Skip to content

What is a Convertible Note in England?

Table of Contents

As the founder of a small or medium-sized business or startup, you may look at ways to finance your company’s growth. If you are running an early-stage company, having startup capital available is essential to achieving your short-term goals. Using a convertible note is an alternative to equity investment and can be beneficial for your business. This article will explain key ideas about convertible notes and how you might issue convertible notes to your advantage. 

What is a Convertible Note?

Generally, a note is a debt instrument. It is essentially a loan from an investor to your company. 

The investor gives you money, and in return, you agree to pay back the ‘principal’ amount at a set time. This is called the maturity date. You also give the investor interest, usually called ‘coupon’ payments. The principal is the amount you are borrowing as part of your agreement to issue the bond. 

As an example, you may issue a note with a value of £1,000 and interest rates of 5% with a maturity period of two years. This means that after two years, you will pay £1,000 to the purchaser of your bond. Likewise, you will pay interest at regular intervals throughout the two years.

A convertible note is slightly different. A convertible note is still like a loan, but it will automatically change from a note to a share. How this happens depends on the terms of the convertible note your company issues. 

Convertible Notes for Seed Investors

Seed investors are investors who are putting equity into early-stage companies. In seed funding, a convertible note is where the debt converts into preferred stock at a later date. An alternative option is where the debt converts into an obligation from the issuer to pay the principal amount. The period in which the notes convert into shares is usually at the end of a financing period. 

What this means for your business is that you can incentivise investors to put money into your company in the form of a loan. Then, instead of paying back that loan, the investor will receive a share in your company. 

Typically, the share is preferred stock, meaning that the shareholders have priority in payments to common stockholders. Therefore, using a preferred stock method can help incentivise those investors and gain confidence in getting a return on their money. 

Continue reading this article below the form
Need legal advice?
Call 0808 196 8584 for urgent assistance.
Otherwise, complete this form and we will contact you within one business day.

Why Not Issue Preferred Stock in the First Place?

You may wonder why you would go through the process of having a note convert into equity rather than just giving the equity outright. 

One key advantage is that by raising money through debt instruments, you do not have to calculate the company’s valuation until the end of the first equity round. At the end of the financing period, it will be much easier to value your startup. This will further grow shareholder confidence. Also, since there is no valuation, you will not have to deal with issues arising from tax, share dilution, and pricing options. 

Another key advantage of issuing convertible notes is its speed. Your company can make a convertible note offering with relatively low costs. Likewise, it is a swift process because all you will need is a short promissory note given to your prospective convertible noteholders. In contrast, issuing preferred stock on its own can take weeks and will cost you much more in legal fees. 

Additionally, because the investors are not holders of shares or equity, they will not have any of the rights of shareholders. This means they cannot make demands through board seats and veto rights, which they would typically have concerning certain corporate actions. 

Finally, because you are the issuer of the note, you will be able to set the price for giving the note to investors. This can avoid problems where investors wait to see whether other investors will invest before giving you equity themselves. 

Key Takeaways

Using convertible notes is a good way of raising money for your early-stage startup. It can help you keep flexibility when running your business while giving you a quick and cost-efficient way of raising money through investors. Convertible notes are a great way of raising money if your business is in its very early stages before you have a comprehensive company valuation. 

Alongside this, using convertible notes means that you can have equity investors at a later date in your company’s growth. This gives you more control over corporate decisions while still having debt raised without paying high-interest rates or worrying about making your principal payments at the note’s maturity date. 

If you need help understanding your capital raising options, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

Frequently Asked Questions

What is a note?

A note is a debt instrument where the bondholder gives a loan to the issuer of the bond. Likewise, over time, they will receive interest payments and a payment of the principal. 

What is the maturity date?

The maturity date of a note is when the principal amount is payable. 

Register for our free webinars

Selling a Business: Tips for a Successful Sale

Online
Selling your business? Learn essential tips to reduce risk and achieve a successful sale. Register for our free webinar today.
Register Now

How to Recover Unpaid Debts from Customers and Suppliers

Online
Struggling with unpaid debts? Discover your options. Register for our free webinar today.
Register Now

Preventing Employee Competitors: How to Protect Your Business

Online
Learn how to protect your business from employee competitors. Register for our free webinar today.
Register Now

Protecting and Enforcing Your Brand

Online
Protect your brand from misuse and infringement. Register for our free webinar.
Register Now
See more webinars >
Efe Kati

Efe Kati

Read all articles by Efe

About LegalVision

LegalVision is an innovative commercial law firm that provides businesses with affordable, unlimited and ongoing legal assistance through our membership. We operate in Australia, the United Kingdom and New Zealand.

Learn more

We’re an award-winning law firm

  • Award

    2024 Law Company of the Year Finalist - The Lawyer Awards

  • Award

    2024 Law Firm of the Year Finalist - Modern Law Private Client Awards

  • Award

    2023 Economic Innovator of the Year Finalist - The Spectator

  • Award

    2023 Law Company of the Year Finalist - The Lawyer Awards

  • Award

    2023 Future of Legal Services Innovation - Legal Innovation Awards