Some companies outgrow bank debt, and some never fit it. Selling notes to investors gives an issuer longer maturities, fewer maintenance covenants, and a broader buyer base, at the cost of securities law disclosure and indenture terms that are hard to change once the notes are out. At the earlier end of the market, convertible notes and note purchase agreements are how many technology companies raise money before a priced equity round. We advise issuers at both ends, with a focus on growth-stage and middle market companies, and we keep the debt terms consistent with the company's equity structure and cap table.
Notes Versus Loans
The choice between a note offering and a loan usually turns on size, timing, and flexibility. High-yield notes issued by companies below investment grade carry incurrence covenants, which restrict the issuer only when it takes an action such as borrowing more or paying a dividend, rather than maintenance covenants tested every quarter. Investment-grade notes carry very few covenants at all. Private placements to insurance companies and other institutional buyers sit between the two, often under a note purchase agreement with financial covenants. Convertible notes, used by public companies and startups alike, trade some interest cost for the investor's right to convert into equity.
The Securities Law Framework
Notes are securities. A public offering must be registered under the Securities Act of 1933, so most debt deals rely on exemptions. In a Rule 144A offering, the issuer sells to initial purchasers under Section 4(a)(2), and they resell to qualified institutional buyers; Regulation S covers offers and sales outside the United States. Startup convertible notes are usually sold under Regulation D Rule 506(b) or 506(c), with a Form D due within 15 days of the first sale. The Trust Indenture Act of 1939 requires a qualified indenture and an eligible trustee for registered debt, and its Section 316(b) protects each holder's right to payment. Rule 10b-5 applies to every offering.
Indentures, Covenants, And Conversion Terms
For issuers, the work concentrates in the indenture and the offering memorandum. We negotiate the covenant package, including limitations on debt, liens, restricted payments, asset sales, and affiliate transactions, along with change of control puts, optional redemption and make-whole provisions, and the amendment thresholds that decide how hard the terms will be to change later. For convertible notes, we draft the conversion mechanics, valuation caps and discounts, the maturity and qualified financing definitions, and the treatment of a sale of the company before conversion. We also review how the notes interact with existing credit facilities, intercreditor arrangements, and the rights of preferred stockholders.
Noteholder Disputes
Disputes over notes are governed by the indenture and the securities laws, and they usually involve sophisticated counterparties. With our litigation practice, we handle claims that an issuer breached a covenant, challenges to amendments made through exit consents, disputes over whether a make-whole premium is owed after acceleration, and Section 316(b) claims following an out-of-court restructuring. Indentures typically contain no-action clauses that require holders to go through the trustee first, and that procedure often shapes the case. For startups, the typical dispute is whether a financing triggered conversion, how the conversion price was calculated, or whether a sale of the company entitled holders to a multiple of principal.
Mistakes Issuers Make
The most common error in a convertible note round is drafting the note in isolation, without modeling what conversion will do to the cap table in a likely next round. Another is skipping the Form D and state notice filings, which does not by itself destroy the exemption but creates avoidable problems in later diligence. In larger offerings, issuers sometimes accept covenant definitions copied from a precedent deal without testing them against their own plan, then find that a planned acquisition or dividend is blocked. Disclosure is the other recurring problem. Risk factors and descriptions of the business and its technology must be accurate, because the offering memorandum is the document a plaintiff will quote.
