will give your business cash to be repaid. However, it differs from a conventional loan because the term sheet will set out certain conditions that convert the loan from a debt obligation to shares in the company. At this point, the convertible note holders cease to be lenders and become shareholders.&nbsp;<\/p>\n\n\n\n<div  class=\"box box--icon box--info\">\n    <p>The exact circumstances that must be fulfilled to convert the loan to shares are a substantial source of negotiation. Therefore, before you sign the convertible note term sheet, you should undertake appropriate due diligence to ensure the agreement benefits your business.<\/p>\n<\/div>\n\n\n\n<h2 class=\"wp-block-heading\">Founders\u2019 Warranties&nbsp;<\/h2>\n\n\n\n<p>All financing term sheets contain warranties. These are statements of facts the business and its owners give investors about the state of the business, such as its value and liabilities. If the investor later determines the statements are incorrect, they can sue you and your business for damages.&nbsp;<\/p>\n\n\n\n<p>Convertible term sheet warranties are likely to contain warranties common to both traditional loan agreements and equity investments. These include warranties related to:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>the value of the business and valuation method used;&nbsp;<\/li>\n\n\n\n<li>disclosure of all known and potential liabilities like contractual obligations and debts; and<\/li>\n\n\n\n<li>ownership rights of valuable assets, such as a statement that the business\u2019 intellectual property vests with the startup company and not the founders.&nbsp;<\/li>\n<\/ul>\n\n\n\n<p>You want to ensure that these warranties are reasonable. For instance, say you agree to a warrant that there is no litigation in contemplation against your business. At the time you make it, you believe this to be true. But, unbeknownst to you, a former employee intends to sue you, which they do after you execute the convertible agreement. As a result, the investor could hold you liable for breach of warranty because it is unfairly worded to hold you liable for circumstances outside your control and knowledge.<\/p>\n\n\n\n\n<a href=\"#content-next\"\n   class=\"block p-4 mt-10 text-xl font-bold text-center text-white no-underline bg-gray-800 rounded-t-xl\">\n    Continue reading this article below the form\n    <i class=\"text-xl fa-regular fa-arrow-down\"><\/i>\n<\/a>\n<div class=\"px-6 pt-10 pb-12 mb-10 text-center bg-gray-100 rounded-b-xl sm:px-12 test\">\n    <div class=\"mb-8 text-2xl font-bold text-orange\">\n        Need legal advice?\n        <br>\n        <span class=\"text-lg not-prose\">\n                            Call <a href=\"tel:+448081968584\" class=\"not-prose\">0808 196 8584<\/a> for urgent assistance.\n                <br>\n                Otherwise, complete this form, and we will contact you within one business day.\n                    <\/span>\n    <\/div>\n\n    \n\n<div class=\"not-prose flex 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You should ensure such trigger events align with your business\u2019 long-term goals. For instance, if the trigger events entitle the note holders to exercise their conversion rights absolutely in five years, this may adversely impact a future fundraising round. You may therefore wish to negotiate a provision that entitles you to delay the trigger event if a Series A financing round is due to close.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Valuing the Conversion Rights&nbsp;<\/h2>\n\n\n\n<p>When the convertible notes convert to shares, the holders become shareholders in your company. This impacts existing shareholders\u2019 proportion of share ownership. Therefore, you want to ensure that the conversion formula does not grant the convertible notes too many shares in your business.&nbsp;<\/p>\n\n\n\n<div  class=\"box box--icon box--info\">\n    <p>Your legal and financial advisers will work with you to develop a conversion formula that does not unduly compromise existing shareholders\u2019 rights in the business.