Receiving capital investment by converting loans into shares is very common in Vietnam. In this way, the Investor may have more time to assess whether the business operations of the Target Company are positive and whether the investment is profitable. After that, the Investor can decide to convert part or all of his loans into shares according to the ratio agreed by the parties or to withdraw all his loans to protect his investment.
To carry out these transactions, the parties generally enter into loan agreements with more sophisticated conditions than those of other ordinary loans. For example, these loan agreements often require the target company to meet certain conditions before receiving the loan and guarantee the investor’s right to decide how the loan is converted.
Some notes for the Target Company when receiving an equity conversion loan are as follows:
1. The amount of the loan and the conversion rate
Depending on the capital requirement and the Target Company’s business plan, the parties will negotiate and agree on the amount of the loan and the disbursement schedule. In particular, the amount of the loan will directly affect the shareholding ratio of the Target Company if the Investor decides to convert the loan into shares. The Investor will have the right to vote at the General Meeting of Shareholders and to adopt important decisions of the Target Company according to the ownership ratio.
Investors and target companies can refer to the legal issues that should be of concern with respect to convertible loans in This article.
2. Prerequisites for receiving loans
Once the result of the due diligence is available, the Investor can decide which conditions must be fulfilled by the Target Company before receiving part or all of the loan. These conditions are commonly referred to as prerequisites. Some notable conditions are:
- Sufficiently provide the minutes of the meeting and the decisions of the general meeting of shareholders on the receipt of loans convertible into shares;
- Sufficiently provide the minutes of the meeting and the decisions of the general meeting of shareholders on the appointment of one or more persons by the investor as members of the board of directors or inspectors;
- The Target Company must complete its tax finalization from its period of establishment until the most recent month;
- The target company must apply for permits and certificates to operate legally, as required by law;
- Existing Shareholders undertake not to transfer their shares to other investors without the consent of the Investor, etc.
3. The decision to convert or repay the loan
During the term of the loan, if the investor realizes the growth potential of the target company and its advantages for the investor’s investment, the investor will decide to convert part or all of the loan into shares and will hold a certain percentage of the target company. Depending on the method of conversion and the nationality of the Investor, the Target Company will have to carry out certain administrative procedures in accordance with the law.
At the expiration of the term of the loan, subject to the loan agreement, the investor has the right to decide not to convert the loan into shares and to request the target company to repay the entire loan with a pre-determined interest rate (if applicable) . There are many reasons why the investor suspends his current investment, such as inefficient business operations resulting in low return; key personnel do not respect the work schedule commitment; breach by the Target of material covenants, etc.
4. Engage key personnel
The efficiency of the Company’s operations often depends on certain key personnel, such as the general manager, technical director, etc. They are usually also the existing shareholders of the target company. In order to maintain the Target Company’s growth potential, the Investor generally requires such key personnel to work in the Target Company for 3-5 years after receiving the loan, and if they are also the Company’s existing shareholders, they may also be prohibited from transferring their shares for 3 to 5 years.
5. Foreign Loans (if applicable)
In case the Investor is a foreign person or organization, the Target Company should pay attention to the following points:
- Register the loan at the State Bank if the term charge is 12 months or more (i.e. medium and long term loans). In addition, the Target Company must periodically report to the State Bank on its foreign borrowings, including short, medium and long-term borrowings.
- The Target Company will receive the loan in a foreign currency loan bank account or in a direct investment capital bank account (if it is a foreign-invested company that meets the legal requirements).
The above are some legal issues related to investing in the form of loan-to-equity conversion. However, the nature of the transaction may vary depending on the request of the Investor and the agreement of the parties, making the statements above inappropriate. Therefore, during the negotiation of an investment agreement and the completion of the conversion, the Investor and the Target Company should consult lawyers specialized in this field.