What are the Benefits for Startups when using Convertible Loan Notes (CLNs) for their funding?
Startup Funding through Convertible Loan Notes: Convertible Loan Notes (CLNs) are mainly used by smaller businesses to secure a first-stage investment, often through close friends, business partners, and family. Or risk-averse investors, of course. Generally speaking, these CLNs offer startups and early-stage companies a fast, flexible alternative to equity financing, delaying complex valuation discussions until a future funding round. They reduce immediate dilution for founders, offer investors protection through debt status and favorable terms, and provide Startups of all kinds with an efficient, cost-effective way to raise the capital they need.
Generally, Convertible Loan Notes are common in all Common Law Jurisdictions, but can be used in any location. However, Ireland, Cyprus (both with EU-Nexus), and Gibraltar offer favorable conditions. To use them in Switzerland or Germany, the contracts need to be amended. In either case, Startup Funding through Convertible Loan Notes is a good way for Startups to attract investors. Our Boutique Law Firm TAXEDO Legal will advise you on that matter and possible alternatives.
What are the Key Benefits of Convertible Loan Notes
- Delayed Valuation: Companies can raise funds without immediately setting a company valuation, which is often difficult for early-stage businesses.
- Speed and Lower Costs: Compared to traditional equity financing, CLNs involve less complex legal documentation, facilitating quicker, more cost-effective fundraising.
- Reduced Initial Dilution: Founders retain more control and ownership of their company until the loan converts into shares during a later, often higher-valued, funding round.
- Attracting Investors with Risk Mitigation: Investors enjoy the safety of debt (seniority in liquidation) while securing the upside of converting debt into equity at a discount.
- Favorable Terms for Investors: CLNs offer a 15% or 20% discount (Giveaway) on future equity rounds, simplifying the funding landscape.
- Flexible Funding Structure: Notes generally allow for 18–24, or sometimes 36-month maturity periods, with interest (often 3-8%) accruing and converting to shares rather than requiring cash repayments, aiding cash flow. Even longer periods are possible.
- Tailored for Bridge Financing: Ideal for raising cash between major equity rounds or to fund rapid growth without triggering immediate shareholder restructuring.
But how do investors benefit from investing in CLNs
- Convertible notes defer valuation discussions until you have revenue or product-market fit, avoiding premature dilution or unrealistic expectations. Meaning, investors do not buy over-priced shares.
- Convertible Loan Note holders convert at either the valuation cap or discount rate, whichever gives them more shares when your Series A closes.
- Typical convertible notes include 18-36-month maturities, 5-8% annual interest, 15-25% discounts, and €2-10 million valuation caps.
- We recommend using Convertibles for Capital Requirements of up to €500,000. However, smaller amounts under €250,000 can speed up closing and funding in less than a month. And please do not pile up CLN after CLN, as this will upset the A series investors.
- What kinds of costs should I expect? Well, it depends on the complexity. A small funding round or drafting contracts for investors you already have will trigger legal costs of €1,500-€4,000, versus €5,000-€15,000 for equity. You may also need to check the company’s Constitution.
So, what are the next steps to obtain our Funding?
If you are considering Startup Funding through Convertible Loan Notes, you should speak with us about your projects and funding needs. Just contact us via Contact Form, WhatsApp, or Telegram.