<\/p>\n<\/div>\n\n\n\n<h2 class=\"wp-block-heading\">Confidentiality and Exclusivity Clauses&nbsp;<\/h2>\n\n\n\n<p>The purpose of a <a href=\"https:\/\/legalvision.co.uk\/documents\/heads-of-agreement\/\">term sheet<\/a> is to specify the key terms the parties have agreed to in principle. Parties rarely intend term sheets to have a legal effect because there is often a lot to negotiate before parties execute the agreement.&nbsp;<\/p>\n\n\n\n<div  class=\"box box--icon box--info\">\n    <p>While term sheets are generally not legally binding, terms relating to confidentiality and exclusivity clauses often are.<\/p>\n<\/div>\n\n\n\n<p>Investors require access to most of your business\u2019 sensitive information to investigate your business adequately. As a business owner, you want to ensure that even if negotiations fall apart, the investors cannot disclose the contents of your business to third parties. Accordingly, a term sheet often contains a legally binding confidentiality clause.&nbsp;<\/p>\n\n\n\n<p>Negotiating a convertible note investment is time-consuming and costly. They want to ensure you are not negotiating with other potential investors. Therefore, they may implement an exclusivity clause. This obligates you to deal with them throughout the negotiations.&nbsp;<\/p>\n\n\n\n    <div class=\"my-7 lg:my-10 border-y-2 border-gray-100 py-7 lg:py-10 flex flex-col sm:flex-row items-start gap-10\">\n                    <img decoding=\"async\" class=\"w-52 mx-auto my-0! rounded\" src=\"https:\/\/img.legalvision.com.au\/wp-content\/uploads\/sites\/4\/2022\/09\/06164254\/uk-startup-manual-290x410-1.jpg\" alt=\"Front page of publication\"\n                 loading=\"lazy\" width=\"208\" height=\"298\">\n                <section>\n            <div class=\"text-2xl font-bold\">UK Startup Manual<\/div>\n            <div class=\"body-text\">\n                <p>LegalVision&#8217;s Startup Manual is essential reading material for any startup founder looking to launch and grow a successful startup.<\/p>\n            <\/div>\n            \n\n<a href=\"https:\/\/go.legalvision.co.uk\/uk-startup-manual.html\" class=\" block px-5 py-3.5 max-w-fit bg-orange button__hover transition rounded text-white font-bold text-lg no-underline uppercase leading-tight text-center\" target=\"\" rel=\"\">Download Now<\/a>        <\/section>\n    <\/div>\n\n\n\n\n<h2 class=\"wp-block-heading\">Key Takeaways&nbsp;<\/h2>\n\n\n\n<p>Convertible loans are one form of financing available to your startup. It combines debt and equity financing. Hence, you want to conduct proper due diligence when reviewing the term sheet, which includes the:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>value of the investment;<\/li>\n\n\n\n<li>repayment schedule; and&nbsp;<\/li>\n\n\n\n<li>trigger events.&nbsp;<\/li>\n<\/ul>\n\n\n\n<p>If you need help with your startup, our experienced <a href=\"https:\/\/legalvision.co.uk\/business-sale-purchase-lawyers-lp\/\">business lawyers<\/a> can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on <a href=\"tel:+448081968584\" class=\"AVANSERnumber dynamic-number\">0808 196 8584<\/a> or visit our <a href=\"https:\/\/legalvision.co.uk\/membership\/\">membership page<\/a>.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Frequently Asked Questions<\/h2>\n\n\n\n<div class=\"schema-faq wp-block-yoast-faq-block\"><div class=\"schema-faq-section\" id=\"faq-question-1677641156604\"><strong class=\"schema-faq-question\"><strong>What is a convertible note term sheet?<\/strong><\/strong> <p class=\"schema-faq-answer\">When negotiating a convertible loan, a term sheet is a critical document that details the essential commercial terms of the investment. However, it does not usually have a legal effect, which means it is not binding on the parties.<\/p> <\/div> <div class=\"schema-faq-section\" id=\"faq-question-1677641170823\"><strong class=\"schema-faq-question\"><strong>What are the key terms in a convertible note term sheet?<\/strong><\/strong> <p class=\"schema-faq-answer\">Typically, a convertible note term sheet will detail the value of the investment, the repayment schedule, the interest rate, and the trigger events.<\/p> <\/div> <\/div>\n<div class=\"not-prose m-feedback-prompt\">\n    <!-- Thumbs up\/down bar -->\n    <div class=\"m-feedback-prompt__main\">\n        <div class=\"m-feedback-prompt__title\">Was this article helpful?