OPTICAL SENSORS INC
INVESTMENT AGREEMENT
<DOCUMENT>
<TYPE>EX-10.16
<SEQUENCE>2
<FILENAME>0002.txt
<DESCRIPTION>INVESTMENT AGREEMENT
<TEXT>

<PAGE>

                                                                   EXHIBIT 10.16

                              INVESTMENT AGREEMENT

     THIS INVESTMENT AGREEMENT ("Agreement") is made and entered into effective
as of March 10, 2000, by and among Optical Sensors Incorporated, a Delaware
corporation (the "Company"), with its principal place of business at 7615 Golden
Triangle Drive, Suite A, Eden Prairie, Minnesota 55344, and the investors listed
on Schedule I hereto (collectively, the "Investors").

     A. The Company desires to raise up to $3,000,000 of additional capital in
order to fund its operations.

     B. The Investors desire to make an investment in the Company on the terms
and conditions set forth in this Agreement.

     Accordingly, in consideration of the foregoing, the mutual promises set
forth herein, and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties hereto agree as
follows:

1.   Purchase of Convertible Promissory Notes. Upon the terms and subject to the
     conditions set forth in this Agreement, the Company agrees to issue to each
     Investor, and each Investor agrees to purchase from the Company, a
     convertible promissory note in the form attached hereto as Exhibit A in the
     maximum principal amount set forth opposite such Investor's name on
     Schedule I (the "Notes"). The maximum aggregate principal amount of all of
     the Notes to be issued hereunder shall be Three Million Dollars
     ($3,000,000). The Notes shall not bear interest and shall be due and
     payable in full one (1) year from the date of issuance (the "Maturity
     Date") unless converted into Units pursuant to Section 3 prior to the
     Maturity Date; provided, however, if the Notes are not paid in full or
     converted into Units on or before the Maturity Date, any remaining unpaid
     principal balance shall bear interest at the rate of ten percent (10%) per
     year from the Maturity Date until paid in full. The Company shall have the
     right to prepay the Notes, in whole or in part, at any time or from time to
     time, on ten (10) days' prior written notice to the Investors, without
     premium or penalty pursuant to Section 1 of the Note. All partial payments
     of the Notes shall be made among the Investors on a pro rata basis. For
     purposes of this Agreement, "pro rata" shall mean with respect to any
     Investor the portion that the maximum principal balance of such Investor's
     Note bears to the aggregate maximum principal balance of all of the Notes.

2.   Advances Under Notes.

     (a)  Initial Advances. Upon execution of this Agreement, each Investor
          shall advance to the Company in immediately available funds, its pro
          rata share of One Million Four Hundred Thousand Dollars ($1,400,000).

     (b)  Additional Advances. At any time during the Advance Period (as defined
          below), the Company shall have the right to request up to two
          additional advances under the Notes in the amounts of Six Hundred
          Thousand Dollars ($600,000) and One
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          Million Dollars ($1,000,000) each, pursuant to this Section 2(b). The
          "Advance Period" shall mean the sixty (60) day period beginning on the
          first day after both of the following have occurred: (i) the Company
          executes a definitive distribution agreement (the "Distribution
          Agreement") for the Company's CapnoProbe product with a major medical
          company on terms no less favorable to the Company than those set forth
          in the letter of intent, dated January 4, 2000, between the Company
          and Baxter Healthcare Corporation ("Baxter"), and (ii) the
          shareholders of the Company have approved the conversion of any
          additional advances to be made under the Notes pursuant to this
          Section 2(b) into Units at the Company's 2000 Annual Meeting of
          Shareholders; provided, however, that in any case the Advance Period
          will expire on June 15, 2000, after which date the Company will not
          have any right to request any advance hereunder. Within five (5) days
          of a written request by the Company, each Investor shall advance to
          the Company its pro rata share of an aggregate of Six Hundred Thousand
          Dollars ($600,000). Within five (5) days of a written request by the
          Company, each Investor shall have the option to advance to the Company
          its pro rata share of an aggregate of an additional One Million
          Dollars ($1,000,000); provided, however, that the Investors will be
          required to make such advance if the Company notifies the Investors
          that the Company needs such funds as part of a plan to maintain its
          listing on the Nasdaq National Market or to assist in avoiding a going
          concern qualification with respect to its audited financial statements
          for the year ended December 31, 1999. If any Investor fails to advance
          its pro rata share of any advance request, the other Investors shall
          have the right, but not the obligation, to advance such amount to the
          Company.

