Convertible Loans (aka Convertible Notes)
A convertible loan, also known as a convertible note, is a type of short-term debt that converts into equity, typically in a future financing round. Rather than getting repaid in cash, the lender (often an angel investor or early-stage VC) receives shares in the company, usually at a discount or with a valuation cap.
Convertible loans are a common way for ecommerce startups and early-stage businesses to raise capital before a priced equity round.
How Convertible Loans Work
Here's how a convertible loan generally functions:
- Investor provides capital as a loan to the company.
- The loan includes a maturity date (when it’s due) and an interest rate (often 4–8%).
- Instead of repayment, the note automatically converts into equity when the company raises a qualifying round (e.g., Series A).
- The investor typically receives:
- A conversion discount (e.g., 20%)
- A valuation cap (maximum company valuation for conversion)
- Or both
Why Startups Use Convertible Loans
Convertible loans are popular for ecommerce and SaaS startups because they:
- Avoid immediate company valuation debates
- Are faster and cheaper to execute than full equity rounds
- Provide flexibility in early-stage fundraising
- Allow founders to maintain control while still raising capital
Accounting for Convertible Loans
On the balance sheet, a convertible loan is generally recorded as a liability until it converts into equity. Interest is accrued over time. Upon conversion:
- The liability is removed
- New equity is issued
- Any remaining unconverted interest may be waived or converted
Accounting treatment can vary, especially across IFRS and GAAP, so it's important to consult with a qualified CPA or use modern accounting tools like Finaloop that can automate this based on real-time data.