"Convertible loans" also know as "convertible loan notes" or "convertible debt" refer to any type of investment made initially by loan that can, or must convert, in whole or in part into shares. This is a financing structure used by many companies.
An investment through a convertible note has a number of advantages when compared to an equity investment. The major advantages are summarised below in the downloadable convertible loan guide.
To read our full guide on convertible loans please find the link to the download at the bottom of the page.
Example: Harry invests £1,000 in a convertible loan, at an interest rate of 9%, for a term of 360 days. At the end of the term the note is convertible into shares in the issuing company at a 10% discount to the market price.
Harry can treat the loan as a straight loan and receive £1,090 in cash at the end of 360 days (loan interest of £90 and the £1,000 principal amount)
Harry can convert part or all of the loan into shares.
Harry decides to convert the entire loan on the 360th day. The total amount to convert is £1,090 - principal plus accrued interest. The market price for the shares is 20p so Harry will be issued with 6,055 shares at the discounted price of 18p, with the balance of 10p refunded.
If Harry then goes on to sell the shares at a higher share price he could make a higher return than if he simply redeemed the loan in cash. Of course, this is a riskier course of action as share prices can fall as well as rise.
Download our full guide to convertible loans here.