3.   Conversion.

     (a)  Terms of Conversion. The Notes are convertible into units ("Units"),
          each unit consisting of 50,000 shares of the Company's common stock,
          $.01 par value (the "Common Stock"), and a warrant to purchase 12,500
          shares of Common Stock, at a conversion price equal to Fifty Thousand
          Dollars ($50,000) per Unit in accordance with this Section 3, subject
          to adjustment of the conversion price as set forth in the Notes. The
          warrant shall be in substantially the form attached hereto as Exhibit
          B ("Warrant"), have an initial exercise price equal to $1.00 per share
          and shall be exercisable for a period of five years from the date of
          issuance.

     (b)  Optional Conversion. Each Investor shall have the right to convert all
          or any portion of the principal balance under its Note, at the option
          of the Investor holding such Note, into Units at any time.

     (c)  Automatic Conversion. An aggregate of One Million Four Hundred
          Thousand Dollars ($1,400,000) of the principal balance of the Notes
          will automatically convert into Units, without any action of the
          Investors, thirty (30) days after written notice from the Company to
          the Investors that the Distribution Agreement has been executed by the
          Company and a major medical company. The principal balance under the
          Notes related to the $600,000 advance will automatically convert into
          Units, without any action of the Investors, thirty (30) days after the


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          date of such $600,000 advance, and the principal balance under the
          Notes related to the $1,000,000 advance will automatically convert
          into Units, without any action of the Investors, thirty (30) days
          after the date of such $1,000,000 advance. Any conversion under this
          Section 3(c) shall be made on a pro rata basis among all holders of
          Notes.

4.   Representations and Warranties of the Company. The Company represents and
     warrants to the Investors as follows:

     (a)  Organization. The Company is a corporation duly organized, validly
          existing and in good standing under the laws of the State of Delaware
          and has the requisite corporate power and authority to own, lease or
          operate its properties and to carry on its business as it is now being
          conducted and as it is proposed to be conducted. The Company has no
          subsidiaries or direct or indirect ownership in any firm, corporation
          or business which either, individually or in the aggregate, is
          material to the business of the Company. The Company is qualified to
          do business and is in good standing as a foreign corporation in every
          jurisdiction in which its ownership of property or conduct of business
          requires it so to be qualified and in which the failure to so qualify
          would have a material adverse effect on the financial condition or
          business of the Company.

     (b)  Authorization. The Company has the corporate power and authority to
          execute and deliver this Agreement, the Notes and the Warrants and to
          perform its obligations hereunder and thereunder, including the
          issuance of the Notes, the Warrants, the Conversion Securities (as
          defined below) and the Warrant Securities (as defined below). This
          Agreement, the Notes and the Warrants have been duly authorized by all
          necessary corporate action on behalf of the Company, have been duly
          executed and delivered by authorized officers of the Company, are
          valid and binding agreements on the part of the Company and are
          enforceable against the Company in accordance with their respective
          terms, except as the enforceability thereof may be limited by
          bankruptcy, insolvency, moratorium, reorganization or other similar
          laws affecting the enforcement of creditors rights generally and to
          judicial limitations on the enforcement of the remedy of specific
          performance and other equitable remedies. All corporate actions
          necessary for reservation and issuance of the shares of Common Stock
          issuable upon conversion of the Notes ("Conversion Securities") and
          the Common Stock issuable upon exercise of the Warrants ("Warrant
          Securities") has been taken, except for shareholder approval
          contemplated by Section 3(c). The Conversion Securities and the
          Warrant Securities, when issued pursuant to the terms of the Notes and
          the Warrants, respectively, including the payment of any consideration
          required thereunder, will be duly authorized, validly issued, fully
          paid and nonassessable, free and clear of any and all liens, charges,
          claims, encumbrances and preemptive rights.

