TL;DR
- The Definition: A short-term debt instrument that converts into equity during a future financing round.
- The Goal: To bridge the gap between "Seed" and "Series A" without setting an immediate valuation.
- The Mechanics: Interest rates, maturity dates, Valuation Caps, and Discount Rates.
- The Strategy: When to use a Convertible Note vs. a SAFE or a Float Facility.
What is a convertible loan?
A Convertible Loan (often called a Convertible Note) is a hybrid financial instrument. It begins its life as debt (a loan with interest) but is designed to convert into equity (shares) upon the occurrence of a specific event, usually a "Qualified Financing Round" (like a Series A).
Founders use them to raise capital quickly when they don't want to argue with investors about the company's valuation today. Instead, they "kick the can down the road," letting the Series A lead investor set the price later.
The anatomy of a convertible loan: 4 key terms
1. The valuation cap
The Valuation Cap is the most important term. It is a "safety net" for the investor. It sets the maximum valuation at which their loan will convert into shares, regardless of how high the Series A valuation is.
- Case Example: You raise £500k on a £5M Cap. A year later, you raise a Series A at a £10M valuation. Your convertible investors convert as if the company was only worth £5M, effectively getting twice as many shares as the new investors.
2. The discount rate
The Discount Rate is a reward for early-stage risk. It gives the lender a percentage discount on the share price paid by the Series A investors.
- Common Range: 15% to 25%.
- The "Either/Or" Rule: Most notes convert at the lower of the Capped Price or the Discounted Price.
3. The interest rate
Because it is technically a loan, it must accrue interest.
- Current Market (2026): 4% to 8%.
- Important Note: The interest isn't usually paid in cash. It "accrues" and is added to the principal, meaning the investor gets even more shares upon conversion.
4. The maturity date
The deadline. If you haven’t raised your Series A by this date (usually 18–24 months), the loan is technically due.
- The Risk: If you haven't raised money and hit the maturity date, the investor can technically demand their cash back, which can bankrupt a startup.
Pros and cons of convertible loan
Pros
- Speed: You can close a Convertible Note in days with a simple 10-page document.
- No Immediate Valuation: Avoids "Down Rounds" if you haven't hit your metrics yet.
- Lower Legal Costs: Significantly cheaper than a "Priced Round", which requires restructuring the board and articles of association.
Cons (The "hidden" debt trap)
- The "Debt" Stigma: It sits on your balance sheet as a liability. If the company fails, these investors are "Senior" and get paid before you.
- Liquidation Preference: Upon conversion, these investors usually get "Preferred Shares," which carry extra rights.
- Dilution Uncertainty: Because the price isn't set, you won't know exactly how much of your company you've sold until the Series A happens.
Convertible loans vs. SAFEs vs. Float facility
| Strategic Pillar |
Convertible Loan |
The Float Facility |
| Equity Impact |
Dilutive (Converts to Shares) |
Non-Dilutive (0% Equity) |
| Valuation |
Requires a "Cap" or "Discount" |
Irrelevant (Data-Driven) |
| Repayment |
Maturity Date (Hard Deadline) |
Revenue-Linked (Flexible) |
| Ownership Control |
Future Board / Information Rights |
Full Founder Autonomy |
| Setup Speed |
2–4 Weeks (Legal Docs) |
1–2 Weeks (API Integration) |
Case study:
The "Bridge" scenario
The company:
SaaS Co is at €500k ARR. They need €1M to hit €1.5M ARR (the "Magic Number" for a Series A).
Option A (Convertible loan):
They raise €1M on a €10M Cap. They get the money today, but they give up roughly 10% of the company in the future.
The Result:
Under Option B, the founders still own 100% of that extra 10% equity. When they raise their Series A at a €15M valuation, that 10% is worth €1.5M in founder wealth.
Option B (Float facility):
They use their existing €500k ARR to secure a Float facility. They get the €1M growth capital in 7 days. They hit their €1.5M ARR target.
FAQs
How does a convertible loan impact my cap table hygiene?
While a convertible loan is technically debt, it is "deferred dilution." The primary risk to cap table hygiene is uncapped notes or excessive interest accrual. If a note sits on the balance sheet for too long without converting, the accrued interest essentially grants the lender "free" equity at the Series A.
- The Strategic View: In a down-market, convertible notes can create a "liquidation preference overhang," where debt holders get paid before founders in a modest exit. This is why many modern founders use a Float Facility to bridge gaps, as it leaves the cap table entirely untouched and "clean" for future VC due diligence.
When does the liquidation preference of a convertible loan trigger?
A convertible loan is "Senior" to all equity. If your company is sold before the loan converts into shares, the note holders are paid back their principal plus interest before a single penny goes to common shareholders (the founders).
- The Strategy: Founders often forget that if they sell for a modest amount (e.g., €5M) before a Series A, a €2M convertible note takes 40% of the exit immediately. A Float Facility, being revenue-linked, scales with your cash flow and doesn't claim a massive "chunk" of your exit proceeds in the same binary way.
Can I refinance a convertible loan with a Float facility?
Yes. If you have a convertible note approaching its Maturity Date and you aren't ready for a Series A, you are in a high-risk position. The note holders could technically demand repayment.
- The Fix: Sophisticated CFOs use a Float Facility to pay off the principal of a maturing note. This "refinances" dilutive, ticking-clock debt into a flexible, revolving credit line. This removes the "Maturity Cliff" and gives the founder back 100% of the leverage when they finally do go to the equity market.
How do valuation caps interact with my next lead investor?
A Valuation Cap is a double-edged sword. While it protects the early lender, it sets a "Price Anchor" for your Series A. If you raise a note with a €10M cap, a new VC investor might see that as your "ceiling" rather than your floor.
- The Risk: You may inadvertently cap your own valuation before you’ve even started the roadshow. Using non-dilutive capital (like Float) allows you to grow your ARR without setting a public price anchor, giving you maximum negotiation power when you finally decide to set a valuation.
Why is the cost of capital for a convertible note higher than it looks?
On paper, a note might have an 8% interest rate. However, once you add the Valuation Discount (20%) and the Warrant-like nature of the conversion, the "Effective APR" can exceed 40–50% if the company’s value grows quickly.
- The Math: You aren't just paying 8% interest; you are selling future equity at a 20% discount. A Float Facility has a transparent, fixed cost that doesn't scale with your company’s success. You keep the upside; the lender just gets their margin.
