Convertible Note Terms: Website, App And Marketplace Risk Points

For US startups, raising capital with convertible notes is often seen as a fast, founder-friendly way to bring in early investment. But many founders do not realize that the terms of these notes can create legal risks not only in the documents themselves but also in how you present your business online. Posting about your raise on your website, describing investment opportunities in your app, or running a marketplace with investor features can all trigger securities and consumer protection rules. Common mistakes include making public offers without proper exemptions, using vague or misleading language about investment risks, or failing to update website terms and privacy policies to cover investor data. This guide explains the key legal risk points for startups using convertible notes, with practical examples, checklists, and state law caveats for founders, operators, and small business owners.

What Are Convertible Note Terms?

A convertible note is a debt instrument that converts into equity, usually when your startup raises a future round of financing. Instead of repaying the principal plus interest in cash, the investor receives shares. These notes are popular because they delay the need to value the company and can be executed quickly. However, the terms of a convertible note are legally binding and can affect your obligations to both investors and the public.

Common convertible note terms include:

• Principal amount: The amount the investor loans to the company.
• Interest rate: The rate at which the note accrues interest until conversion or repayment.
• Maturity date: The date by which the note must convert or be repaid.
• Valuation cap: The maximum company valuation used to calculate the conversion price.
• Discount rate: The percentage discount applied to the price per share in the next equity round.
• Conversion triggers: Events that cause the note to convert, such as a qualified financing round, sale of the company, or at maturity.
• Repayment terms: What happens if the note does not convert (for example, repayment of principal and interest).
• Investor rights: Information rights, pro rata rights, or other special provisions.

While these terms are usually negotiated privately, they can have public implications. For instance, if you reference your convertible note raise on your website or app, you may inadvertently trigger securities law requirements. Even the way you describe your business or investment opportunity online can affect your legal obligations.

Example: A Delaware C-corp startup issues convertible notes to early investors. The company posts on its homepage: "Now accepting investments from anyone interested in joining our journey!" This could be considered a public offer of securities, which is only allowed under specific SEC exemptions.

Federal Securities Law: What Founders Must Know

Convertible notes are securities under US federal law. The Securities and Exchange Commission (SEC) regulates their offer and sale. Most startups rely on exemptions from registration, such as Regulation D (Rule 506(b) or 506(c)), to avoid the lengthy and expensive process of registering their offering with the SEC.

Key federal compliance points include:

• Disclosure obligations: You must provide investors with accurate, complete, and non-misleading information. Any misstatements or omissions in your website, pitch deck, or app can create liability.
• General solicitation restrictions: Under Rule 506(b), you cannot advertise your offering to the public. Under Rule 506(c), you can generally solicit, but only if you take reasonable steps to verify that all investors are accredited.
• Anti-fraud provisions: The SEC prohibits fraud and misrepresentation in connection with securities offerings. This includes misleading statements about your company, fundraising, or investor returns on your website or app.
• Exempt offerings: If you use an exemption, you must comply with its specific requirements. For example, Rule 504 has lower offering limits and may allow some general solicitation, but only in certain states and with additional restrictions.

State laws ("blue sky" laws) also apply. These vary by state and may require notice filings, fees, or additional disclosures. For example, California and New York have their own rules about securities offerings, and failing to comply can result in penalties or investor rescission rights.

If your company is incorporated in Delaware, you must also follow Delaware corporate law when issuing convertible notes. This includes proper board approvals, documenting the issuance, and updating your cap table. Delaware does not have its own securities laws for private offerings, but you must still comply with federal and other state rules.

Common mistakes:

• Announcing your convertible note raise on your website or app without confirming you can generally solicit.
• Failing to verify accredited investor status under Rule 506(c).
• Not filing required Form D notices with the SEC or state regulators.
• Using the same fundraising materials for all states without checking for state-specific requirements.

Checklist for federal and state compliance:

• Determine which SEC exemption you are relying on (506(b), 506(c), 504, etc.).
• Review your website, app, and marketing materials for any public statements about your offering.
• File Form D with the SEC and any required state notices.
• Keep detailed records of investor communications and verification steps.
• Consult with an attorney to review your compliance in all states where you have investors.