     (c)  No Violation. Neither the execution and delivery of this Agreement,
          the Notes or the Warrants by the Company, nor the performance by the
          Company of its obligations hereunder or thereunder, nor the
          consummation of the transactions


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          contemplated hereby or thereby will: (a) conflict with or result in
          any breach of any provision of the Articles of Incorporation or
          By-Laws of the Company; (b) result in a default (or give rise to any
          right of termination, cancellation or acceleration) under any of the
          terms, conditions or provisions of any note, lease, mortgage, license,
          agreement or other instrument or obligation to which the Company is a
          party or by which any of its assets may be bound, except for such
          defaults (or rights of termination, cancellation or acceleration) as
          to which requisite waivers or consents have been obtained or which, in
          the aggregate, would not result in a material adverse effect on the
          Company; (c) violate any order, writ, injunction, decree, statute,
          rule or regulation applicable to the Company or any of its assets,
          except for violations which would not result in a material adverse
          effect on the Company; or (d) result in the creation or imposition of
          any liens, charges or encumbrances upon any assets of the Company.

     (d)  SEC Reports. The Company has filed all reports, registration
          statements and other filings with the Securities and Exchange
          Commission (the "Commission") required to be filed by it pursuant to
          the Securities Act of 1933, as amended (the "Securities Act"), and the
          Securities Exchange Act of 1934, as amended (the "Exchange Act"). All
          such reports, registration statements and other filings (including all
          notes, exhibits and schedules thereto, all documents incorporated by
          reference therein, and any amendments thereto) are collectively
          referred to herein as the "SEC Reports." As of their respective dates
          of filing with the Commission, the SEC Reports complied in all
          material respects with all of the rules and regulations of the
          Commission and did not contain any untrue statement of a material fact
          or omit to state a material fact required to be stated therein or
          necessary in order to make the statements made therein, in light of
          the circumstances under which they were made, not misleading.

     (e)  Financial Statements. The financial statements of the Company included
          in the SEC Reports (the "Financial Statements") have been prepared in
          accordance with United States generally accepted accounting principles
          consistently applied and fairly present the financial position of the
          Company at the dates thereof and the results of the Company's
          operations and cash flows for the periods then ended (subject, in the
          case of unaudited statements, to normal adjustments and the omission
          of footnotes). The Company has no material liabilities, known or
          unknown, absolute, contingent or otherwise, except for (i) liabilities
          that are set forth in the Financial Statements, the notes thereto or
          the SEC Reports, (ii) liabilities that have been incurred in the
          ordinary course of business since September 30, 1999 and (iii)
          potential liability to Instrumentation Laboratory Company ("IL") in
          connection with the termination of the Private Label Reseller
          Agreement, dated as of January 7, 1998, between the Company and IL.

     (f)  No Material Adverse Change. There have not been any changes in the
          assets, properties, liabilities, financial condition, business or
          operations of the Company from that reflected in the Financial
          Statements except for (i) changes in the ordinary course of business
          which have not been, either individually or in the aggregate,
          materially adverse, (ii) the Company's continued operating losses and


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          negative cash flow, (iii) an anticipated write-down of inventory of
          approximately $400,000; and (iv) potential liability to IL in
          connection with the termination of the Private Label Reseller
          Agreement, dated as of January 7, 1998, between the Company and IL.

