A Covertible Loan Agreement (CLA) is a financial agreement between a lender and a borrower. This type of deal combines features from both loans and shares.
Here are some key elements:
Loans:
In the beginning, the agreement works like a regular loan where the borrower receives a sum of money from the lender.
The loan typically has an interest rate and a fixed repayment period.
Convertibility:
The special feature of a convertible loan agreement is that the loan can be converted into shares at a later date, usually at a predefined event or period.
Conversion price:
A conversion price is set, which indicates the price at which the loan can be converted into shares. This price is often set at a discount to the price new investors pay for shares in the company in a subsequent capital injection.
Benefits for the lender:
The lender has the potential to become a shareholder in the company and benefit from the company’s increase in value.
Benefits for the borrower:
The borrower gains access to financing without having to immediately determine a business valuation. This can be particularly useful for startups where valuation can be challenging.
Disadvantages for the borrower:
Upon conversion, existing shareholders are diluted as more shares are in circulation and the total ownership of the company is distributed differently.
Convertible loan agreements are often used in the start-up environment as a way to attract capital at early stages when it can be difficult to determine a fair valuation of the company.
