Now that we understand the basic pros and cons, let´s get into the nitty gritty of the key elements of convertible loans.
Convertible loans, like others, usually come with an attached interest rate. This rate usually ranges between 1-5%, but professional venture debt investors might ask for significantly higher interests. We suggest to always have the interest rate checked by a lawyer or tax expert. The interest is usually not paid in cash but will also be converted to equity once the full loan gets converted.
The convertible loan has a maximum length of time – let’s assume three years. If no earlier trigger event occurs, then (as in the case of a mandatory convertible loan) the convertible has to be converted after the maturity date has been reached, which leads to a capital increase.
If the convertible loan is mandatorily convertible (at the discretion of the investor), then the convertible needs to be paid back on the maturity date. The terms of maturity dates are often pre-defined and consider at what condition or price the load converts if no prior trigger event has taken place. For example, a maturity date valuation price is usually agreed upon.
In any case, you should retain the right to, at any time, repay the loan without penalty payments prior to the maturity date. In most cases, early repayment is a non-issue, but if you get lucky and win the lottery, you want to be able to get the debt investors off your back!
Conversion Trigger Events
A trigger event defines what has to happen in order to cause an automatic or voluntary conversion of the convertible loan. The most obvious triggering event is the maturity date, but others there are others to consider as well.
For example, it can be defined that the next capital increase round will trigger the convertible loan to automatically convert or it would give the lender the right to convert. This can make a lot of sense since you plan ahead with investors and you want to reduce the amount of paperwork. Therefore, once you make a capital increase, you can simultaneously convert the open convertible loans.
There are many other frequently seen trigger events such as exit transactions and fulfilment of certain milestones. You are pretty much free to agree on the terms with your investor and define which are best for you!
When an investor gives you money without enjoying shareholders’ rights, it is not unusual for them to ask for a discount in order to compensate for the additional risk they are taking. This also depends on if a loan accrues interest and if yes, at what rate. Instead of accruing interest, an investor could be happy with a discount.
Discounts given usually vary between 10% and 25%, and 15% to 20% are quite common rates.
These discounts give the current investors an advantage versus future ones and provide credits for the early risk-taking.
Since investors at an early stage are taking risks without receiving full rights, they might request to have a valuation cap in place. What does this mean?