     (g)  Authorized Capital Stock. The authorized capital stock of the Company
          is as set forth in the SEC Reports. The issued and outstanding shares
          of capital stock of the Company have been duly authorized, validly
          issued and are fully paid and nonassessable. As of the date hereof,
          the Company has outstanding options and warrants to purchase 1,263,628
          shares of Common Stock, and there are no other outstanding warrants,
          options or other rights to acquire any shares of capital stock of the
          Company, except as disclosed in the SEC Reports. All of the above
          securities of the Company were issued in compliance with all
          applicable federal and state securities laws and were not issued in
          violation of or subject to any preemptive rights or other rights to
          subscribe for or purchase securities. Except for IL, no holder of any
          security of the Company is entitled to any preemptive or similar
          rights to purchase any securities of the Company.

     (h)  Intellectual Property. The Company owns or possesses adequate rights
          to use all patents, patent rights, inventions, trademarks, trade
          names, copyrights, licenses, domain names, governmental
          authorizations, trade secrets and know-how that are used or necessary
          for the conduct of its business; neither the Company nor any of its
          subsidiaries has received any notice of, or has any knowledge of, any
          infringement of or conflict with asserted rights of others with
          respect to any patents, patent rights, inventions, trademarks, trade
          names, copyrights, licenses, governmental authorizations, trade secret
          or know-how that, individually or in the aggregate, if the subject of
          an unfavorable decision, ruling or finding, would have a material
          adverse effect on the condition (financial or otherwise), earnings,
          operations or business of the Company and its subsidiaries considered
          as a whole.

     (i)  Securities Laws. Subject to the accuracy of the representations of the
          Investors in Section 5, no consent, authorization, approval, permit or
          order of or filing with any governmental or regulatory authority is
          required under current laws and regulations in connection with the
          execution and delivery of this Agreement or the offer, issuance, sale
          or delivery to the Investors of the Notes, the Warrants, the
          Conversion Securities or the Warrant Securities other than (i) the
          filing with the Commission of a Form D pursuant to Regulation D under
          the Securities Act, and the qualification thereof, if required, under
          applicable state securities laws, which qualification has been or will
          be effected as a condition of the sale of the Notes and the Warrants
          and the issuance of the Conversion Securities and the Warrant
          Securities, and (ii) the filing of a registration statement or
          statements pursuant to Section 7. Under the circumstances contemplated
          by this Agreement, the offer, issuance, sale and delivery of the Notes
          and the Warrants will not, under current laws and regulations, require
          compliance with the prospectus delivery or registration requirements
          of the Securities Act.


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     (j)  Litigation. Except for the pending arbitration proceeding with IL and
          an informal investigation by the Commission regarding recent trading
          in the Company's Common Stock, there are no actions, suits,
          proceedings or investigations pending or, to the best of the Company's
          knowledge, threatened against the Company or any of its properties
          before or by any court or arbitrator or any governmental body, agency
          or official in which there is a reasonable likelihood (in the judgment
          of the Company) of an adverse decision that (a) would have a material
          adverse effect on the Company's properties or assets or the business
          of the Company as presently conducted or proposed to be conducted or
          (b) would impair the ability of the Company to perform in any material
          respect its obligations under this Agreement. The Company is not in
          default with respect to any judgment, order or decree of any court or
          governmental agency or instrumentality which, individually or in the
          aggregate, would have a material adverse effect on the assets,
          properties or business of the Company.

     (k)  Properties. The Company has good and marketable title to all the
          properties and assets reflected as owned in the Financial Statements,
          subject to no lien, mortgage, pledge, charge or encumbrance of any
          kind except (i) those, if any, reflected in such Financial Statements,
          or (ii) those which are not material in amount and do not adversely
          affect the use made and promised to be made of such property by the
          Company. The Company holds its leased properties under valid and
          binding leases, with such exceptions as are not materially significant
          in relation to the business of the Company. The Company owns or leases
          all such properties as are necessary to its operations as now
          conducted or as proposed to be conducted.

     (l)  Brokers or Finders. To the knowledge of the Company, no person, firm
          or corporation has or will have, as a result of any act or omission of
          the Company, any right, interest or valid claim against any Investor
          for any commission, fee or other compensation as a finder or broker in
          connection with the transactions contemplated by this Agreement. The
          Company shall indemnify and hold each Investor harmless for any claims
          made for any commission, fee or other compensation concerning the
          transactions contemplated by this Agreement.