Example: A Texas-based marketplace startup raises funds using convertible notes and posts a call for investors on its website. Texas law requires a notice filing for certain exempt offerings. The company fails to file, and a state regulator contacts them, requiring corrective action and threatening penalties.

Website, App, and Marketplace Risk Points

Your website, app, or online marketplace is often the first place investors, customers, and regulators look for information about your business. Convertible note terms can create specific legal risks for these platforms, including:

• Public fundraising statements: Posting details about your convertible note offering on your website or app can violate SEC rules if not done correctly. For example, advertising your offering to the general public may be prohibited unless you comply with Regulation D Rule 506(c) and verify all investors are accredited.
• Customer-facing representations: Overstating the security of investor funds, the likelihood of conversion, or the future value of equity on your website or in app notifications can be misleading and create liability under federal and state law.
• Terms of service and privacy policy: If your platform collects investor information or processes payments, your terms of service and privacy policy should address how you handle sensitive data, especially if you are using third-party fundraising platforms or investor portals.
• Marketplace disclosures: If your marketplace allows users to invest in your company or related ventures, you may need to provide specific risk disclosures and comply with additional securities regulations, such as those governing crowdfunding or investment platforms.

Practical checklist for founders:

• Review all website and app content for statements about your fundraising, investor returns, or convertible note terms.
• Ensure you are not making public offers of securities unless you meet the requirements for general solicitation.
• Update your terms of service and privacy policy to reflect any investor-facing activities.
• Consult with an attorney before launching any online fundraising campaign or investor portal.

Example: A SaaS startup posts a blog post on its website announcing a convertible note raise and invites anyone to invest. If the startup is relying on a private placement exemption that prohibits general solicitation, this public invitation could violate SEC rules and jeopardize the exemption.

State law caveat: Some states, such as California, have additional restrictions on public solicitation and may require more detailed disclosures or filings, even if you comply with federal rules. Always check state requirements before making any public fundraising statements online.

Common mistakes:

• Failing to update website terms to address investor data collection.
• Using generic privacy policies that do not cover investor information.
• Allowing users to "invest" through your marketplace without proper risk disclosures.
• Describing investment opportunities in overly optimistic or vague terms.

Customer Notices and FTC Issues

In addition to securities laws, your website and app must comply with Federal Trade Commission (FTC) rules regarding advertising, consumer protection, and disclosures. The FTC prohibits deceptive or unfair business practices, which can include:

• Making false or unsubstantiated claims about your fundraising, business prospects, or investor returns.
• Failing to disclose material risks associated with convertible notes, such as the possibility that notes may never convert or that investors could lose their entire investment.
• Using testimonials or endorsements without proper disclosures or substantiation.

If your website or app allows customers to invest, or if you use customer testimonials about your fundraising, you must ensure these communications are truthful, not misleading, and include all required disclosures. The FTC has taken action against startups that mislead consumers or investors through online statements.

Checklist for FTC compliance:

• Review all fundraising-related statements for accuracy and substantiation.
• Include clear risk disclosures for potential investors.
• Disclose any material connections in testimonials or endorsements.
• Monitor customer communications for compliance with FTC guidelines.

Example: An app-based marketplace allows users to invest in the company and displays testimonials from early investors about high returns. If these claims are not typical or are unsubstantiated, the FTC could view this as deceptive advertising, leading to enforcement action.

State law caveat: States like New York and California have their own consumer protection laws that may impose stricter requirements than the FTC. For example, California's Unfair Competition Law can apply to misleading statements made to both investors and customers, regardless of federal compliance. Always check state consumer protection rules if you have users or investors in multiple states.

Common mistakes:

• Using investor testimonials without disclosing if they received compensation or have a material connection to the company.
• Failing to include risk warnings in app notifications or marketing emails about convertible notes.
• Relying on marketing language that promises or implies guaranteed returns.

Practical tip: When in doubt, add a clear risk disclosure and avoid making any statements about future returns or the certainty of conversion. Use plain language and make disclosures prominent, not buried in fine print.

