Our private company issued a 24-month convertible note for $5M with 8% simple annual interest. The outstanding principal and accrued interest are payable at maturity date. Prepayment is not allowed without the holder's consent. Upon a qualified financing, the outstanding principal and accrued interest will automatically be converted to preferred stock at a discounted price of the lowest price per share paid in the qualified financing. Upon a non-qualified financing, the same terms apply except that the conversion is optional. If there is a change in control, the holder can elect to receive cash equal to 200% of the outstanding principal and accrued interest, or to convert the outstanding principal and accrued interest to preferred stock at a fixed price. My initial thought was that all of these embedded conversion features should be bifurcated from the debt host instrument and accounted for as derivative liabilities at fair value. However, since the preferred stock is not publicly traded and cannot be readily convertible to cash, the qualified and non-qualified financing features might not meet the net settlement criteria of a derivative. Any help with the proper GAAP accounting treatment for this would be much appreciated. Thanks!