5.   Representations and Warranties of the Investors. Each Investor represents
     and warrants to the Company as follows:

     (a)  The Notes are being purchased for investment for such Investor's own
          account and not with the view to, or for resale in connection with,
          any distribution or public offering thereof. Each Investor understands
          that neither the Note, the Warrant, the Conversion Securities nor the
          Warrant Securities have been registered under the Securities Act or
          any state securities laws by reason of their contemplated issuance in
          transactions exempt from the registration requirements of the
          Securities Act and applicable state securities laws and that the
          reliance of the Company and others upon these exemptions is predicated
          in part upon this representation by the Investor. Each Investor
          further understands that its Note, the Warrant, the Conversion
          Securities and the Warrant Securities may not be


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          transferred or resold without registration under the Securities Act
          and any applicable state securities laws, or pursuant to an exemption
          from the requirements of the Securities Act and applicable state
          securities laws.

     (b)  Each Investor's principal place of business is located at the address
          set forth on Schedule I. Each Investor qualifies as an "accredited
          investor," as defined in Rule 501 of Regulation D under the Securities
          Act. Each Investor acknowledges that the Company has made available to
          such Investor at a reasonable time prior to the execution of this
          Agreement the opportunity to ask questions and receive answers
          concerning the business, operations and financial condition of the
          Company and the terms and conditions of the sale of securities
          contemplated by this Agreement and to obtain any additional
          information requested by such Investor. Each Investor is able to bear
          the loss of its entire investment in the Note, the Conversion
          Securities and the Warrant Securities and has such knowledge and
          experience of financial and business matters that he is capable of
          evaluating the merits and risks of the investment to be made pursuant
          to this Agreement. However, neither the foregoing nor any other due
          diligence investigation conducted by such Investor or on its behalf
          shall limit, modify or affect the representations and warranties of
          the Company set forth in Section 4 of this Agreement or the right of
          such Investor to rely thereon.

     (c)  This Agreement has been duly authorized by all necessary action on the
          part of each Investor, has been duly executed and delivered by such
          Investor and is a valid and binding agreement of such Investor.

6.   Use of Proceeds. The Company will use the proceeds from the sale of the
     Notes for general corporate purposes, including obtaining regulatory
     clearance for the Company's CapnoProbe monitor and disposable probe.

7.   Registration Rights.

     (a)  Filing of Registration Statement. Within thirty (30) days of the
          issuance of the Notes, the Company will file a registration statement
          with the Commission under the Securities Act covering the Conversion
          Securities and the Warrant Securities subject to Warrants issuable
          upon conversion of the principal balance of the Notes outstanding at
          the time of such filing. Within thirty (30) days of any additional
          advance under the Notes pursuant to Section 2(b), the Company will
          file a registration statement with the Commission under the Securities
          Act (or an amendment to any prior registration statement) covering any
          Conversion Securities and Warrant Securities issuable upon conversion
          of such advances and not previously registered. The Company may, on
          not more than one occasion, delay the filing of any registration
          statement required hereunder for a period of not more than 90 days in
          the event that the Company has furnished the Investor with a
          certificate executed by the Company's President or Chief Executive
          Officer stating that such delay is necessary in order to (i) not
          significantly adversely affect financing efforts then underway at the
          Company or (ii) avoid disclosure of material non-public information.
          Any registration of Conversion Securities and


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          Warrant Securities hereunder shall cover any additional Conversion
          Securities or Warrant Securities issued or issuable pursuant to
          anti-dilution or other similar rights.

