For small-scale businesses or startups, the prime concern is regarding investment capital. Gathering the money and then using it to start the business needs a lot of courage because one has to leap faith. If unfortunately, everything spirals down, the entire investment goes into loss. This is where the concept of convertible loans comes into the scenario.
These loan types are issued for a short-term period based on the concept of equity. The amount is converted into various equity shares at a share per price, which is usually decided later on once the business reaches its first milestone. Now, the convertible loan note has its cons and pros, making it one of the best financial solutions for startup enterprises.
Since most of you aren’t aware of the CLN, we will discuss both the commercial loan type’s flaws and virtues.
Pros 1: with CLN, you will have a lot of flexibility
If you have taken convertible loans as a means of investing in the business, you will be able to enjoy a lot of flexibility. For example, if a certain situation arises, you will be able to choose between equity shares or cash repayment against the CLN.
Cons 1: A financial uncertainty for future loss of the company
Even though the convertible loan note will reduce the chances of liquidation of the company’s assets, it certainly raises several uncertainties. If your company fails to make profits and reach the breakeven point within the stipulated time, you will be able to convert the loan into equity shares. But even by doing this, you won’t be able to retain the assets.
Pros 2: The CLN amount for equity is applicable to the valuation cap
The valuation cap is the maximum loan amount on which the CLN will be converted into the shareholders’ equity shares. Once you declare the validation cap amount, you will convert the maximum amount without suffering a loss.
Cons 2: Doesn’t provide you with a shareholder’s basic rights
With CLN, you will lose the rights of a basic shareholder. You will have to sit out of the voting process because you won’t have the company’s equity shares. Also, unlike other stakeholders, you wouldn’t be able to back out of the company if you think it will suffer a huge loss.
With the CLN, you will certainly enjoy a lowered financial risk. But, since startups are always uncertain and usually take a lot of time to gain high ROIs, you will have to carefully consider the convertible loan.
