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Convertible loan: What is it? And what are the benefits?

An example of mezzanine financing

More and more growing companies are opting for a so-calledmezzanine solution when financing growth. Growth companies often have a shortage of guarantee capital (equity capital or the character of equity capital). This capital is important to absorb any setbacks. Often these are investments that banks (loan capital) are unwilling to make. Think of development costs, marketing or personnel. Mezzanine has the character of equity capital and is therefore particularly interesting for growth companies. With a mezzanine solution, financing is realized with a subordinated or blank character, which can be an alternative for guaranteed capital. A good example of a mezzanine solution is the convertible loan. But what is a convertible loan? And what are the advantages of a convertible loan compared to other forms of financing?

What is a convertible loan?

A convertible loan is a loan which can be converted (conversion moment) to ordinary shares at a moment in time to be determined, subject to clear agreements and rules. In addition, no repayments are made on a convertible loan up to and including the conversion moment. Subsequently, at the conversion moment, the provider of the convertible loan can choose whether to convert the loan into a regular loan or into shares.

What can be deferred with a convertible loan?

In addition to deferring repayments, you can also choose to defer interest payments until conversion time. This allows all funds to be used to finance the growth of the company, an important basis for strengtheningEBITDA in the short term.

Who is the convertible loan for?

The convertible loan is particularly suitable for start-ups and growth companies. They more often prefer a loan to selling 'normal shares'. From the investor's perspective, a convertible loan also has advantages. The possibility of converting offers more security than a regular loan.

What are the options besides a convertible loan?

A growth company can also choose to finance its growth by selling a minority share. By choosing a convertible loan instead of a share transaction, the number of agreements is minimized, such as a purchase agreement and/or shareholders' agreement. In an equity transaction, agreement is needed onthe business valuation. A valuation in the case of growth is more difficult to determine rationally. In the eyes of the entrepreneur, this will often be lower than his or her own estimate. By making use of a convertible loan, this discussion is postponed until theEBITDA(operating result) and/or EBIT (profit before tax and interest) is at a structurally higher level that forms the basis for the valuation.

The convertible loan in practice

As with other forms of financing, the term of the convertible loan is determined in advance, with a period of five years being the most common. At the end of the term of the convertible loan, the lender can choose between conversion to shares or repayment. This choice depends on the valuation at which the lender can subscribe. In addition, the discount (investor remuneration), Valuation Cap (to protect the investor) and Valuation Floor (to protect the entrepreneur) are agreed when the loan is contracted.

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Stef Kolen
Stef KolenCorporate Finance Advisor

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