     (b)  Registration Procedures. If and whenever the Company is required by
          the provisions of Section 7(a) to effect the registration of any
          Conversion Securities or Warrant Securities under the Securities Act,
          the Company will:

          (i)  prepare and file with the Commission a registration statement (on
               any available form to effect registration) with respect to such
               securities, and use its best efforts to cause such registration
               statement to become and remain effective until such securities
               are sold pursuant to such registration statement or are eligible
               to be sold pursuant to Rule 144(k);

          (ii) prepare and file with the Commission such amendments to such
               registration statement and supplements to the prospectus
               contained therein as may be necessary to keep such registration
               statement effective until such securities are sold pursuant to
               such registration statement or are eligible to be sold pursuant
               to Rule 144(k);

          (iii)furnish to the Investors and to any underwriters of the
               securities being registered such reasonable number of copies of
               the registration statement, preliminary prospectus, final
               prospectus and such other documents as the Investors and
               underwriters may reasonably request in order to facilitate the
               public offering of such securities;

          (iv) use its best efforts to register or qualify the securities
               covered by such registration statement under such state
               securities or blue sky laws of such jurisdictions as the
               Investors may reasonably request, except that the Company shall
               not for any purpose be required to execute a general consent to
               service of process or to qualify to do business as a foreign
               corporation in any jurisdiction wherein it is not so qualified;

          (v)  prepare and promptly file with the Commission and promptly notify
               the Investors of the filing of such amendment or supplement to
               such registration statement or prospectus as may be necessary to
               correct any statements or omissions if, at the time when a
               prospectus relating to such securities is required to be
               delivered under the Securities Act, any event shall have occurred
               as the result of which any such prospectus or any other
               prospectus as then in effect would include an untrue statement of
               a material fact or omit to state any material fact necessary to
               make the statements therein, in the light of the circumstances in
               which they were made, not misleading; and

          (vi) use its best efforts to cause all securities covered by such
               registration statement to be listed on any securities exchange,
               quotation system,


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               market or over-the-counter bulletin board, if any, on which the
               Common Stock shall then be listed and trading.

     (c)  Expenses. Except as set forth in the last sentence of this Section
          7(c), with respect to any registration of securities pursuant to
          Section 7(a), the Company shall bear all fees, costs and expenses,
          including, without limitation: all registration, filing and NASD fees,
          printing expenses, fees and disbursements of counsel and accountants
          for the Company, all internal Company expenses, the premiums and other
          costs of policies of insurance against liability arising out of the
          public offering, and all legal fees and disbursements and other
          expenses of complying with state securities or blue sky laws of any
          jurisdictions in which the securities to be offered are to be
          registered or qualified. Fees and disbursements of counsel and
          accountants for the Investors, underwriting discounts and commissions
          and transfer taxes for the Investors and any other expenses incurred
          by the Investors not expressly included above shall be borne by the
          Investors.

     (d)  Indemnification. In the event that any Conversion Securities or
          Warrant Securities owned by the Investors are included in a
          registration statement under Section 7(a):

          (i)  The Company will indemnify and hold harmless each Investor
               (including for this purpose its directors, officers and partners)
               and any underwriter (as defined in the Securities Act) from and
               against any and all loss, damage, liability, cost and expense
               (including, subject to Section 7(d)(iii), reasonable fees and
               expenses of counsel) to which any such Investor or any such
               underwriter may become subject under the Securities Act or
               otherwise, insofar as such losses, damages, liabilities, costs or
               expenses are caused by any untrue statement or alleged untrue
               statement of any material fact contained in such registration
               statement, any prospectus contained therein or any amendment or
               supplement thereto, or arise out of or are based upon the
               omission or alleged omission to state therein a material fact
               required to be stated therein or necessary to make the statements
               therein, in light of the circumstances in which they were made,
               not misleading; provided, however, that the Company will not be
               liable in any such case to the extent that any such loss, damage,
               liability, cost or expense arises out of or is based upon an
               untrue statement or alleged untrue statement or omission or
               alleged omission so made in conformity with written information
               furnished by such Investor or such underwriter.

