Investors are always looking to invest in promising start-ups in the form of traditional equity financing. But in recent times, with uncertainties prevailing all around, CLN seems to be a great choice. It can be described as a perfect hybrid between debt and equity which offers the investors the right amount of protection that an equity holder would have in case the company dissolves. It comes with added security and income from debt.
CLN or convertible loan note can be described as a short-term debt instrument using which the loans can be turned into equity shares at a later stage. They are a great option for investors looking for secured choices in the crisis-filled economy. It offers some great rewards for those investors who are willing to take a risk.
Initially, CLNs can be considered as debt, but soon they get converted into equity during the next qualifying funding round or a previously agreed upon date. So what happens is, that the investors do not receive the outstanding amount in cash, but they receive shares at a discounted price.
Post-COVID, things have become a little tight when it comes to business and emergency fundraisings. Any investor would become more cautious during a recession, and a convertible loan note can be a great alternative to the traditional equity investment. During these hard times, investors generally opt for both secured CLNs (debenture agreement) and unsecured CLNs (discounted conversion rates on share prices).
The CLNs depend on the converting balance’s valuation caps, and due to the pandemic, the valuations are considerably lowering. This has led to a limited cash flow, and this enabled investors to get discounted shares that would not be otherwise available to them- they get about a 20% discount on the total valuation in the next round of funding. If an investor is asking for high-interest rates, that too can be converted into discounted shares.
In case the company fails and they are unable to reach the given funding target, then the investor is termed a creditor. The company has to pay the investment and interest to the investor in full, and the loan will take precedence during liquidation. In case the investors need further reassurance, they might also ask for warranties from the concerned company.
With the right company and right investor, CLN can be an excellent option. As investors are taking a high risk by investing in a company at an early stage, they are rewarded with high returns.
Due to all the above advantages, convertible notes have become quite famous in the world of startup financing. But before you start dealing with it as an investor, you must understand it thoroughly. Understanding if it is a good choice for you as an investor is essential before you start.
Leave a Reply
You must be logged in to post a comment.