Categories
Investing

Legal Matters: Convertible Note Gotcha’s

I’ve never invested with Convertible Notes before, the idea has always had a funny smell that’s put me off. I feel too inexperienced with Convertible Notes, and therefore don’t feel like I know all the risks and things to look out for when buying Convertible Notes.

What Are Convertible Notes?

Convertible Notes are an alternative to buying shares, in order to invest in a company. Essentially Convertible Notes are a legal contract that defines a thing you get, which at some point should convert into actual shares in the company.

Convertible Notes are a great way to invest if it’s hard to place a value on the company. For example, if a company has limited financial history making a valuation difficult, then Convertible Notes can be used to invest, such that the notes convert into shares after a period of time has passed that would enable a valuation. The value that they would convert into would then be based on that future value and an investor would either get a large chunk of a small company, or a small chunk of a big company.

Problems With Convertible Notes (From An Investors Perspective)

Like any legal contract, you have to read and understand the terms so you don’t get caught out. You also need experience in the area to know what gotcha’s need covered off, and what snakes could be hiding in the long grass.

As I am inexperienced when it comes to investing in companies via Convertible Notes, I thought it might be useful to use this article to store information about Convertible Note gotcha’s that I come across or can think of. I expect this list to grow organically as I discover new information or am forced to investigate this more thoroughly due to investment opportunities popping up with Convertible Notes. If you are aware of things that should be added to the list, please leave a comment below.

  • Convertible Notes must have a condition that ensures that they convert into shares, and it must be impossible for that condition not to not come true, otherwise the Convertible Notes will never be worth anything.
    An example of a Convertible Note that never matures would be one that is converted to shares based on the market value ascribed at the next capital raising. Existing shareholders / directors could then ensure that they never raise any more capital, causing the Convertible Notes never to convert to shares.
  • You don’t have the same rights as a shareholder, which means the terms of your investment could change if the existing shareholders vote to change the Company Constitution.
  • In the case of investing in very early stage companies, the (typically 20%) discount to the next capital raise that you get in buying the Convertible Notes is probably not enough to represent the level of risk of investing in a less mature company – so the risk premium is not fairly reflected in the price of the Convertible Notes.
  • What happens if the company is bought out? Is this covered by the conditions of the note?
  • What happens if the subsequent fund raise which dictates the value of your Convertible Notes is not at arms length from the existing shareholders? They could manipulate the share price higher, so you don’t get fair value for your investment.
Categories
Business

Do I Need To Repay The Wage Subsidy?

A few weeks ago I wrote an article about the economic future of NZ, in which I praised the government’s reaction to COVID19 and the associated financial policies arising from it. Specifically I said that I liked the wage subsidy as an implementation of Helicopter Money.

Why I liked it so much, is because it directed money straight to all businesses (small and large), and forced those businesses to ensure their staff were looked after. Trickle- Down Economics, anybody? I think this is better than Quantitative Easing because the money goes straight where it’s needed (though arguably there are better ways to implement Helicopter Money).

Every business owner I talked to, had applied for and got the wage subsidy. Comments on the no-questions-asked ease of acquiring the subsidy, along with the soft eligibility requirements of “…a 30% decline in predicted revenue…” and soft wording on repaying it, stating that you can repay it if you become no longer eligible, all suggested that the wage subsidy was actually Helicopter Money.

Now it seems that numerous large law firms are repaying the wage subsidy and the wage subsidy page on the Work and Income website is dominated by large red text talking about repayments.

So the question for employers is do i need to repay the wage subsidy? I don’t have the answer to this, but I suspect that the fact that the law firms are repaying it might be a clue.

In some ways it’s no surprise that the government is asking for the money back. In fact, I stated that there would be a need to replenish the coffers in the very same article in which I praised the wage subsidy policy. I’m just a little disappointed in the way the Work and Income website phrased the repayment, because for me, to say that you are eligible if you predict a 30% drop, then say that it has to be paid back if you are no longer eligible, I would have thought that having had predicted the 30% drop made you eligible.

Additionally I think that in the case of a growing company (especially those who have recently done capital raises or increased investment to fund growth), it’s quite possible that revenue could be up from last year, but 30% less than predicted. This could validly cause an increase in staffing costs that is not sustainable as returns didn’t fit the anticipated financial modeling, and such a company could be in need of the wage subsidy.

I think there’s scope for arguing a position here, but I suspect that increased need to replenish the coffers in the coming year may result in the IRD comparing past and present returns for those who kept the subsidy, and correspondingly auditing those who didn’t report at least a 30% drop. I expect that this will result in a lot of unpleasant words like “fraud” being thrown around.

It is my understanding that in cases where tax law is based on your opinion (such as whether you’re a share trader or share investor), the opinion of the taxman overrides any thoughts the business owner may have had on their intentions.

To leave on a positive note, while we may not have got any Helicopter Money, the alternative methods of replenishing the coffers are less attractive.

If you are wondering whether you need to repay the wage subsidy, you may wish to talk to your lawyer, accountant or ring the number on the Work and Income wage subsidy page that offers advice on whether you need to repay (though I expect in the case of any ambiguity, a ruling would not be in favor of these business).

Categories
Investing

Legal Matters: Should I Become A Company Director?

As an Angel Investor, there are always opportunities to become a director, and this is a very attractive proposition. You get to have influence over your investment, which is both fun and protects your investment to some degree because you can influence the thinking at the board meeting.

There are however, downsides to becoming a director, especially in early stage companies. Directors are personally financially and legally responsible for the actions of the company. This means that if the company becomes insolvent and the company owes money, the directors will be chased by the debt collectors. This is a particular problem if you are an angel investor in the company, for two reasons:

  • You probably won’t have enough of an investment to control the decisions of the board
  • As an investor, you’ll probably have more equity than the other board members (otherwise why else would they have sought equity at the cost of losing some of their business?)

This means that if the company becomes insolvent, debt collectors will probably come after you first, as they always chase the director who is most likely able to pay. This will be particularly frustrating because the board can make decisions that are against your will because you do not represent the voting majority of the board.

Secondly, directors are responsible legally. This means that even if the board acts against your advice as a director, you are still legally responsible for the company’s actions.

Finally, did you know that you can be a director without being a director? For example, if there is a sufficient paper trail to prove that you’ve been acting as a company Director without being on the board or registered as a director in the Companies Office, you can be held responsible as a director if things go South.

Before taking the position as a director, I recommend looking at the company’s financials to make sure there are no liabilities of concern and things are tracking in the right direction. I also recommend considering the risks of existing contracts that might factor in. You might do some Google searches and check the DRO and insolvency registers on the other directors, large shareholders and any shareholders that may be related to any of the directors. You might also take a look at Prover to take a punt a what level of equity other directors have, in case of the event of company insolvency. You might also want to look at directors insurance and consider getting a list of warrants from the company for more certainty around things, such as if any PAYE is owed or other undisclosed liabilities. I’ll start to build a list of warrants at the end of this article.

I hope that helps someone decide whether they want to accept an offer to become a director. Obviously their a positive points that I’ve not listed, but these are the catches that I think might be useful.