Convertible Loan Agreement

Under a convertible loan agreement, the lender grants the borrower a loan, usually without interest. The key difference to the ordinary loan agreement is that the loan is generally not repaid but converted into shares of the borrower. The lender thus becomes a shareholder of the borrower and the debt capital (loan) becomes equity capital (shares). This is advantageous for the borrower, especially at early stages, as it does not have to repay the loan with its usually short financial resources. The lender thus agrees to participate in the entrepreneurial risk of the borrower and, in the event of success, benefits from the increase in value that it has helped fund.

The loan is often granted for a short period of time, as it usually serves to bridge the time until the next financing round. Therefore the parties determine the deadline for the next financing round has to take place.

The number of shares issued upon conversion depends on their price (conversion price). The conversion price is calculated by dividing the value of the borrower) by the total number of shares. While determining these parameters, various modalities can be agreed, such as price discounts or a valuation cap to compensate for the risk taken by the lender.

In principle, the issue of new share upon conversion  requires the consent of the borrower’s shareholders. To ensure that the shares are delivered, the lender should therefore request a declaration of consent from the shareholders before disbursing the loan.