          (ii) Each Investor, severally but not jointly, will indemnify and hold
               harmless the Company and any underwriter from and against any and
               all loss, damage, liability, cost or expense (including, subject
               to Section 7(d)(iii), reasonable fees and expenses of counsel) to
               which the Company or any underwriter may become subject under the
               Securities Act or otherwise, insofar as such losses, damages,
               liabilities, costs or expenses are caused by any untrue or
               alleged untrue statement of any material fact contained in such
               registration statement, any prospectus contained therein or any


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               amendment or supplement thereto, or arise out of or are based
               upon the omission or the alleged omission to state therein a
               material fact required to be stated therein or necessary to make
               the statements therein, in light of the circumstances in which
               they were made, not misleading, in each case to the extent, but
               only to the extent, that such untrue statement or alleged untrue
               statement or omission or alleged omission was so made in reliance
               upon and in strict conformity with written information furnished
               by such Investor. Notwithstanding the provisions of this clause
               (ii), no Investor shall be required to indemnify any person
               pursuant to this Section 7 in an amount in excess of the amount
               of the aggregate net proceeds received by such Investor in
               connection with any such registration under the Securities Act.

          (iii) Promptly after receipt by an indemnified party pursuant to the
               provisions of paragraph (i) or (ii) of this Section 7(d) of
               notice of the commencement of any action involving the subject
               matter of the foregoing indemnity provisions, such indemnified
               party will, if a claim thereof is to be made against the
               indemnifying party pursuant to the provisions of said paragraph
               (i) or (ii), promptly notify the indemnifying party of the
               commencement thereof; but the omission to so notify the
               indemnifying party will not relieve the indemnifying party from
               any liability which it may have to any indemnified party
               otherwise than hereunder nor of its obligations or liabilities
               pursuant to this Agreement, except to the extent that the failure
               to so notify materially prejudices the indemnifying party. In
               case such action is brought against any indemnified party and it
               notifies the indemnifying party of the commencement thereof, the
               indemnifying party shall have the right to participate in, and,
               to the extent that it may wish, jointly with any other
               indemnifying party similarly notified, to assume the defense
               thereof, with counsel satisfactory to such indemnified party;
               provided, however, if the defendants in any action include both
               the indemnified party and the indemnifying party and there is a
               conflict of interest which would prevent counsel for the
               indemnifying party from also representing the indemnified party,
               the indemnified party or parties shall have the right to select
               one separate counsel to participate in the defense of such action
               on behalf of such indemnified party or parties, which counsel
               shall be reasonably satisfactory to the indemnifying party. After
               notice from the indemnifying party to such indemnified party of
               its election so to assume the defense thereof, the indemnifying
               party will not be liable to such indemnified party pursuant to
               the provisions of said paragraph (i) or (ii) for any legal or
               other expense subsequently incurred by such indemnified party in
               connection with the defense thereof other than reasonable costs
               of investigation, unless (x) the indemnified party shall have
               employed counsel in accordance with the proviso of the preceding
               sentence, (y) the indemnifying party shall not have employed
               counsel satisfactory to the indemnified party to represent the
               indemnified party within a reasonable time after the notice of
               the commencement of the action, or (z) the indemnifying party has
               authorized the employment of


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               counsel for the indemnified party at the expense of the
               indemnifying party. No indemnifying party shall, without the
               prior written consent of the indemnified party, consent to entry
               of any judgment or enter into any settlement which does not
               include as an unconditional term thereof the giving by the
               claimant or the plaintiff to such indemnified party of a release
               from all liability in respect of such action, and no indemnified
               party shall consent to entry of any judgment or settle such
               action without the prior written consent of the indemnifying
               party.

     (e)  SEC Reports. The Company will file with the Commission, on a timely
          basis, all SEC Reports required to be filed under the Exchange Act and
          any other documents required to meet the public information
          requirements of Rule 144(c) under the Securities Act.

