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Understanding Qualified Financing Rounds

Legal Solutions Feb 13, 2023

A 'Qualified Financing' round is a future investment that a company should raise to trigger the conversion of pre-existing debt into equity, typically used in debt agreements.

This financing is considered "qualified" because it must meet specific criteria to trigger the conversion, such as the minimum value of the investment, the type of investors involved, and a minimum valuation.

How Qualified Financing Works

  1. Debt Investment: Companies raise debt investment, often through convertible loans (CLs), to finance their operations and growth.
  2. Conversion: Investors who have lent money to the company (CL investors) want to convert their debt into shares at a later date, typically when the company's valuation is higher.
  3. Qualified Financing: If a Qualified Financing occurs, CL investors receive shares in exchange for their debt under preferential terms. If a Qualified Financing does not occur, CL investors may keep the debt until maturity, convert it under better terms, or explore other options.

Key Considerations in Qualified Financing

There are several items that companies and investors should pay attention to in Qualified Financing:

  • Automatic Conversion: The minimum size required for the Qualified Financing for the debt to convert.
  • Discount Price and Valuation Cap: These factors determine how conversion occurs versus the valuation in the Qualified Financing round.
  • Valuation Floor: The price per share of the Qualified Financing, pre-set at a minimum value.

What to Negotiate in Qualified Financing

There are several aspects worth negotiating in connection to a Qualified Financing term, such as:

  • Qualification of Qualified Financing Investors: Determining who qualifies as a Qualified Financing investor is crucial for the conversion to effectively occur.
  • Fair Values for the Discount Price, Valuation Cap, and Valuation Floor: Establishing fair values for these factors based on the company's maturity is essential for a successful investment.
  • Timeline for Qualified Financing: The speed at which Qualified Financing needs to happen is an important factor to consider.