UK: Convertible Loan Notes: A Brief Summary

Last Updated: 31 August 2017
Article by Graham Halliday

Instead of going straight into an equity funding round (i.e. the issue of shares in exchange for funds) some companies initially raise money through a type of debt funding, known as convertible loan notes, in order to prove a concept, start trading or to stay afloat. They are also used at later stages as bridging finance in order to keep a company trading in anticipation of a sale or listing. However, this note focusses on the first use. I have provided a brief summary of what a convertible loan note is and their advantages, disadvantages and common terms.

What is a convertible loan note?

Convertible loan notes are essentially loans which bear interest and are repayable at some point in the future, except that they convert into equity (i.e. shares in the borrower company) in certain circumstances (usually a future equity funding round or a sale of the company). This is essentially the whole point of a convertible loan note.

Why use a convertible loan note?

As there is usually less documentation to negotiate in comparison to a normal equity investment, they are typically used where a company is looking to raise money quickly, usually to prove a concept, in anticipation of an equity funding round in the near future. This also allows companies to minimise the costs of raising money when budgets are tight.

What are the advantages to the founders of the borrower company?

In addition to allowing companies to raise money quickly, they also allow the company and the loan note investor to delay negotiating the valuation of the company until the first equity round. If a company is not yet profitable (or hasn’t even started trading), it may be difficult to value the company. The founders can therefore hold off negotiating the value of the company until it is in a stronger position and avoid potentially giving away too much equity at an early stage.

What are the advantages to the investor?

Convertible loan notes are often viewed as giving investors the best of both worlds. On the one hand, if the company’s fortunes decline and the company becomes insolvent they (and the other creditors) will rank ahead of the shareholders and will have priority over the shareholders in respect of the assets of the company. On the other hand, if the company’s value grows and, for example, it receives a large equity investment, the loan note investor can convert the loan into equity at a discounted rate to the new investors. They usually also benefit from the preferential rights that the new investors receive under this equity funding round.

Under what circumstances do notes usually convert?

As mentioned above, the idea behind convertible loan notes is that they should convert into equity at some point in the future. They typically convert automatically on a qualifying funding round (as explained below) or a sale of the company. Sometimes the loan note investors also have the option of the loan notes converting or becoming repayable on a maturity date (e.g. if a qualifying funding round hasn’t occurred within 2 years of the loan being made) or on a non-qualifying funding round (as explained below).

A qualifying funding round is where the company achieves new investment in excess of an agreed amount before an agreed date e.g. raising £2 million within 2 years of the loan note. On a qualifying funding round the notes usually automatically convert at a discount into the most senior class of share issued in the funding round. For example, if the new investors are subscribing for shares at £1.00 and the loan note investors have a 20% discount, their loans will convert at £0.80 per share. This eliminates the debt and rewards the loan note investors with a discounted price per share.

A non-qualifying funding round is where the pre-agreed fund raising amount is not achieved within the agreed time. As the objective is not met, the loan note investors can choose to convert their shares at a discount or wait until a qualifying funding round where, for example, the loan note investors are happy with the rights attaching to the shares to be issued under that round.

What are the common terms relating to the conversion of the notes?

  • Class of share on conversion: As mentioned above, when the loan converts on a funding round the class of shares issued to the loan note investors is usually the most senior class under the fund raising round. This is typically preferred shares with preferential rights to the ordinary shares on the liquidation and sale of the company.
  • Discount: The loan notes also usually convert at a discount to the price per share on the equity funding round to compensate the risk the loan note investors have taken with their money. This discount is usually between 10% and 30% and is one of the key terms to negotiate.
  • Valuation cap: As a high valuation of the company could give the loan note investors an insignificant percentage of the company’s share capital following conversion, a valuation cap on a qualifying funding round guaranteeing the loan note investor a minimum percentage of equity if the company’s valuation is extremely high is sometimes included. For example, a loan note investor could be guaranteed at least 5% of equity if the company is valued at £20 million or more. However, including a cap means that discussions will need to be had over the company’s valuation, which can make negotiations protracted and to some extent undermine one of the key advantages of convertible notes.
  • Interest rate: Convertible loan notes usually accumulate interest in the same way as normal loans. The interest rate on a convertible note is usually between 4 and 8%. Sometimes the interest converts but it is usually only payable on redemption.

Under what circumstances are notes usually redeemed (i.e. when is the loan is paid back)?

When loan notes are redeemed the loan becomes repayable and the loan will not convert into equity. Usually, the loan note investor can redeem their loan notes if they have not converted into equity by a certain date (e.g. if a qualifying funding round has not taken place within two years). The loan note investors also usually have the right to redeem the loan notes on a non-qualifying fund raising round (as explained above) or if the company becomes insolvent.

What are the disadvantages of convertible loan notes?

Founders should be aware that when the loan note converts at the next funding round the loan note investors are likely to get similar rights to the new investors in that round. These rights may be more favourable than those the loan notes investors would have received had they invested in shares.

In respect of investors, loan notes do not enable them to benefit from Seed Enterprise Investment Scheme (SEIS) relief or Enterprise Investment Scheme (EIS) relief at present, both of which are very valuable to business angels. This is one of the main reasons why convertible loan notes are not used in the UK as much as in the US.

In any case, if a company decides to raise money by issuing loan notes, it is important to carefully consider the impact on raising money under a proper equity round in the future. Equity investors can be put off from investing under an equity funding round if, for example, loan notes will make up a significant proportion of the equity funding round and/or if the loan note investors are entitled to a large discount on their shares. If the loan notes make up a significant proportion of the equity funding round, then a large amount of equity could be given away under the round whilst a comparatively small amount of money is being raised, which can be unattractive to potential new investors. It is therefore important for the company to consider the timing of the convertible loan notes in relation a future equity funding round and how the share capital of the company could look after conversion of the notes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.