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As has already been said, a converted loan is a short-term debt converted into equity. As a rule, it is transformed in the next investment cycle. For example, if you get your initial capital investment in the form of a converted loan, it will be converted into equity if you increase your Series A investment. The advantage, from an entrepreneur`s point of view, is that before its conversion, a converted loan behaves in a very similar way to that of a standard credit: the investor generally does not have many rights of a preferred shareholder (board seats, liquidation preferences, etc.). As this is a fairly short and simple document, it is also executed more quickly (which is why convertible bonds can be processed faster than a stake, usually a few weeks). This is the second part of my mini-series, which focuses on termsheets. The aim is to cover the converted credit – in general, the less used method of investment. Second, converted lending is used at a time when investors and entrepreneurs are unable to agree on valuation, particularly when they define a conversion discount, but not necessarily the valuation ceiling (explained below). I am not a big fan of this application case: instead of immediately confronting a major issue, both parties decide to postpone their resolution to a later date. Such a strategy can easily backfire and create bad disputes between investors and entrepreneurs, who can block fundraising and kill a start-up. The downside also arises from the nature of the loan: until the loan is converted into equity, the investor has a priority right on the due date to claim assets (i.e.
cash – hardware for most startups) to repay the loan and interest. It goes without saying that most start-ups do not have enough money to repay the loan at maturity and are therefore obliged to liquidate all assets and close the business. The purpose of this organization is to cover the converted loan – in general, the less used method of investment. Nevertheless, it usually contains only a few terms that can easily be covered in a single article. These are the most common terms that an entrepreneur can find in a converted loan, at least based on what we experienced with Credo Ventures. There are a few scenarios in which a converted loan can be used. First, it can serve as a source of “bridge funding” before a large expected funding cycle. Suppose you have collected a seed cycle of 200,000 euros and are in the process of collecting The A-Series of EUR 2 MM, but it will take you a few more months to complete the cycle.
So you take out a converted loan of 100,000 euros as an additional cushion for the fundraising process. As noted above, convertible bonds must be executed more quickly from a legal point of view, so that the entire transaction can be settled in a matter of weeks. However, bridge financing can be difficult: if investors are not 100% convinced that things are going well, applying for a quick converted loan can raise serious concerns about performance and prospects (i.e., why do you need more money to raise funds?). Losing the trust of existing investors is a very bad way to start the fundraising process.