Demystifying Convertible Loan Notes

Posted Wednesday 20th May 2026

For founders and startups, raising capital is one of the most critical steps for any growing business. There are several funding options available to businesses, Convertible Loan Notes (“CLNs”) are one favoured option for their flexibility and ease. In this article, we will cover what CLNs are and why you might want to consider them for your business as a route to take money in.

What are Convertible Loan Notes?

A Convertible Loan Note is a hybrid instrument that starts as a loan but has the potential to convert into equity later (commonly during a funding round).  Initially, investors lend money to the company, and the loan can either be repaid (plus interest) in cash, or the loan converts into shares under agreed terms.

Why are they attractive?

1. Speed and flexibility:

• CLNs usually require less negotiation than a full set of investment documents (investment agreement, shareholder agreement and articles of association), making them ideal for startups and for bridging finance.

2. Deferred valuation:

• CLNs can allow a company to delay their valuation until later rounds of funds which protects founders from giving away too much equity at an early stage in their growth cycle and when valuation of the company is uncertain.

3. Has investor incentives:

• Typically feature discounts, a percentage reduction applied to the price per share during the next qualified funding round. This means that when the CLN converts into equity, the investor will pay less per share than the new investors for that round. This compensates investors for the risk they take investing early in a company and the amount can vary.
• Valuation caps can make CLNs appealing to investors while protecting founders from excessive dilution. This is a mechanism that sets a pre-agreed maximum valuation at which the convertible note will convert into equity during a subsequent financing round.
• An upside (for the investor) is that CLNs have the option for the investor to be repaid, de-risking their investment generally (i.e. the investor is repaid rather than being left with shares that may end up being worthless if the business does not succeed).
• A CLN can accrue interest for the investor (it is debt after all!)

Potential difficulties with CLNs?

1. Ambiguous drafting – we often see unclear drafting, in relation to maturity or conversion triggers, alongside poor drafting on applied caps which can lead to misunderstandings, disputes, and delayed funding rounds for Companies. Likewise, poorly drafted or inconsistently applied caps can cause conflict and unexpected dilution for founders and investors.
2. Dilution surprises – multiple notes on different terms can significantly increase dilution if not modelled early.
3. No Tax Benefits – investments made through CLNs will not qualify for Seed Enterprise Investment Scheme (“SEIS”) or Enterprise Investment Scheme (“EIS”) purposes, meaning that the attractive tax reliefs offered under those schemes will not be available to investors, which could deter them from CLNs.
4. Constitutional and authority problems – company articles, pre‑emption rights, or lack of shareholder/board authority can block or complicate conversion later.
5. Repayment / cashflow implications – a CLN is debt and therefore may have to be repaid if you do not manage to conclude your funding round – a maturity date will have been set within the CLN. This can have a serious impact on the business’s cashflow.
6. Balance sheet and accounting impact – until conversion, a CLN is debt and will be treated as such; accrued interest on the loan increases its carrying value over time and the notes are recorded as liabilities while they remain outstanding. Consequently, the company’s balance sheet will show a higher level of debt, which may deter companies from choosing this structure.

Why is it best to seek legal advice in relation to Convertible Loan Notes?

Navigating CLNs without expert advice can lead to costly mistakes for companies further down the line. From drafting conversion mechanics to anticipating discounts and caps at future funding rounds, early advice can help avoid disputes and protect the long-term value of your business.

Our team specialises in structuring convertible loan notes that align with founders’ growth strategies while safeguarding their interests at every stage. Please contact us on hello@joelsonlaw.com if you would like further information or require additional assistance in relation to Convertible Loan Notes for your business.

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This article is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.

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