Maturity Conversion under the CARE

What is a Maturity Date?

As its name suggests, the CARE’s primary purpose is to convert into equity (i.e. shares).  If and when this happens depends on the event that triggers the CARE’s conversion: an Equity Financing, a Liquidity Event or a Dissolution Event.  The timing of these events – or whether they happen at all – is not fixed, so the CARE has an optional feature that can set a pre-determined date (i.e. a ‘Maturity Date‘) after which an investor can convert their CARE.

Using this feature can, however, create additional complexities and is not always needed or wanted.

What makes the Maturity Date relevant?

The CARE is intended to be simple and easy to use.  This is made possible, in part, by the purpose of the CARE: for an investor to make an upfront cash investment in a company on the expectation of receiving shares in the future.  The fact the investor is not receiving shares now means the parties won’t need to negotiate the value of the company and, therefore, the price of its shares.

Avoiding these valuation discussions is important because, when signing the CARE, the company is often at a very early stage – sometimes pre-revenue, or even just an idea and a slide deck.  These early-stage ventures may lack key data needed for a meaningful valuation (e.g. no current or short-term future earnings or positive cash flows).  Without this data, negotiating a value for the company could take a long time and, even if one is agreed, there’s a high chance it would be very wrong.  Spending a long time negotiating an unreliable figure is not really in anyone’s interests.

If you can’t, or don’t want to, agree a valuation now – what can you do?  That’s right: agree it later!

The CARE postpones valuation to a future event; specifically, the first to occur between an Equity Financing and a Liquidity Event.  The hope is that, with the money from the CARE investment and the benefit of more time, the company will get to a more advanced stage where a reliable valuation becomes feasible.  The people involved in that future event (e.g. the lead investor in an Equity Financing) will negotiate and agree the company’s valuation at that time.  See our articles on an Equity Financing and a Liquidity Event for how this works.

As a side note, in addition to an Equity Financing and a Liquidity Event, the occurrence of a Dissolution Event would also ‘convert’ the CARE.  However, on a Dissolution Event the investor is simply entitled to a return of their original investment; there is no conversion to shares, meaning no need to value the company.

Why have a Maturity Date?

The above begs the question: what if there is no Equity Financing, Liquidity Event or Dissolution Event?  There’s no guarantee any of these will happen.  The company could, for example, use the money from the CARE to become a runaway success, never needing to fundraise again and avoiding being acquired.  In that case, the CARE would simply sit there dormant; potentially indefinitely.  It wouldn’t convert to shares and wouldn’t entitle the investor to any of their money back.  Some investors see this as an acceptably low risk.  Others, however, want to ensure their CARE has a pre-determined end date.

For those demanding such an end date, the CARE has an optional feature to set a ‘Maturity Date‘, i.e. a long-stop date when the CARE can be converted to shares if it has not already converted. 

Sounds good. What's the catch?

The problem is, to convert the CARE to shares, you need to have a price per share.  To have a price per share, you need to have an agreed value for the company.

Hopefully the predicament is somewhat clear.  The CARE is appealing because you don’t have to value the company at such an early stage.  But there is a risk the company may never need to be valued, meaning the CARE wouldn’t serve its primary purpose: for the investor to get shares in the company.  Setting a Maturity Date avoids this risk but, to do so, you need to place a (future) value on the company.  This effectively undermines one of the CARE’s main selling points.

How does a Maturity Conversion work?

If, regardless of this predicament, the parties agree to set a Maturity Date, they will also need to agree a ‘Maturity Cap‘.  This is the expected value of the company on the Maturity Date.  Importantly, this is not the value at the time of signing the CARE.  A crystal ball can be helpful here.

On the Maturity Date, or on any date after, the investor can trigger a ‘Maturity Conversion‘ and convert their CARE into shares.  The price per share for this Maturity Conversion (i.e. the ‘Maturity Price‘) would be the pre-agreed Maturity Cap divided by the total number of shares in the company on a fully-diluted basis.  The initial CARE investment amount is then converted into shares at that Maturity Price.

When an investor is considering a Maturity Conversion they will, first and foremost, be interested in the company’s actual value at that time:

If the value is significantly higher than the Maturity Cap, they would convert.  Doing so gives them a discount on the ‘true’ price of the company’s shares.  If, for example, a company’s value was $20 million, a CARE investment of $500,000 with a Maturity Cap of $2.5 million would convert into a 17% shareholding worth around $3.3 million.

If the value is lower than the Maturity Cap, the investor would not convert.  Doing so would mean paying a premium on the ‘true’ price of the shares.  If, in the same example, the company’s value was $1.5 million, the CARE investment would convert into a 17% shareholding worth around $250,000.

If the value is between those two extremes, the conversion decision becomes a little more complicated.

In a Maturity Conversion, the investor would receive ordinary shares instead of the preference shares commonly issued in an Equity Financing.  Preference shares rank ahead of ordinary shares (e.g. for payments from the company), so accepting ordinary shares could be detrimental.  A Maturity Conversion is also based entirely on the Maturity Cap; it does not reflect any agreed discount.

Instead of converting, the investor may hold off and hope for an Equity Financing or a Liquidity Event when they could see a more beneficial conversion (e.g. preference shares issued at a discount).  On top of this, the investor will need to take into account when they made their initial investment (i.e. the time value of money).

So... Should we set a Maturity Date?

There is no “best” answer here.

It could be debated forever whether to set a Maturity Date, what the Maturity Cap should be and, for the investor, whether its CARE should be converted if the Maturity Date arrives.  The answers to these questions will vary from deal-to-deal depending on a wide variety of factors, including the investor’s appetite for risk, the negotiating power of the parties, the company’s industry, and its current status and expected path to growth, to name a few.

The hope is that, by understanding the reasons for and against having a Maturity Conversion, the parties can have more focused discussions on these points to reach a swift and mutually beneficial conclusion.