8.   Nasdaq Covenants. The Company will use its best efforts to meet any
     requirements or take any action necessary to maintain listing of the
     Company's Common Stock on the Nasdaq National Market, including seeking
     shareholder approval at the Company's 2000 Annual Meeting of Shareholders
     for the conversion of the Notes into Units. The Company will use its best
     efforts to hold the 2000 Annual Meeting of Shareholders by May 15, 2000.
     Each Investor agrees to vote all shares of Common Stock of the Company
     beneficially owned by such Investor for the conversion of the Notes into
     Units at the Company's 2000 Annual Meeting of Shareholders

9.   Miscellaneous.

     (a)  This Agreement and the rights and obligations of the parties hereunder
          shall not be assignable, in whole or in part, by the Company without
          the prior written consent of the Investors. This Agreement and the
          rights and obligations of the parties hereunder shall not be
          assignable, in whole or in part, by an Investor without the prior
          written consent of the Company, except that any Investor may assign
          its rights under this Agreement to any affiliate without the prior
          written consent of the Company. This Agreement shall inure to the
          benefit of and be binding upon and be enforceable by the successors
          and permitted assigns of the parties hereto. Neither this Agreement
          nor any provision hereof may be amended, modified, waived or
          discharged without the written consent of the parties hereto.

     (b)  This Agreement, including the exhibits attached hereto, constitutes
          the entire agreement of the parties relative to the subject matter
          hereof and supersedes any and all other agreements and understanding,
          whether written or oral, relative to the matters discussed herein.

     (c)  All representations and warranties contained herein shall survive
          after the execution and delivery of this Agreement for a period of two
          (2) years from the date hereof. All covenants and agreements which by
          their terms are to be performed after the date hereof will survive
          indefinitely, unless such covenants and agreements by their terms
          expire at an earlier date, in which case they will expire on such
          earlier date.


                                       11
<PAGE>

     (d)  All notices, requests, consents and other communications required or
          permitted hereunder shall be in writing and shall be given in writing
          by personal delivery, facsimile, commercial air delivery service or by
          registered or certified mail, postage prepaid, return receipt
          requested, addressed to the Company at the address set forth in the
          introductory paragraph to this Agreement and to the Investors at the
          addresses set forth on Schedule I, or at such other address as the
          respective parties may designate by like notice from time to time.
          Notices so given shall be effective upon the earlier of: (a) receipt
          by the party to which notice is given (which, in the instance of a
          facsimile, shall be deemed to have occurred at the time that the
          machine transmitting the facsimile verifies a successful transmission
          of the facsimile); (b) on the fifth business day following the date
          such notice was deposited in the mail; or (c) on the second business
          day following the date such notice was delivered to a commercial air
          delivery service.

     (e)  This Agreement shall be construed and enforced in accordance with the
          laws of the State of New York.

     (f)  This Agreement may be executed in two or more counterparts, each of
          which shall be deemed an original, but all of which together shall
          constitute one and the same instrument. This Agreement may be executed
          by facsimile.

                          [Next Page is Signature Page]


                                       12
<PAGE>

     IN WITNESS WHEREOF, the Company and the Investors have executed this
Agreement effective as of the date first written above.

                                       OPTICAL SENSORS INCORPORATED


                                       By /s/ Paulita M. Laplante
                                          --------------------------------
                                          Paulita LaPlante,
                                          President and Chief Executive Officer


                                       CIRCLE F VENTURES LLC


                                       By /s/ Hayden R. Fleming
                                          --------------------------------------

                                       Its
                                          --------------------------------------


                                       SPECIAL SITUATIONS FUND III, L.P.


                                       By /s/ David Greenhouse
                                          --------------------------------------

                                       Its
                                          --------------------------------------


                                       13
<PAGE>

                                   SCHEDULE I


                                                          Maximum
Investors                                             Principal Amount

Circle F Ventures LLC                                     $1,500,000
17797 North Perimeter Drive
Suite 105
Scottsdale, Arizona 85255

Special Situations Fund III, L.P.                         $1,500,000
153 E. 53rd Street, 55th Floor
New York, New York 10022

Total                                                     $3,000,000


                                       14
</TEXT>
</DOCUMENT>
