Convertible Loan Notes explained: how to use them for startup funding

A convertible loan note allows you to take loans from investors for startup funding. They can help you raise funding without giving away equity and they’re perfect for investors who want to earn interest on their investment.

In this article, we’ll break down the key things you need to know about convertible debt and how to use a SeedNOTE. 

This article covers:

• Convertible loan note definition
• The SeedNOTE solution: why use this convertible debt instrument?
• Difference between a convertible loan and an advanced subscription
• Key takeaways 

Convertible loan note definition

Convertible loan notes (or just convertible notes) are short-term debt instruments. Investors can provide a loan to your company via a convertible note.

Depending on its terms, the convertible note can be either converted into shares (typically at the next funding round) or “redeemed”, which means that you need to repay the investment amount in full, with the agreed interest. The reason they’re called “convertible notes” is because they can be converted into shares.

Being a debt instrument, convertible notes:

• Are treated as debt in your company’s books of accounts
• Are not SEIS/EIS eligible (Read more in our complete guide on SEIS/EIS)
• Give an investor equity in your company if certain events occur (eg. at the next funding round) and typically at a discounted rateto the valuation paid by new investors in the round

The SeedNOTE solution: why use this convertible debt instrument?

It used to be expensive and complicated to raise capital by convertible debt – there was a lot of paperwork involved and you had to keep a register of all the loan note holders. But as part of our agile fundraising revolution, we’ve developed SeedNOTEs as a simple yet powerful way to take in one-off investments.

SeedNOTE allows you to create one agreement to which you can add multiple investors. All you need to do is:

• set the terms of your agreement (such as maturity date, interest rate and when/if the loan converts into shares or must be returned)
• add your investors and their investment amount
• send the agreement to all investors to e-sign

SeedNOTE is a simple way to keep all your convertible loan legals in one, easy-to-use workflow.

Difference between a convertible loan (e.g. SeedNOTE) and an advanced subscription agreement (e.g. SeedFAST)

Convertible loan notes sometimes get confused with advanced subscription agreements. This is because they’re both agreements you make with investors that help you raise funding before a funding round.

The main difference between advanced subscription agreements (ASAs) and convertible notes is that convertible notes are debt instruments while ASAs are equity agreements. The convertible debt is still capable of being repaid in certain scenarios, and it can carry interest, while a SeedFAST or ASA is not repayable at all.

SeedLegals offers an advance subscription agreement as well as our SeedNOTE convertible agreement. The SeedLegals ASA is called a SeedFAST. Read our full guide on SeedFAST here.

Key takeaways

Before you decide that convertible debt is the way to go, factor in the following:

• If your company isn’t SEIS/EIS eligible or the investor doesn’t want to claim SEIS/EIS, convertible debt can be a good option.
• Investors are attracted to convertible loan notes because debt ranks higher than equity if your company is insolvent or looking to liquidate/wind up, meaning they can get their money back if the company fails.
• Convertible debt can help you raise capital if your company has a high risk profile.
• Your company must be able to pay back the original investment amount plus interest on maturity. If you can’t, speak to your investor and find out what their terms are for the investment amount.
• If you’re looking for quick and simple one-off investments, interest-free, advanced subscription agreements (e.g. SeedFASTs) may be the better way to go.

Talk to an expert

Got questions about convertible agreements? We’ll convert them into answers. Book a call with a funding team expert or hit the chat button.