Convertible Loan Facility Agreement

06 Déc Convertible Loan Facility Agreement

The purpose of this organization is to cover the converted loan – in general, the less used method of investment. Nevertheless, it usually contains only a few terms that can easily be covered in a single article. Before looking at individual concepts, it is important to distinguish between the two most commonly used investment methods: convertible bonds and equity. In the case of a stake, an investor receives a stake in the company for cash. Simple and simple. If the investor instead makes a convertible loan available, he will provide a loan with a maturity date, interest and a particular turning point: the right to later convert the loan into a stake in the company. In addition, a standard converted loan does not require immediate interest payments. Instead, it is overstretched and converted into equity, as explained below. Convertible bonds are also increasingly used during the start-up phase. There is a lot of criticism of this practice of VCs, especially when the notes are overused and contain harsh terms. I recommend reading this piece by Mark Suster on the subject.

The advantage, from an entrepreneur`s point of view, is that before its conversion, a converted loan behaves in a very similar way to that of a standard credit: the investor generally does not have many rights of a preferred shareholder (board seats, liquidation preferences, etc.). As this is a fairly short and simple document, it is also executed more quickly (which is why convertible bonds can be processed faster than a stake, usually a few weeks). Second, converted lending is used at a time when investors and entrepreneurs are unable to agree on valuation, particularly when they define a conversion discount, but not necessarily the valuation ceiling (explained below). I am not a big fan of this application case: instead of immediately confronting a major issue, both parties decide to postpone their resolution to a later date. Such a strategy can easily backfire and create bad disputes between investors and entrepreneurs, who can block fundraising and kill a start-up. These are the most common terms that an entrepreneur can find in a converted loan, at least based on what we experienced with Credo Ventures. The downside also arises from the nature of the loan: until the loan is converted into equity, the investor has a priority right on the due date to claim assets (i.e. cash – hardware for most startups) to repay the loan and interest.

It goes without saying that most start-ups do not have enough money to repay the loan at maturity and are therefore obliged to liquidate all assets and close the business.