Traditionally, when an early stage company was seeking quick financing, it often turned to convertible debt instruments, most commonly referred to as convertible loan agreements.
A convertible loan agreement (“CLA”) is an agreement between a lender and a company whereby the lender loans the company a specific loan amount. The lender can either get repaid cash upon the maturity date (usually with interest), or instead of repayment, convert the loan into company equity upon a qualified financing event. The qualified financing event (the “QF”) is often a new round of financing in which the company issues new shares to a third party investor. Under the terms of the convertible loan agreement, in a QF the lender often automatically converts into the same type of shares as the third party investor, but at a discounted price.
Benefits of a convertible loan agreement:
For the company -
A convertible loan agreement (“CLA”) is an agreement between a lender and a company whereby the lender loans the company a specific loan amount. The lender can either get repaid cash upon the maturity date (usually with interest), or instead of repayment, convert the loan into company equity upon a qualified financing event. The qualified financing event (the “QF”) is often a new round of financing in which the company issues new shares to a third party investor. Under the terms of the convertible loan agreement, in a QF the lender often automatically converts into the same type of shares as the third party investor, but at a discounted price.
Benefits of a convertible loan agreement:
For the company -
- The company receives funding more quickly than it would, had the financing round been for equity.
- At this stage, the Company need not enter negotiations for stock liquidation preferences, anti-dilution protection, registration rights, etc., since the lender is not becoming a shareholder.
- The Company, thus, avoids the long hours and expenses of the drafting of numerous transaction documents that usually accompany a share purchase agreement as opposed to the shorter and more concise CLA.
- The lender will receive future stock at a discounted price.
- If the company will not reach the qualified financing event by the maturity date, the lender is entitled to receive repayment of his loan. The lender can even negotiate a higher return percentage, such as 150% or 200% of the loan amount. In some cases, lenders have negotiated up to 500% of the loan amount back.
- Until the company either converts or repays the loan, the lender, essentially, remains a creditor. Debts owed to such creditors generally take priority over any shareholder debt.