Loan notes are a popular fixed-interest investment product, offering investors the opportunity to lend money to companies. These notes can be secured, unsecured, traded, or convertible.
The convertible variety, often referred to as convertible loan notes (CLNs) or convertible bonds, are a hybrid debt instrument that expat investors ought to understand. Let's get into what they entail.
What are Convertible Loan Notes?
A convertible loan note is a type of short-term debt that can be converted into equity shares of the borrowing company at a later date. Initially, it functions as a loan to the business, but with the option or requirement to convert into shares.
How Do They Work?
When investing via a CLN, the valuation and share price are usually not defined upfront. Conversion occurs upon the next qualifying funding round or a predetermined date or duration.
In the UK and other European countries, the conversion price is often set at a discounted rate, typically 10-20% lower than the price paid by new investors during that funding round.
Benefits for Expat Investors
Like most types of loan notes, CLNs offer expats in Europe some advantages as an investment vehicle. These include:
Potential for Discounted Shares
CLNs allow investors to acquire shares at a discounted valuation compared to subsequent funding rounds. Expats can get on the ground-level of most startups.
Interest Income
Most CLNs come with a coupon or interest rate, providing a regular income stream until conversion. The fixed income usually comes at higher interest than those for stocks, bonds, or CoDs.
Prioritised Repayment
As debt holders, CLN investors rank ahead of shareholders in case of insolvency, making it a relatively safer investment.
Simpler Process
Investing via CLNs often requires fewer documents and negotiations than direct equity financing, enabling quicker capital raising.
Deferred Valuation
CLN terms can postpone valuations until specific milestones, avoiding complex negotiations early on.
Drawbacks for Investors
Tax Implications
CLNs may not qualify for certain tax reliefs like EIS or SEIS, potentially reducing investment returns.
Dilution Risk
Upon conversion, a significant portion of shares could be held by CLN investors, dissuading new equity investors.
Repayment Obligations
If conversion triggers are not met, the borrower must repay the loan, which may be challenging for early-stage companies.
Are Convertible Loan Notes Good for Expats?
Convertible loan notes can be an attractive investment option for expats, offering potential discounted share acquisition and regular interest income. However, the associated tax implications and dilution risks should be carefully evaluated. As with any investment, seeking professional advice from experienced financial advisors is highly recommended.
The team of expert advisors at International Wealth Ventures guide you through the intricacies of convertible loan notes and other investment opportunities.