When To Seek Attorney Review

While convertible notes are often marketed as simple fundraising tools, their terms can have complex legal effects, especially when your business operates online. Attorney review is strongly recommended in the following situations:

• You plan to mention your fundraising or convertible note terms on your website, app, or through email campaigns.
• Your platform collects investor information, processes investments, or facilitates introductions between investors and your company.
• You are unsure whether your fundraising activities constitute a public offering or general solicitation.
• You are using templates or documents from online sources without customization for your business or state of incorporation.
• You have investors in multiple states, triggering potential blue sky law compliance issues.
• Your business is considering using a third-party crowdfunding or investment platform.

Attorney review can help you:

• Identify and mitigate legal risks in your website, app, and marketplace disclosures.
• Ensure your fundraising complies with SEC, state, and FTC rules.
• Draft or update your terms of service, privacy policy, and investor communications.
• Respond to investor or regulator inquiries with accurate, defensible information.

Example: A New York-based startup uses a generic convertible note template found online. The template does not address state-specific requirements or disclosures. An investor later claims the company failed to provide necessary risk disclosures under New York law, resulting in a dispute and potential rescission claim. Attorney review could have identified and corrected these issues before the raise.

Checklist for when to seek legal help:

• Planning to advertise your raise or accept investments online.
• Unsure about which SEC or state exemptions apply.
• Using investor portals, crowdfunding, or new fundraising technology.
• Raising funds from out-of-state or international investors.
• Wanting to update your website, app, or marketplace terms for investor activities.

Common mistakes:

• Assuming a template convertible note is always sufficient.
• Not updating legal documents as your business model evolves.
• Overlooking the need for state filings or local legal review.

FAQs

Can I advertise my convertible note offering on my website?

Generally, you cannot publicly advertise your convertible note offering unless you comply with specific SEC exemptions, such as Regulation D Rule 506(c), which requires you to verify that all investors are accredited. Publicly posting details about your offering without meeting these requirements can jeopardize your exemption and expose you to liability. Always review your fundraising strategy with an attorney before making public statements.

What disclosures should I include for investors on my app or marketplace?

You should include clear, accurate disclosures about the risks of investing in convertible notes, including the possibility of loss, lack of liquidity, and the terms of conversion. Avoid making promises about returns or future equity value. If you use testimonials or endorsements, disclose any material connections and ensure all statements are truthful and not misleading.

Do state laws affect my convertible note fundraising?

Yes, state securities laws (blue sky laws) can impose additional requirements, such as notice filings or investor limits, even if you comply with federal rules. These requirements vary by state and can apply based on where your investors are located. It is important to review both federal and state requirements before raising funds with convertible notes.

How do FTC rules apply to my fundraising communications?

The FTC prohibits deceptive or unfair business practices, which includes making false or misleading statements about your fundraising, investor returns, or business prospects. All communications with customers or investors on your website, app, or marketing materials must be truthful, substantiated, and include any required risk disclosures.

What are some practical steps to reduce legal risk when raising with convertible notes?

Review all public statements about your raise, update your website and privacy policy to address investor activities, verify investor status if required, file all necessary SEC and state notices, and consult with an attorney before launching any online fundraising campaign or investor portal. Avoid making promises about returns and include clear risk disclosures in all investor communications.

Key Takeaways

• Convertible note terms are legally binding and subject to federal and state securities laws.
• Public statements about fundraising on your website, app, or marketplace can create legal risks if not handled properly.
• Federal SEC rules and state blue sky laws may limit how you communicate about your offering online.
• FTC rules require all investor- and customer-facing statements to be truthful, substantiated, and include risk disclosures.
• Attorney review is recommended before launching any online fundraising campaign or investor portal, especially if you have investors in multiple states or are using new technology.
• Update your website terms, privacy policy, and investor communications as your business evolves and as laws change.

If you are considering a convertible note raise or want to make sure your website, app, or marketplace is handling investor communications correctly, contact our team at (888) 449-8437 or team@sprintlaw.com for a confidential discussion about your options. Where legal services are required, they are delivered by licensed lawyers at trusted US law firms through the Sprintlaw platform.