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Convertible Loan Note

/kənˈvɜːtəbəl ləʊn nəʊt/

A loan given to a company that can be changed into shares later. This usually happens when the company raises new money from investors in future funding rounds.

What is a Convertible Loan Note?

A convertible loan note is a loan that can turn into company shares later. It's popular with startups because it lets them raise money quickly without setting a company value right away.

How Does it Work?

An investor lends money to the company. Later, when the company raises more funding, the loan converts into shares. The conversion usually happens at a discount to the new share price, giving early investors a better deal.

Why Do Companies Use Them?

Startups like these loans because they're faster than equity deals. There's no need to argue about company value early on. Companies can focus on growing their business instead of long negotiations.

What Are the Key Terms?

Interest rate: Usually 3-8% per year on the loan amount.

Discount rate: Often 10-30% off the future share price when converting.

Value cap: Sets a maximum company value for conversion, protecting investors if the company does very well.

End date: When the loan must be repaid if it hasn't converted, usually 12-36 months.

What Happens at Conversion?

When the company raises new money, the loan automatically becomes shares. The number of shares depends on the conversion terms. Investors get shares at a lower price than new investors pay.

What Are the Risks?

For companies, the main risk is giving away more shares than expected if the business grows quickly. The value cap means early investors get a bigger slice of the company.

For investors, the company might fail before conversion. Or the conversion terms might not work out as well as hoped.

When Might This Not Convert?

If the company doesn't raise more funding before the end date, investors might get their money back instead of shares. Some loans have other conversion triggers, like a company sale.

Convertible loan notes help bridge the gap between debt and equity. They help startups raise money quickly while giving investors the chance to benefit from future growth.