A convertible loan, sometimes referred to as a ‘convertible note’ or ‘convertible loan note’, is a form of short-term debt that converts to equity shares at a later date.
Convertible loans are more common at an early stage when it’s difficult to value the company and tend to be more popular with investors in the US than in the UK.
The amount you can raise in a convertible loan varies greatly and just like an equity raise, should be determined by the capital requirement detailed in your financial model.
You’ll need to raise enough to get you to your next point of growth inflection and the converting funding round.
Conversion of the loan into shares usually happens in the next qualifying equity funding round or when a certain date is reached. Exceptions to this are if you sell the company in advance of these events or the investor requests their loan be converted to equity at a certain price.
All of the variable conversion scenarios should be outlined in the term sheet which you should have a solicitor prepare and explain to you.
The class of shares investors receive is usually the same as the investors in the qualifying funding round, again there may be exceptions which can be outlined in the term sheet.
No, convertible loan investors are not eligible to receive EIS or SEIS tax relief on their investments. This is because their investment in the first instance is a form of debt that can accrue interest and be repaid.
If you’d like to raise money in advance and allow your investors to claim tax relief then raising under an Advance Subscription Agreement (ASA) might be more suitable.
The coupon is the amount of interest accrued whilst the loan remains unconverted. The details of the amount of interest and its rate of accrual (daily, monthly, annually) are outlined in the term sheet. Sometimes the interest is paid in cash as the loan period goes on, much like any other loan; sometimes it’s paid in principle which is a lump sum payment when the loan converts and sometimes the interest converts to shares along with the rest of the loan at the conversion event. Every term sheet is different and there are no right or wrong ways of doing it which is why we urge you to speak to a solicitor about what is best for you and your circumstances.
The longstop date is the date outlined in the term sheet when the loan will automatically convert to shares at a pre-agreed price or be repaid in full plus interest if a conversion event hasn’t already occurred.
Convertible loans can be secured or unsecured.
The most common is the latter where a convertible loan is considered an advance payment for shares with the bonus of interest.
A convertible loan funding round is similar to any other form of fundraising. Particularly if you are raising a significant amount. You’ll still need to prepare investment assets and pitch to investors.
Please do speak with a solicitor about your specific requirements and get a bespoke term sheet drawn up for your round. This will allow you to tailor any of the nuances we’ve outlined above and ensure you fully understand what you are signing up for before you commit. Don’t use a template or any quick-fix tech to do this. It’s not quick, it’s not easy, unless you’re a qualified corporate solicitor you should always seek professional, regulated advice.
Sign up now to receive actionable insight to help scale your business.