Raise funds without valuing your startup? Use a convertible loan.

Are you a startup or an investor and want to carry out or participate in a fundraising without having to value a company and with limited costs and formalities?

There’s an ideal tool for you: the convertible loan.

What is a convertible loan ?

There are two main types of investment

• investment via debt, whereby an investor lends money and simply remains a creditor
• equity investment (venture capital), whereby investors receive shares in return for their investment.

Alongside equity (venture capital) and debt investments, the convertible loan is a hybrid financing instrument that combines the two in an alternative way.

A convertible loan is an advance that the company obtains from a lender, reserving the right to convert the debt linked to this loan into shares. In other words, a loan can be converted into equity (venture capital) under certain conditions.

No valuation of the company?

Valuing startups and scaleups is a tricky business. It is generally linked to their growth potential over time, so the traditional valuation methods used for established companies are not appropriate. The valuation hurdle can already be difficult, if not impossible, to overcome.

At certain stages of a startup or scaleup, the question of valuation can be particularly sensitive, especially if the company is in the startup phase without having been able to demonstrate commercial traction, or even worse if, at a more advanced stage, it is experiencing significant financial difficulties.

How the convertible loan postpones the valuation

Convertible loans help to resolve this dilemma. The company does not have to be valued at the time the loan is granted. Instead, the valuation is postponed until the time the loan is to be converted.  In most cases, the conversion will be linked to the valuation adopted for a larger investment by a professional investor.

Limited cost and reduced administrative burden?

Investing via a convertible loan avoids that the investor immediately becomes a shareholder in the company. This eliminates the need to go to a notary and draft/update the company’s shareholders’ agreement. This saves the company a considerable amount of time and money, as only a private agreement needs to be signed between the parties.

A popular investment mechanism for existing shareholders

The advantages of a convertible loan described above make it a very popular financing mechanism for startups and scaleups. It is generally accepted by all types of investors.

What Beyond sees in practice

Generally speaking, our experience at Beyond has taught us that if the startup is to succeed, and provided that the startup is careful to set a reasonable interest rate, discount and cap, the convertible loan is generally a favourable instrument for founders and historical shareholders in that it limits the dilutive effect of the investors who subscribe to it.

A convertible loan can also be an attractive option for investors who are reluctant to invest in equity or in debt and feel unable to negotiate the company’s valuation properly.

It should always be borne in mind that if the convertible loan is not converted, it will have to be repaid.

FAQ

What is a convertible loan?

A convertible loan is a hybrid financing instrument, combining features of debt and equity financing. The company obtains a loan from an investor, with the possibility for that debt to be converted into shares under agreed conditions. Until conversion takes place, the investor remains a creditor of the company rather than a shareholder.

Do you need to do a valuation of the startup before it can take out a convertible loan?

No. One of the main advantages of a convertible loan is that the company does not need to be valued when the loan is granted. The valuation is postponed until conversion, where it will usually be based on the valuation adopted for a larger equity investment.

What costs and formalities does a convertible loan save?

Because the investor does not immediately become a shareholder, the financing can be put in place without a notarial deed and the drafting or updating of the shareholders’ agreement. Instead, the parties enter into a private convertible loan agreement. This significantly reduces the time, cost and administrative burden compared with an equity investment.

Is a convertible loan more favourable to founders or to investors?

It can be attractive to both. Based on Beyond’s experience, where the company performs well and the interest rate, discount and cap are set at reasonable levels, a convertible loan can be favourable to founders and historical shareholders by limiting the dilution caused by the investment (for example, because the company’s growth in value outstrips the discount granted). At the same time, in other circumstances, it can be attractive to investors or offer an alternative for investors who do not (yet) wish to invest in shares or who prefer to postpone discussions regarding the company’s valuation.

At what stage should a startup consider a convertible loan?

A convertible loan is particularly useful when the company’s valuation is sensitive or difficult to determine. This may be the case at an early stage, before the start-up has demonstrated significant commercial progress, or at a more advanced stage but where the company is at that time facing financial difficulties. In these situations, postponing the valuation until a later financing round can make the fundraising process considerably easier.