Convertible loan: an interesting way to raise capital?

A convertible loan is a standard loan with one particularity: repayment can be converted into shares. It is a popular, relatively simple way for start-ups to raise capital without having to value the shares immediately. The investor often receives a discount (and sometimes a cap) on the share price later on. The agreement is always custom-made.

There are various ways to raise seed capital; a popular one is the convertible loan. We will guide you through this document.

What is a convertible loan?

With a convertible loan, you take out a loan with an agreed term, maturity date, and interest rate, often including a grace period so that the start-up can first focus on the start-up phase. The unique feature is that the repayment can be converted into shares: instead of receiving cash back, the investor can receive shares in the company.

Advantages and disadvantages

For the start-up: you raise money, it is relatively simple (often no notary is required, which saves time and money), and you retain control during the start-up phase. If you choose an investor with experience and expertise, you simultaneously acquire knowledge at a low cost. The disadvantage is the time pressure and the fact that, with healthy growth, the chance increases that the investor will opt for shares, causing the other shareholders to be diluted.

For the investor: he can play it safe and choose between repayment or converting into shares at a favorable price. If things go wrong, as a lender he has a higher rank than shareholders and therefore more security in the event of bankruptcy. The downside lies in the risks inherent in investing in start-ups.

What is stated in a convertible loan agreement?

There is freedom of contract, and every agreement is custom-made. Important buttons are:

• term, interest-only period, maturity date and interest;
• agreements regarding the conversion. Because the shares have often not yet been valued (and early valuation is difficult), that discussion is often shifted to the moment of conversion. As a reward, the investor then receives a discount on the share price, sometimes with a cap (an upper limit on the valuation);
• the moment of conversion or agreed triggers;
• other provisions, such as penalty-free early repayment or applicable law.

Frequently Asked Questions

Why do start-ups choose a convertible loan?

Because it generates capital quickly and relatively easily without the shares needing to be valued immediately, and the founders retain control during the start-up phase.

What is a discount and a cap on conversion?

The discount rewards the investor with a lower share price upon conversion. The cap is an agreed upper limit on the valuation over which the conversion is calculated.

Do I need a notary?

For the convertible loan agreement itself, this is often not the case, which saves time and costs. However, the situation may be different for the actual issuance of shares upon conversion.

Have a custom convertible loan drawn up

The legal experts at MKB Juristen draft a convertible loan agreement that suits your terms. View our expertise in corporate law or schedule a free consultation .