What if my convertible loan is not converted?

A convertible loan is an opportunity… until the day it has to be repaid. If the conversion fails, your start-up could find itself in trouble. Find out how to anticipate this deadline so that it doesn’t become a threat to your growth.

What non-conversion means for a startup

Non-conversion is often the result of the startup or scaleup’s inability to raise new funds or insufficient performance to induce the investor to convert its debt. It usually leads to serious financial difficulties for the company, which in turn can result in the investor losing any chance of a return on investment.

As most startups and scaleups are short of cash, repaying the loan is generally not an option and could even lead to bankruptcy. However, there are notable exceptions in situations where startups and scaleups are able to find cheaper or less dilutive funding, usually because they have performed beyond their expectations.

Bullet loan or loan repayable in fixed monthly instalments?

Convertible loans are often structured as “bullet” loans, which means that the full principal amount of the loan (and interest, if not paid during the term of the loan) must be repaid in full by a fixed due date.

In other cases, the due date marks the end of a grace period during which no repayments need to be made. Once this grace period has passed, repayment of the principal in periodic instalments begins.

Maturity date: a conversion triggering event

The maturity date is also generally defined as a triggering event for conversion, allowing the investor to decide whether to convert the loan rather than demand repayment.

Avoiding a maturity date that is too soon

The maturity date is the date on which the debt becomes due and payable. It is therefore advisable to set a maturity date well after the planned closing date for the next round of equity financing.

Planning a maturity date that is too soon and betting on a rapid conversion could put your startup in a very unfavourable position vis-à-vis the investor. In fact, the investor could subject the renegotiation of the terms of his loan to very harsh conditions.

On the other hand, providing for a maturity date that is too far in the future could be costly in terms of interest, particularly if the interest is not convertible but has to be paid by the company.

Early repayment

The possibility of repaying the loan before its maturity is rarely offered to the company, and will generally be subject to the lender’s ability to convert its loan beforehand.

FAQ

What happens if a convertible loan is not converted?

If the convertible loan is not converted, it must in principle be repaid in accordance with its terms. Non-conversion often results from the company being unable to raise new funds or from performance that is insufficient to persuade the investor to convert its debt. For such startups, repayment is generally not an option and can lead to bankruptcy. There are, however, exceptions where the company has performed strongly enough to obtain cheaper or less dilutive financing instead and has retained the option to refuse conversion.

What is a bullet loan?

A bullet loan is a loan where the full principal (together with any interest that has not been paid during the term) is repaid in one go at maturity. Convertible loans are often structured this way. In other cases the maturity date marks the end of a grace period, after which repayment of the principal begins in periodic instalments.

How should the maturity date of a convertible loan be set?

The maturity date is the date on which the debt becomes due and payable. It is advisable to set it well after the planned closing date of the next equity financing round, so that the company has adequate time to complete that financing before repayment becomes due. A maturity date set too far in the future can, however, increase the cost of the loan through additional interest, particularly where that interest is not convertible and has to be paid in cash.

What are the risks of setting the maturity date of a convertible loan too early?

Betting on a rapid conversion can put the company in a weak negotiating position if the expected financing or conversion has not yet occurred. The investor can then attach very harsh conditions to renegotiating the terms of the loan. The maturity date is also commonly a triggering event for conversion, allowing the investor (depending on the terms of the agreement), to convert the loan rather than require repayment.

Can a company repay a convertible loan early?

The company is rarely given an unrestricted right to repay a convertible loan before maturity.

Where early repayment is permitted, it is generally subject to the lender first having the opportunity to convert its debt into shares or with a steep early repayment fee.