<\/div>\n        <div>\n            <!--span class=\"m-feedback-prompt__button--text\">Thanks!<\/span-->\n            <button type=\"button\" class=\"m-feedback-prompt__button m-feedback-prompt__button--yes\"\n                    data-analytics-link=\"feedback-prompt:yes\" aria-label=\"Agree\">\n                <i class=\"fa-regular fa-thumbs-up fa-3x\"><\/i>\n            <\/button>\n            <button type=\"button\" class=\"m-feedback-prompt__button m-feedback-prompt__button--no\"\n                    data-analytics-link=\"feedback-prompt:no\" aria-label=\"Disagree\">\n                <i class=\"fa-regular fa-thumbs-down fa-3x\"><\/i>\n            <\/button>\n        <\/div>\n    <\/div>\n\n    <!-- Feedback form -->\n    <div class=\"m-feedback-prompt__form\">\n        <div class=\"m-feedback-prompt__form--thanks \">\n            <div>Thanks!<\/div>\n            <p>\n                We appreciate your feedback \u2013 your submission has been successfully received.            <\/p>\n        <\/div>\n        <form id=\"contact-form\" class=\"m-feedback-prompt__form--form\" action=\"\" method=\"post\">\n            <input type=\"hidden\" id=\"authenticity_token\" name=\"authenticity_token\" value=\"488c9024c8\" \/><input type=\"hidden\" name=\"_wp_http_referer\" value=\"\/api\/wp\/v2\/posts\/179867\" \/>            <input value=\"https:\/\/legalvision.co.uk\/startups\/due-diligence-convertible-note-term-sheet\/\" type=\"hidden\" name=\"currenturl\"\n                   id=\"currenturl\">\n            <input value=\"Due Diligence When Reviewing a Convertible Note Term Sheet\" type=\"hidden\" name=\"currenttitle\"\n                   id=\"currenttitle\">\n            <label>\n                <!-- display on thumbs-up -->\n                <span class=\"m-feedback-prompt__feedback m-feedback-prompt__feedback--yes\">\n                    Can you tell us <span class=\"font-semibold\">why<\/span> you found it helpful?\n                <\/span>\n\n                <!-- display on thumbs-down -->\n                <span class=\"m-feedback-prompt__feedback m-feedback-prompt__feedback--no text-lg\">\n                    How can we better improve this article?\n                <\/span>\n                <textarea name=\"feedbackmessage\" id=\"feedbackmessage\" required><\/textarea>\n            <\/label>\n\n            <div class=\"m-feedback-prompt__form--error\" id=\"form-submit-error\"><\/div>\n            <button id=\"submit-contact-form-button\" type=\"submit\" name=\"commit\" class=\"m-feedback-prompt__form--submit\"\n                    data-analytics-link=\"feedback-prompt:submit\">\n                Submit            <\/button>\n        <\/form>\n    <\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>If you want to raise capital for your business, convertible notes are an attractive option because they combine features common to both debt and equity. In practice, your business and the outside investors will negotiate the terms of the convertible note financing. The negotiated terms will then be included in the convertible note term sheet.<a href=\"https:\/\/legalvision.co.uk\/startups\/due-diligence-convertible-note-term-sheet\/\">Continue reading <span class=\"sr-only\">&#8220;Due Diligence When Reviewing a Convertible Note Term Sheet&#8221;<\/span><\/a><\/p>\n","protected":false},"author":13522,"featured_media":3211,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_relevanssi_hide_post":"","_relevanssi_hide_content":"","_relevanssi_pin_for_all":"","_relevanssi_pin_keywords":"","_relevanssi_unpin_keywords":"","_relevanssi_related_keywords":"","_relevanssi_related_include_ids":"","_relevanssi_related_exclude_ids":"","_relevanssi_related_no_append":"","_relevanssi_related_not_related":"","_relevanssi_related_posts":"176630,2790,175385,2650,176934,175938","_relevanssi_noindex_reason":"","editor_notices":[],"footnotes":""},"categories":[31],"tags":[117,297,483,501],"class_list":["post-179867","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-startups","tag-startup","tag-confidentiality","tag-term-sheet","tag-convertible-note"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast 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