Funding your startup via a convertible loan, not to be confused with…

In this article, we explain the advantages of the convertible loan and why they are widely used. Of course, there are other financing methods. Here, we look at alternative financing methods and explain how they differ from convertible loans.

Convertible loan <-> Bank loan

A bank loan has the advantage of being cheaper than a convertible loan (interest rate). Unlike a convertible loan, it is not subordinated to the company’s other debts. It is generally guaranteed by a significant security, in the form of a pledge on the business, unless it is guaranteed (in whole or in part) by a regional, national or European fund as part of a specific programme. Bank loans are never convertible into shares and are therefore non-dilutive (i.e. they do not dilute shareholders’ equity by issuing new shares). Ideally, the two types of loans should be combined. As convertible loans are considered quasi-equity by banks, they may open up access to bank loans as part of programmes offering guarantees to banks. Indeed, convertible loans have characteristics similar to equity because of the low probability of having to be repaid and their subordinated nature.

Convertible loan <-> Convertible bond

A convertible bond is essentially a convertible loan represented by a negotiable debt instrument, governed by the companies and associations Code, unlike a convertible loan which is purely contractual. Some professional lenders may require the creation of convertible bonds to secure the conversion of their debt. However, this involves a fairly heavy legal burden (extraordinary general meeting before a notary), whereas the purpose of a convertible loan is generally to avoid such red tape and waste of time and money.

Convertible Loan <-> SAFE

A « Simple Agreement for Future Equity » (SAFE) is essentially a deferred contribution that is not debt. A SAFE encompasses many of the same key characteristics as convertible debt. However, in a SAFE, instead of lending money, the investor buys the right to subscribe to shares at a later date for a set amount, paid in full in advance. This financing solution, developed in the United States and France, has rapidly gained in popularity due to its simplicity. Unfortunately, while the mechanism is possible under Belgian law, this simplicity cannot be replicated. Although the convertible loan is considered ‘quasi-equity’ by financial institutions, it remains a debt under Belgian accounting law. It will therefore not enable the company to ‘clean up its balance sheet’ as an investment in shares or a SAFE would.

FAQ

What is the difference between a convertible loan and a bank loan?

An ordinary bank loan typically carries a lower interest rate, is not subordinated to the company’s other debts and is never convertible into shares so it is not dilutive. It is, however, usually secured by substantial security such as a pledge over the business, unless it is guaranteed in whole or in part by a regional, national or European fund.

Can a startup combine a convertible loan and a bank loan?

Yes, and ideally it should. Banks treat convertible loans as quasi-equity, because of the low probability of repayment and their subordinated nature. This can strengthen the company’s financing position and help it access additional bank funding.

What is the difference between a convertible loan and a convertible bond?

A convertible bond is a transferable debt security governed by the Belgian companies and associations Code. A convertible loan is a contractual loan with agreed conversion terms.

Some professional investors prefer convertible bonds to secure the conversion of their debt, but this brings a heavy legal burden (an extraordinary general meeting before a notary) which is precisely what a convertible loan is designed to avoid.

Does a SAFE work under Belgian law?

Not really. A SAFE (Simple Agreement for Future Equity) allows an investor to pay now in exchange for the right to receive shares later, under agreed conditions. Such an agreement remains a debt under Belgian accounting rules until conversion, even if banks treat it as quasi-equity. It therefore does not clean up the balance sheet the way an investment in shares or the SAFE model that became popular abroad would.