What is a Convertible Equity Loan Agreement?
A Convertible Equity Loan Agreement loan is an investment product that mixes the characteristics of two similar financial products: convertible notes and equity loans.
These investment products share the common characteristic of being non-traditional debt securities. This means that they combine the rules of stock products and traditional debt products, like loans and bonds, to create a new one. These are often called hybrid securities.
How can a Convertible Equity Loan Agreement help my startup?
Both the convertible note and equity loan are, in their own right, great products for financing seed-phase startups. Therefore, combining both only enhances their benefits but how do they differ?
Convertible Note
A classic convertible note is a type of bond that’s issued by corporations and is convertible to company stock under certain circumstances.
It works as a normal note or bond most of the time but the difference is only felt on repayment day. Unlike a normal note, the investor will have the right to be paid in stock, instead of money.
This characteristic makes them a good choice to finance startups in the seed stage, as they allow investors to fund a company but defer the task of valuation until a later stage, when there are more elements to assess it.
Equity Loan Agreement
An equity loan allows the investor to have a percentage of the company’s profits for a period of time without having to become a shareholder. However, this debt is one of the lowest in terms of seniority and can not be repaid early unless an equivalent share capital increase takes place.
A Convertible Equity Loan Agreement works is by establishing two different interests in the contract. First, there is a fixed interest that repays the loan debt. There’s also variable interest in the event that the company makes a profit, so the investor is rewarded in line with the company’s performance.
This is one of the best types of startup financing as it allows the payment of little interest if it is not successful, which is very common. It strengthens the company’s balance sheet and positions it to receive even more financing and a company with a Convertible Equity Loan Agreement projects an image of trust to other institutional investors.
What are the requirements?
There are no formal requirements to arrange and secure a Convertible Equity Loan Agreement.
The challenge is to convince a financial institution of your venture’s prospects and persuading them to partner with you. Typically, a company needs a well-drafted business plan with a high potential of expectation to compensate the investor if there is success. It’s this balance that makes this loan typical for startups in the seed phase.
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How can a lawyer help me?
Investment agreements are one of the most creative and unregulated fields in Spanish Corporate Law. There are significant risks in agreements like this and not just financial ones.
As there’s so much freedom to draft this type of agreement, including the clauses and conditions that the parties deem necessary, there are also potentially greater risks for you to consider.
Our Corporate Lawyers at Lexidy LegalTech Boutique have the necessary expertise to help you design the legal document that best suits your case, either in the form of an Equity loan, Convertible Note or Convertible Equity Loan Agreement.
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