The breakdown: convertible loan notes

What is a convertible loan note and why are they popular?
What the…? 

A convertible loan note (CLN) is a way for a business to raise cash in the shape of a loan from an investor – which converts into equity at a pre-determined date or milestone. That might be on completion of a funding round, if the business reaches a certain valuation, can’t pay back the loan, is sold or liquidated. 

The precise terms of a CLN will differ in each case, but it’s typically a one-page document that allows the business to take the same loan from multiple investors, at the same time and on the same terms. 

Why the…?

CLN’s are popular for their relative simplicity and flexibility.

They appeal to businesses because: 

- It allows them to raise cash quickly to prove a concept – especially in anticipation of a future funding round.

- It means they don’t have to burn precious cash – and time – on equity negotiations.

- Interest rates are fairly favourable (8% to 10% pa) and interest is often not repaid, but converted into shares. 

And investors because:

- They’re seen as being less risky than equity investment – particularly early-stage businesses with no track record.

- The CLN is classed as a debt – meaning they get priority of repayment over other shareholders if the business fails.

- They get a discount on the share price at any future equity round – provided the business increases in value.

In practice 

Willem van Roosmalen, co-founder, Homerun, Amsterdam

Having founded the company in 2015, Willem and co-founder Thomas Moes decided to raise cash for Homerun in 2019, considering the traditional equity route before finally deciding to pursue convertible loan notes. ‘Convertible notes fitted our scenario best, as we were raising a fast and straightforward seed round. It was one simple contract that’s the same for every (angel) investor, over tailored contracts, negotiation, hefty legal fees and endless paperwork.’ 

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