Convertible loan note

Definition

A convertible loan note is a loan note that can convert into shares, usually at a future equity round, often with a discount or valuation cap rewarding the early lender.

In plain terms

Investors lend money now that becomes shares later. It avoids arguing about valuation today by pushing that decision to the next round.

Why it matters for your company

CLNs raise capital quickly without setting a valuation upfront, but they can dilute later. For established, cash-generative firms, straightforward debt via a business loan avoids dilution entirely. See equity injection.

In practice

Picture a UK limited company bringing in an investor between funding rounds. Rather than agreeing a share price on the spot, the parties draw up a convertible loan note: the investor's money sits on the company's balance sheet as a loan, with terms specifying what happens when a qualifying event, usually the next priced equity round, arrives.

At that trigger point, the note converts rather than being repaid in cash. The company issues shares to the noteholder instead of returning the principal, and the mechanics for that conversion, along with what happens if no qualifying round ever materialises, are set out in the note's terms rather than decided informally later.

For the company, this defers a difficult conversation about what the business is worth until there is better evidence to have it, which is often the appeal for an early-stage or fast-growing firm that would rather focus on trading than a valuation negotiation.

How lenders read it

A lender assessing a company's financial position will usually treat outstanding convertible loan notes as debt until conversion actually happens, since that is how they sit on the balance sheet and how the obligation legally stands unless and until the triggering event occurs.

What tends to draw more scrutiny is the conversion mechanism itself: whether it is tied to a clearly defined event, and what happens to the company's capital structure if that event is delayed or never arrives. A lender will also want to understand where the note sits relative to other creditors, since that shapes recovery in a downside scenario.

None of this changes how a business loan is assessed on its own terms, but a company carrying convertible instruments alongside conventional debt should expect that mix to be part of the wider picture a lender builds up about its structure.