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Convertible Loan Note
"I need a convertible loan note for a startup investment of £50,000, with a 5% annual interest rate, convertible into equity at a 20% discount during the next funding round, and a maturity date of 24 months from the issuance date."
What is a Convertible Loan Note?
A Convertible Loan Note lets investors lend money to a company with the option to convert their loan into shares later on, usually during the next funding round. It's particularly popular with UK startups who need quick funding but aren't ready to set a firm company valuation yet.
The note typically offers investors a discount on future shares and sets an interest rate until conversion. Under English law, these notes give lenders more protection than standard equity investments, as they rank ahead of shareholders if the company faces financial troubles. They're simpler and faster to set up than a full equity investment round.
When should you use a Convertible Loan Note?
Consider using a Convertible Loan Note when your startup needs quick funding but setting a valuation feels premature or complicated. This tool works especially well during bridge rounds between major funding stages, or when you're close to a significant milestone that could boost your company's value.
These notes make perfect sense for early-stage UK companies expecting rapid growth within 12-18 months. They're also ideal when you have interested investors but need to move faster than a traditional equity round allows. The streamlined documentation and flexibility around future valuation make them particularly attractive for tech startups and innovative businesses seeking £50,000 to £1 million in funding.
What are the different types of Convertible Loan Note?
- Basic Convertible Notes: Standard format with fixed interest rate and conversion discount, typically used for seed funding under £250,000
- SAFE-style Notes: Modified for UK law, offering conversion rights without interest or maturity date
- Discount-only Notes: Focus solely on share price discount at conversion, popular with accelerator programs
- Valuation Cap Notes: Include maximum company valuation for conversion calculations, protecting early investors
- Interest-bearing Notes: Higher interest rates instead of equity incentives, often used by more risk-averse investors
Who should typically use a Convertible Loan Note?
- Startup Founders: Lead the negotiation and approval process, sign the Convertible Loan Note on behalf of the company
- Angel Investors: Provide the funding and sign as lenders, often negotiating key terms like valuation caps and discounts
- Corporate Lawyers: Draft and review the notes, ensure compliance with UK company law and FCA regulations
- Company Directors: Approve the terms and manage ongoing compliance with note conditions
- Company Secretary: Maintains official records and handles administrative requirements for the notes
How do you write a Convertible Loan Note?
- Company Details: Gather complete company information, shareholder structure, and existing investment agreements
- Investment Terms: Define loan amount, interest rate, maturity date, and conversion discount or valuation cap
- Board Approval: Secure formal board resolution authorizing the note issuance
- Investor Information: Collect KYC details and confirm investor's sophistication status under UK regulations
- Conversion Triggers: Specify qualifying funding rounds and other events that trigger conversion
- Security Details: Determine if the note will be secured against company assets
What should be included in a Convertible Loan Note?
- Loan Terms: Principal amount, interest rate, and maturity date clearly stated
- Conversion Rights: Detailed mechanics for converting debt to equity, including discount and valuation cap
- Trigger Events: Qualifying funding rounds, exit events, and default scenarios
- Share Class Details: Type and rights of shares to be issued upon conversion
- Security Provisions: Ranking of the note and any security arrangements
- Governing Law: Explicit statement of English law jurisdiction
- Execution Block: Company details, director signatures, and date of execution
What's the difference between a Convertible Loan Note and a Loan Agreement?
A Convertible Loan Note differs significantly from a Loan Agreement in several key aspects. While both involve lending money, their purposes and outcomes are quite different.
- Investment Intent: Convertible Loan Notes are designed primarily as investment vehicles with the expectation of equity conversion, while Loan Agreements focus purely on debt repayment
- Return Structure: Convertible Notes offer both interest and potential equity upside through conversion rights, whereas Loan Agreements only provide interest returns
- Documentation Complexity: Convertible Notes include specific conversion mechanisms and valuation terms, making them more complex than standard Loan Agreements
- Default Remedies: Loan Agreements typically have stronger enforcement rights and clearer repayment terms, while Convertible Notes focus more on conversion scenarios
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