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8. Convertible notes

9 Months Ended

Mar. 31, 2021

Note 8 – Convertible notes

On January 27, 2021, the Company completed a private placement offering pursuant to which the Company sold to two accredited investors an aggregate of $3,000,000 in convertible notes with a 6% interest per annum (the “Convertible Note”) and warrants to purchase shares of Class A Common Stock equaling 80% of the number of shares of Class A Common Stock issuable upon conversion of the Convertible Notes. The warrants shall be exercisable for a period of three years from the IPO completion date at a per share exercise price equal to the IPO. The Convertible Notes shall be automatically converted into the Company’s Class A Common Stock upon a qualified IPO (the “Mandatory Conversion”) or repayable in cash at the option of the holders of the Convertible Notes with repayment to commence six months after January 27, 2021. The Convertible Notes convert at a price equal to the lesser of (a) a price representing a 30% discount to the public offering price per share of the Class A Common Stock in this Offering, or (b) a price representing a 30% discount to the price per share equal to dividing $200 million by the total number of (x) outstanding shares of Class A Common Stock immediately prior to the IPO, (y) the number of Class A Common Stock issuable upon conversion of the 34,500 shares of Series A Preferred Stock, and (z) the number of Class A Common Stock issuable upon conversion of all outstanding Convertible Notes. Any interest accrued on the Convertible Note will be waived upon conversion. In the event the Company does not receive a minimum of $15,000,000 of gross proceeds in the Offering or otherwise close on the Offering, the Convertible Notes will bear interest at a rate of 6% per annum which shall accrue from January 27, 2021 and be repayable in six equal monthly installments between July 27, 2021 and January 27, 2022. Alternatively, the Convertible Notes may be converted at the conversion price into shares of Class A Common Stock at the option of the holder prior to the maturity date (the “Conversion Option”). If the notes are converted, either on a Mandatory Conversion basis or through each holder’s exercise of the Conversion Option, any interest accrued on the Convertible Note shall be waived.

In connection with the convertible note offering, the Company issued placement agent warrants to purchase 7.0% of the shares of Class A Common Stock underlying the Convertible Notes exercisable at the conversion price of the Convertible Note (the “Conversion Price”). The placement agent warrants shall be exercisable for a period of five years from the issuance date and are treated as a debt issuance cost.

The conversion feature included in the terms of the convertible notes creates an obligation to the Company requiring it to repay the notes for cash in January 2022, if an IPO does not occur. Upon an IPO, the Conversion Option is settleable with a variable number of the Company’s shares resulting in a fixed monetary amount known at inception in accordance with ASC 480-10-25-14a. As such, the conversion feature was determined to be a derivative liability, which represent an embedded derivative predominately based on fixed monetary amount. The convertible note warrants and placement agent warrants were determined to be derivative liabilities, which represent free-standing derivative instruments. The Company measured the derivative liabilities at fair value at the issuance date of the convertible notes, convertible note warrants and placement agent warrants based on a Modified Black Scholes option-pricing model. The derivative liabilities were recorded with a corresponding debit to debt discount that will be amortized over the life of the notes using effective interest rate method. At time of issuance, the convertible notes and warrant liabilities were recorded on the balance sheet as liabilities. Debt issuance costs, which consisted of $120,000 in cash netted against the note proceeds and $84,849 in placement agent warrants, are allocated to derivative liabilities based on its fair value at issuance to total proceeds received. Debt issuance costs associated with warrant liabilities are expensed immediately and the debt issuance cost associated with the debt host are amortized over the life of the notes.

Upon issuance, the Company allocated the total proceeds first to the stock warrants, then to the embedded conversion features and the residual to the note. The amount allocated to debt discount was $1,390,141 and the amount allocated to the note was $1,609,859, respectively. The conversion feature and warrant liabilities of $1,390,141 was recorded as a debit to debt discount that was amortized as other non-operating expense over the life of the notes using effective interest rate method. As of March 31, 2021, the Company recorded amortization of debt discount of $463,380 as other non-operating expense and the remaining unamortized debt discount was $926,761.

As of March 31, 2021, the fair value of the convertible note, net of debt discount, was $2,729,747, which included fair value of the conversion feature of $776,507, and a change in fair value of $83,891 was recorded within other non-operating income (expenses).

	As of March 31, 2021
Expected term	0.3 year
Expected volatility	35%
Risk-free interest rate	0.04%
Expected dividend rate	0%
Probability	60%

As of March 31, 2021, the fair value of the convertible note, net of debt discount, was $2,849,747, which included fair value of the conversion feature of $776,507, and a change in fair value of $83,891 was recorded within other non-operating income (expenses).

For accounting on warrants issued with the convertible notes, see Note 14 below for detail.