Convertible Loan Note (CLN)

What is CLN?

Are you looking to raise finance for your business, whether a start-up or already established?

A convertible loan note is a type of short-term debt that gets converted into equity shares at a later date.

The point at which the loan converts into equity will be determined by the terms of the CLN and will occur on a particular date or upon meeting a set duration.

Benefits of a CLN

For founders

  • Potential to raise money quicker while keeping costs of raising funds lower.

  • For start-ups, founders may be in a position to negotiate with the investor to have the business valued once it is in a stronger position financially thereby controlling the amount of equity given to investors.

For investors

  •  If the company goes insolvent, investors rank above shareholders in order of priority for a claim over the assets of the company.

  • Where the value of the company grows, the investor has the option to convert the CLN into equity at a discounted rate to new investors.

  • Investors will usually get the most senior class of shares in that particular funding round.

Circumstances under which the notes will convert

Conversion into shares will usually occur by the date set out in the CLN. If the company does not reach its funding target under the CLN, they will typically be required to repay the investment amount along with the interest accrued in full.

Where the pre-agreed fund raising amount is not met within the agreed timescale, investors may be able to choose whether to convert their shares at a discounted rate or to wait for a qualifying funding round.

A qualifying funding round would be where the investors are satisfied with the rights attached to the shares issued under that particular round.

When would the notes be redeemed?

Investors have the right to redeem the loan notes in the event that the pre-agreed funding amount is not raised in the relevant time or the company goes insolvent. This is known as a non-qualifying funding round.

Where the loan note is redeemed, it will not convert into equity.

Disadvantages of CLN

For founders:

  • When a loan note converts at the next funding round, current loan note investors may get similar rights to new investors which could be more favourable than rights gotten if the loan note investors had invested in shares before the next funding round.

  • Risk of dilution of ownership and subsequently control of the company.

  • Where a future equity round is not completed, the convertible loan will remain a debt requiring redemption which can cause financial strain on the company.

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