Convertible Loan

A convertible loan is a loan that can later be converted into company shares. Initially, the investor gives the company money as a loan, which can be converted into shares in a later financing round. This form is used for young companies when the valuation is still open. The practical advantage lies in speed and cost: the final valuation can remain open until the next round, and the process is often less demanding than an immediate capital increase. Formal requirements depend on the specific terms, however.

Economically the investor is compensated for the earlier risk through two mechanisms. The discount gives a price reduction on conversion against the next round's price. The valuation cap additionally sets a maximum value at which conversion occurs, so the investor is not left empty-handed if the next round is priced very high. Interest is added, often not paid in cash but converted along with the principal.

The agreement also sets out conversion triggers, typically a qualified financing round above a minimum size, a sale of the company and the end of the term. The insolvency dimension matters: without a qualified subordination the loan counts as a liability and can contribute to over-indebtedness, so subordination is standard practice. A convertible loan should be distinguished from a SAFE, which is not a loan and has neither interest nor a maturity date.

Besides the terms, founders should watch how many such instruments exist in parallel, because several loans with different discounts and valuation caps may convert in the same round and dilution then turns out considerably higher than expected. A running calculation showing the resulting percentages for different valuations of the next round is therefore advisable. It should also be settled whether conversion is mandatory or at the investor's option, since an option removes planning certainty from the company.