What can an investor in a convertible loan negotiate?

In the case of a convertible loan, investors will generally find themselves in a less favourable position than if they had invested in shares.

On the one hand, in the event of the company’s success, and subject to the important proviso of the possible moderating effects of the discount and the maximum valuation (cap), investors are likely to see the dilutive effect of their conversion reduced compared with an investment in the company that they would have made immediately in shares.

On the other hand, if the investor had invested in shares, he would have received shareholder rights by law and also under a shareholders’ agreement that he would certainly have taken the trouble to negotiate. As such, the investor would have been able to influence the company’s governance, the mechanisms governing share transfers, the exit strategy and impose constraints on the founders (non-compete and non-solicitation, temporary standstill on transferring shares and good/bad leaver clauses).

Some professional investors, particularly investment funds, will try to obtain special rights under the convertible loan agreement in order to temper the loss of rights they would have had if they had invested in shares. Historical shareholders may also take the initiative of offering these rights in order to reassure prospective investors who are reluctant to invest via a convertible loan.

Information and control rights/governance

Prior to conversion, the lender is considered to be a mere creditor, which means that in principle it has no say in how the company operates and no role in its governance. This is fundamentally different from shareholders, who have various rights under the companies and associations Code, the company’s bylaws and the shareholders’ agreement. As a result, the convertible loan agreement usually includes certain clauses giving them a right to information and a right of audit, and in some cases even a veto right over certain important decisions (which, if not agreed, would result in the conversion of the loan or its immediate repayment). Some investors also ask to have an observer seat on the board of directors.

Active role of founders/keeping the founders in the company’s shareholding structure

Maintaining the activity of founders is a conditio sine qua non for investment in startups and scaleups. In the case of equity investments, this condition is sanctioned in shareholders’ agreements by good/bad leaver clauses authorising shareholders, or even the company itself, to buy back the founders’ shares. To ensure that this condition is respected when investing in a convertible loan, the investor may require that the inactivity (inexcusable or unapproved, obviously) of one or more founders, without a satisfactory replacement within a certain period, constitutes grounds for immediate repayment of the convertible loan. The same sanction may apply in the event a founder sells all or part of his shares in the company within a certain period of time from the date on which the loan was taken out.

Non-compete and non-solicitation

As emphasised earlier, the exit of a founder, either as a member of the staff or as a shareholder in the company, is non-negotiable for investors. Consequently, such an exit, which would be accompanied by a move to competitor, is a totally unbearable situation for any investor (as for any other stakeholder, for that matter…). Such a situation should also give rise to immediate repayment and/or a penalty payable directly by the founders to the investor. We obviously recommend limiting the sanction to the founder’s penalty, otherwise the company (and indirectly the historical shareholders) will be subject to a double penalty: the departure of a founder and the early repayment of the loan.

Future shareholders‘ agreement

More generally, when the loan is converted, the lender must adhere to the company’s shareholders’ agreement. If this agreement needs to be amended at that time, the lender should therefore ensure that the convertible loan agreement already contains the provisions of the agreement that it wishes to see implemented or amended.