WHAT IT IS CONVERTIBLE LOAN AGREEMENT AND WHAT OPPORTUNITIES DOES IT OFFER FOR START-UPS AND INVESTORS?

The trend of alternative financing for start-ups

Among other things, in view of rising interest rates in traditional credit financing, many companies have started to consider alternative financing methods. One of the alternative financing methods is the Convertible Loan Agreement ("CLA"), or convertible loan agreement.

CLA and its benefits

The essence of a CLA is a commitment by the investor to provide a loan to the start-up, whereby the investor can acquire a stake in the company in lieu of repayment. It is thus a kind of hybrid between loan financing and financing based on the investor's entry into the company.

The conditions under which the conversion from a loan to a stake in the company can take place depend on the will of the parties. It is usually the investor who decides whether to repay the loan or convert it into a share, but it is also possible that the choice lies with the company (start-up).

In contrast to the investor's entry into the company on the basis of a share transfer agreement, in the case of a CLA the investor does not acquire the share immediately, but only if the conversion actually takes place. Otherwise, the loan will be repaid by the company in the standard way. The CLA thus gives the investor room to decide after some time whether or not he believes in the value of the start-up.

Moreover, the CLA is quicker and less costly to arrange than transfer documentation. For investors, a CLA is attractive precisely because of the possible conversion of the loan into a stake in the start-up, especially if its valuation increases in the meantime. In turn, a start-up will extend its financing through a CLA, typically at a lower interest rate.

What arrangements are typically included in a CLA?

The CLA contains mainly the parameters of the loan (terms of the loan, amount, interest rate, maturity) and the terms of conversion of the loan into a share in the company.

The maturity date of the loan is important from a conversion perspective, as it is normally at the maturity date of the loan that the decision will be made as to whether the loan will be repaid with the agreed interest or whether the agreed shareholding will be converted.

An important provision of the CLA is also the mechanism for determining the size of the stake that the investor will receive in the start-up in the event of conversion.

The CLA may also contain, for example, provisions defining the range of matters that the start-up can only do with the investor's consent, provisions limiting changes in the management of the start-up or the possibility of selling shares, or provisions governing the claims regime in the event of liquidation.

CLA as a tailor-made instrument

As discussed above, the CLA is a flexible instrument for financing a start-up. Its parameters can be set specifically according to the needs of the start-up, so that the start-up benefits as much as possible from the advantages offered by the CLA. These are in particular flexibility, speed and low cost. The CLA also presents a number of opportunities for investors.

If you are interested in CLA or want to learn more about investing in start-ups, do not hesitate to contact us - we will be happy to help you.

Adam Weisser contributed to this article.