August 2, 2023
Capital Markets: Pre-IPO Converts
Late-stage pre-IPO companies looking for financing alternatives may want to consider issuing convertible securities. This Cooley blog reviews “pre-IPO converts” and discusses the key considerations that companies thinking about issuing these securities should keep in mind. This excerpt provides an overview of the terms of a typical pre-IPO convert:
A pre-IPO convert is a debt instrument issued by a private company, typically as the last financing round before an IPO. While public company convertible bonds are fairly standardized debt securities, pre-IPO converts tend to have a variety of negotiable structures and features, which also make them more complex than a traditional equity financing or convertible note bridge round.
The key feature of a pre-IPO convert is that, upon some future date or event, such as 2-3 years after issuance or upon an IPO which meets certain size and liquidity criteria, the debt becomes convertible at the option of the noteholder (or, in some cases, is mandatorily converted) into shares and/or cash based on the stock price at the time of the conversion event. Until the conversion event or maturity, the convertible note (or “convert”) is effectively a straight debt instrument. Some pre-IPO converts may be redeemed by the company in cash in limited circumstances (typically at a substantial premium).
In addition, pre-IPO convert structures tend to provide for an increasing interest rate and decreasing conversion price as the time to IPO or other conversion event increases. Features, such as cash interest vs. PIK, incurrence covenants, information rights, boards seats, subsidiary guarantors, collateral, guaranteed minimum internal rate of returns, valuation cap, conversion price resets and registration rights are much more common in pre-IPO converts.
The blog goes on to discuss the type of investors who are typically interested in these securities, the pros and cons for investors in these transactions, and the key considerations in negotiating a pre-IPO convert. It also includes a chart comparing and contrasting the terms of public converts and pre-IPO converts.
– John Jenkins