Fundraising: Know your convertibles
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Convertible loans or non-convertible loans – which is best for your fundraise?
Most people in the fundraising community in the UK are very familiar with the two most common ways of raising growth finance, equity financing and debt financing. Equity being when you offer shares in your company for cash, and debt financing – taking a loan from investors which is paid back regularly at a fixed rate. But not everyone knows that debt financing can be further split into convertible loans and non-convertible loans.
Debt financing is when an investor loans funds to your business with a set interest rate. You make regular payments back to the investor at the agreed rate until the loan reaches maturity.
What makes a loan convertible is what happens once the loan matures. With a convertible loan your investors can choose to convert the loan into shares or equity upon evaluation of your company.
Some loan agreements will convert into equity automatically, and others will offer the choice to investors upon maturity of either receiving a lump sum or taking shares. You will decide this and set this out in the terms of your investment offer once you’ve determined which is best for your business.
Just as the name suggests, non-convertible loans don’t offer your investors the opportunity to convert into equity. They’re more like a conventional loan – the difference being the finance comes from investors rather than a bank and can be a faster option than traditional lenders.
Non-convertible loans may also suit you better if you don’t want to dilute ownership of your business by offering shares.
Business loan interest rates
Whether you decide to take a convertible or non-convertible loan, interest rates are something you will need to consider as part of your investment offer.
There are various permutations of interest rates you can agree to including zero coupons, which we’ll discuss in our next post. This is also something we can discuss with you during the loan application process.
Why get a convertible loan?
This can be a great way of offering future shares to investors who may not want to take the risk of investing in equity until your company is more established. By offering convertible debt you have time to increase brand awareness and reach, and to grow the business, making shares more attractive to your investors.
For investors this can be more appealing as they can postpone taking equity until the business has more of a track record. They’re also free to take back the amount they loaned should they decide to.
In addition investors in convertible loans have the added security of knowing that should the business fail they will be prioritised over shareholders when it comes to receiving funds.
Postpone pricing decision
Convertible loans have a distinct advantage over straight equity financing mainly because the valuation process doesn’t happen until the loan matures. This means you can offer the appeal of future shares in your company without having to go through the long valuation process first.
It also means that by the time your loan has matured, you’ve had more time to increase the value of the company making equity more appealing to your investors.
Convertible loans are a great option over non-convertible loans if you are concerned about having the capital to pay back investors once the loan matures.
By offering investors shares equivalent to the amount they loaned you or equivalent to the interest rate, you can keep the funds invested in the continued growth of your business.
Ultimately, when deciding which method to use for your business, you’ll need to consider which method is of the most benefit to your business and which is financially the most viable based on the stage your business is at.
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A growing number of institutional lender are redirecting their funds, to provide finance to UK SMEs.
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CODE Investing has entered into a strategic partnership with BNP Paribas Asset Management to originate SME loans.