What is an angel investor workout?

An angel investor workout is a restructuring of early-stage investment obligations, typically convertible notes, when a startup is transitioning assets to a new entity (NewCo) or pivoting. It involves negotiating with angel investors to modify, convert, or forgive their notes to enable a clean cap table.

What happens to time-barred convertible notes?

Convertible notes past their maturity date may be time-barred by the statute of limitations (typically 4-6 years). Options include: letting them expire, obtaining written acknowledgment to restart the clock, converting to equity, or negotiating forgiveness. Each has different legal and tax implications.

What are the tax consequences of debt forgiveness?

Forgiven debt creates Cancellation of Debt (COD) income taxable at ordinary rates. Exceptions include: insolvency exclusion (IRC 108), bankruptcy, qualified real property debt, and certain other carve-outs. Always model tax impact before structuring forgiveness.

Can convertible notes be converted after they expire?

Yes, if both parties agree. Post-maturity conversion requires a modification agreement or new consideration. The original conversion terms may no longer apply. Document the modified terms clearly and ensure board approval on both sides.

How do you clean up a cap table for NewCo?

Cap table cleanup involves: (1) identifying all outstanding securities, (2) negotiating with note holders (conversion, forgiveness, or rollover), (3) obtaining releases from non-participating investors, (4) documenting all modifications, and (5) issuing NewCo securities to participating investors with updated terms.

Angel Investor Workout | Convertible Note Restructuring | Cap Table Cleanup

💡 Why Workouts Matter for Litigation

Unresolved investor claims can become creditors with standing to challenge asset transfers under UVTA. Before moving IP and claims to NewCo, align your cap table by converting, forgiving, or settling outstanding notes.

Workout Strategies

🕑

Let Notes Expire (Time-Bar)

Wait for statute of limitations to run on matured notes. Investor loses legal right to enforce.

4-6 year SOL in most states
Clock starts at maturity date
No action required from you
Document expiration date

No COD income No negotiation needed Takes years Investor may sue first

🔁

Convert to Equity

Convert outstanding debt to NewCo equity at agreed valuation. Cleans cap table.

Negotiate conversion price
May use original terms or new
Creates stockholder alignment
Requires securities compliance

No COD income Investor upside preserved Dilutes founders Valuation disputes

💥

Debt Forgiveness

Investor agrees to forgive the debt entirely. Requires written release.

Complete elimination of claim
No future obligations
Cleanest cap table result
Requires investor cooperation

Eliminates debt completely No dilution Creates COD income Hard to negotiate

💰

Partial Payoff + Release

Pay percentage of face value in exchange for full release of remaining amount.

Negotiate payoff percentage
Immediate cash required
Full release of balance
Document consideration

Immediate resolution Quantified cost COD on forgiven portion Requires liquidity

📄

Note Modification

Modify existing note terms: extend maturity, reduce interest, change conversion terms.

Extend maturity date
Reduce or eliminate interest
Change conversion triggers
Add subordination provisions

Preserves relationship Flexible structuring Debt remains May have tax issues

🔗

Rollover to NewCo Note

Cancel OldCo note and issue new NewCo note on modified terms.

Fresh start on terms
Reset maturity date
NewCo becomes obligor
Requires investor consent

Clean NewCo structure Updated terms NewCo has debt Tax analysis needed

⚠ Tax Implications

Cancellation of Debt (COD) Income

Forgiven debt is taxable income at ordinary rates under IRC 61(a)(11). The company recognizes income equal to the amount forgiven. Plan for the tax hit.

Insolvency Exception

Under IRC 108(a)(1)(B), COD income is excluded to the extent the debtor is insolvent immediately before discharge. Document insolvency with balance sheet.

Debt-to-Equity Conversion

Generally no COD income when debt converts to equity (stock-for-debt exception). But complex rules apply. Get tax advice on specific structure.

Modification as Exchange

Significant modification of debt terms can be treated as a taxable exchange under IRC 1001. Compare old and new terms carefully.

Workout Process

Inventory All Obligations

Compile complete list of convertible notes, SAFEs, outstanding options, and any other investor claims. Note maturity dates, interest rates, conversion terms, and statute of limitations status.

Assess Each Investor

Categorize by: strategic importance, likelihood of cooperation, time-bar status, and relationship quality. Prioritize friendly investors who can set the template for others.

Model Workout Options

For each investor, model: conversion at various valuations, partial payoff amounts, forgiveness with COD impact, and rollover terms. Identify optimal structure.

Negotiate Terms

Approach investors with proposed terms. Start with most cooperative. Use early agreements as precedent for others. Document all negotiations.

Execute Documentation

Draft and execute: modification agreements, conversion agreements, debt forgiveness releases, NewCo securities, and updated cap table. Board approval both entities.

Strategy Comparison

Strategy	COD Income?	Dilution?	Cash Needed?	Best For
Time-Bar Expiration	No	No	No	Uncooperative investors
Equity Conversion	No*	Yes	No	Strategic investors
Debt Forgiveness	Yes	No	No	Insolvent companies
Partial Payoff	Partial	No	Yes	Companies with cash
Note Modification	Maybe	No	No	Buying time
NewCo Rollover	Maybe	No	No	Clean NewCo structure

*Equity conversion generally avoids COD but complex rules apply

Required Documentation

Workout Term Sheet

Non-binding summary of proposed workout terms for each investor. Sets expectations before drafting final documents.

Modification Agreement

Amends existing note terms. References original note, specifies changes, and includes acknowledgment of modified terms.

Conversion Agreement

Documents debt-to-equity conversion. Specifies shares issued, valuation, and cancellation of note. Includes standard representations.

Debt Forgiveness Release

Full release of debt obligation. Includes consideration (even nominal), waiver of all claims, and acknowledgment of tax consequences.

Board Resolutions

Both OldCo and NewCo board approval. Authorizes workout terms, securities issuance, and asset transfers.

Updated Cap Table

Post-workout capitalization table showing all outstanding securities, ownership percentages, and resolved investor positions.

Need Angel Workout Help?

Schedule a consultation to review your cap table, model workout options, and prepare investor communications.

Schedule Consultation

Angel Investor Workout