Answer:
A trigger event is a particular situation that prompts a chain of events relating to a loan or contractual agreement to pay money in exchange for equity. Trigger event clauses are common in convertible notes, SAFEs and loan documentation. There can be many kinds of trigger events.
Two common trigger events are:
1. Qualifying equity round
A qualifying equity round is a capital raising round where there is an exchange of equity to cash from an investor or group of investors. The investor or investors may be professional or simply family and friends investors. The trigger event clause may prescribe that a qualifying equity round is only a round of a certain size. For example, a round of at least $750,000. However, this can vary between documentation and there may be no such prescription of a minimum.
2. Liquidation or ‘exit’ event
A liquidation or ‘exit’ event is typically an event that results in:
- The sale of all or the majority of the shares in the company; and
- An initial public offering (which involves listing on a stock exchange).
What happens at a trigger event?
Not only do trigger events vary in capital raising, the result of a trigger event also varies. Typically, at a trigger event, a loan or contractual agreement to pay money in exchange for equity automatically converts into issuing shares to the investor. However, a company or investor may also have discretion. A trigger event may result in either the loan or contractual agreement to pay money in exchange for paying back equity (partially or in full), rather than fully converting into equity.
How is the conversion rate calculated?
A conversion rate determines how a loan or contractual agreement to pay money in exchange for equity converts into shares. There are a range of classes of shares with varying associated rights. If the conversion occurs at the next equity round, typically there is an issue of the same shares as those of the other incoming shareholders. However, if the conversion occurs at a liquidation or ‘exit’ event, there is typically an issue of ordinary shares.
Typically, when the conversion occurs at the next equity round or at a liquidation event, there is a discount. A discount means that the investor receives an issue of their shares at a discount to market value. 10 – 20% discount is common practice. A discount is commonly offered as a reward to an investor who transfers capital to the company prior to being issued with shares (whether by loan, convertible note or SAFE). Offering such recognises the risk taken by the investor and the benefits the company obtains by having that capital available prior to conversion.
