Startup: what happens if my loan is not converted?

The convertible loan allows a company and its investor to avoid the pitfalls associated with valuing a company and a significant legal burden. A convertible loan is intended to be converted but may not be converted and will therefore have to be repaid!

Non-conversion is often the result of the startup or scaleup’s inability to raise new funds or insufficient performance to induce the investor to convert its debt. It usually leads to serious financial difficulties for the company, which in turn can result in the investor losing any chance of a return on investment.

As most startups and scaleups are short of cash, repaying the loan is generally not an option and could even lead to bankruptcy. However, there are notable exceptions in situations where startups and scaleups are able to find cheaper or less dilutive funding, usually because they have performed beyond their expectations.

Bullet loan or loan repayable in fixed monthly instalments?

Convertible loans are often structured as “bullet” loans, which means that the full principal amount of the loan (and interest, if not paid during the term of the loan) must be repaid in full by a fixed due date.

In other cases, the due date marks the end of a grace period during which no repayments need to be made. Once this grace period has passed, repayment of the principal in periodic instalments begins.

Maturity date: a conversion triggering event

The maturity date is also generally defined as a triggering event for conversion, allowing the investor to decide whether to convert the loan rather than demand repayment.

Avoiding a maturity date that is too soon

The maturity date is the date on which the debt becomes due and payable. It is therefore advisable to set a maturity date well after the planned closing date for the next round of equity financing.

Planning a maturity date that is too soon and betting on a rapid conversion could put your startup in a very unfavourable position vis-à-vis the investor. In fact, the investor could subject the renegotiation of the terms of his loan to very harsh conditions.

On the other hand, providing for a maturity date that is too far in the future could be costly in terms of interest, particularly if the interest is not convertible but has to be paid by the company.

Early repayment

The possibility of repaying the loan before its maturity is rarely offered to the company, and will generally be subject to the lender’s ability to convert its loan beforehand.