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Convertible Loans

What is a Convertible Loan?

 

A Convertible Loan is a type of financing where a company borrows money from investors with the option to convert the loan into equity at a later stage, usually at a discounted rate. This instrument is often used by early-stage companies that need capital but want to avoid immediate dilution of their ownership. Instead of paying the loan back in cash, the loan converts into shares of the company at a predetermined conversion rate when certain milestones or financing rounds occur.

Convertable loans

What are the Benefits of Convertible Loans?

Delayed dilution

Founders can maintain control over their company until a later financing round.

Attractive to investors

Convertible loans offer investors the potential for equity at a future discount, increasing their upside.

Flexibility

The company can raise capital quickly without having to set an immediate valuation or go through a complicated equity issuance process.

Lower risk for early investors

Investors may get a favorable price for equity if the company is successful.

Why Set Up a Convertible Loan?

Defer valuation

The company doesn't need to agree on a valuation right away, which can be difficult for early-stage companies.

Attract investors

Investors are often interested in convertible loans because they provide the opportunity to convert the loan into equity at a favorable price when the company grows.

Preserve equity control

The founders can delay equity dilution until a future funding round.

How to Set Up a Convertible Loan

Define the loan terms

This includes the loan amount, interest rate, maturity date, and the conversion terms.

Set the conversion conditions

These conditions specify when and how the loan converts into equity (e.g., during the next financing round or upon a liquidity event).

Establish a cap and discount

 Investors typically receive a discount on the future share price (usually 10-30%) and may also benefit from a valuation cap to protect their investment from excessive dilution.

Examples of Companies Using Convertible Loans

Stripe

The payment processing company has raised capital using convertible loans as part of its early-stage funding.

Dropbox

Dropbox utilized convertible notes during its initial rounds of funding to attract investors and expand its business before going public.

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