Convertible Loan Setup

In addition to the classic equity investment, a convertible loan is an uncomplicated way of financing of a startup. With a convertible loan, an investor gives your startup a loan with the right or obligation to convert the loan into shares in the company when certain events occur (e.g. the next financing round), usually at favorable conditions. 

The main reasons for choosing a convertible loan are: 

• You want to postpone the discussion about the business valuation because you think you can get a much better valuation later. 
• Your startup does not have the time to negotiate a full, often lengthy financing round. A convertible loan, on the other hand, can be closed in a matter of days, making it ideal for bridge financing. 
• You only need to borrow a small amount at this time. 

The main advantage is that there is usually no extensive negotiation and the issue of business valuation (which can be difficult) is deferred to the future. 

With a convertible loan, the money can be in the startup’s bank account within a few days (from the date the agreement is sent), compared to a few weeks for a financing round. Our sample convertible loan agreement is also designed to eliminate the need for a notary appointment. This saves you additional time and money. 

In addition, the loan is usually not due for repayment due to the conversion, but is converted into shares at a later date. This avoids a later capital outflow of the startup. At the same time, the convertible loan is a great opportunity for investors to participate in the growth of the company, as they get their loan back in the form of shares, which can be worth much more than the original loan amount. 

Since the investors initially act only as lenders, they have no say in the general meeting until the convertible loan is converted, unless this is explicitly negotiated into the contract. 

Convertible loans are usually subordinated, which means that they are treated as an intermediate form of equity. This facilitates further debt financing. 

The terms and conditions of convertible loans can be structured in a variety of ways. This makes it all the more important to know what the market standard is. Probably the most important variable is the valuation discount granted for the subsequent conversion of the loan into shares. This usually ranges between 10-30% and is highly depending on the bargaining power of the contracting parties. It is also possible to make the discount variable, so that the later the next financing round, the greater the discount. 

It is also possible to agree on a so-called valuation cap in the form of a floor (minimum valuation) or cap (maximum valuation) to protect the investor from major jumps (down or up) in the business valuation. 

Compared to traditional financing rounds, convertible loans are often smaller (in the range of EUR 100,000 to EUR 400,000) and usually come from business angels or venture capital firms. It is also possible to have multiple convertible loan agreements with different lenders. However, the company’s business strategy should always be taken into account. 

Interest rates on convertible loans are typically in the range of 0-5% and are usually structured in such so that they are not payable in cash, but are also part of the conversion into shares. 

The term is usually one to two years, sometimes as short as 6 months for bridge financing. 

Y Combinator’s SAFE (Simple Agreement for Future Equity) is a special case of a convertible loan under US law. From an economic point of view, a SAFE is essentially the same as a convertible loan under German law. However, from a legal perspective, a U.S. SAFE requires significant adjustments in order to be used to invest in German companies. Without these adjustments, you risk rendering your SAFE ineffective. Therefore, using a SAFE in the German jurisdiction often gives a false sense of security. Our convertible loan templates have been tested many times and are also shorter and easier to understand than Y Combinator’s SAFE.