A cofounder makes a $50K loan to the startup at the time of incorporation with the understanding that it will be able to fold into the next investment round if she chooses, thus increasing her equity by a couple/few percent. The promissory note does not mention anything about conversion into equity, just repayment. However, this investor/cofounder has emails from the other cofounders and CEO that confirm this arrangement prior to accepting the money from her; this loan is being made for the purpose of converting it in the investment round to equity if the investor/cofounder agrees to the terms of the round. The investor/cofounder is starting with a quarter of the cofounders' stake, a seat on the board, and is the company's president. The note term is 'on demand' so that she can demand full repayment anytime. Her vesting was also adjusted so that her stock vests 50% at the outset (and the rest over 2 years) because she is contributing seed funding.
My question is what legal (or possibly criminal) recourse would this investor/cofounder have if the other cofounders and CEO changed their minds and decided against allowing the note to fold into the investment round after accepting the money (so that repayment is the only option). Also, would any other concessions by the company be reasonable, such as the other cofounders taking on personal liability for this investor/cofounder's loan?
1 Answer from Attorneys
It would seem at the heart of it, this is a contracts questions and whether the emails can be said to have modified the written agreement (the promissory note in this case) as is required. Otherwise, a court will not go beyond the four corners of the actual written agreement and the investor/co-founder will be left with debt not a convertible instrument. That is, if the parties intended to create a convertible instrument such as a warrant, which is what you described, then they should have done so in writing.
Nothing you described implicates the criminal code in my opinion. Depending on the success and value of the company within duration of the note, the investor's recourse will likely be a civil action in equity to force the interest transfer.
I suggest you consult a lawyer in private and discuss in more detail. The written agreement along with all the other correspondence and facts will need to be reviewed before a proper best course of action can be reached.
If you would like to discuss further over a free phone consult, feel free to contact me anytime that is convenient.
DISCLAIMER: this is not intended to be specific legal advice and should not be relied upon as such. No attorney-client relationship is formed on the basis of this posting.
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