A convertible loan note is a loan that expects to become equity. The investor lends money now, the company spends it now, and the question of what the shares are worth is postponed to the next funding round — which is exactly the appeal for an early-stage business that cannot yet defend a valuation. It is also the instrument that quietly disqualifies an investor from SEIS and EIS relief, which for UK startups is frequently the most valuable thing on the table.
How the mechanics work
Four terms do most of the work in any convertible:
- The trigger. Usually a qualifying funding round above a stated size; sometimes a sale or an IPO. On the trigger, the loan converts into shares of the same class the new investors are buying;
- The discount. The noteholder converts at a reduction to the round price — commonly 10% to 25% — compensating them for taking the risk earlier;
- The valuation cap. A ceiling on the valuation at which conversion happens, so an investor who funded a company at £2m does not convert at a £20m round price. Where both apply, the noteholder normally takes whichever is better for them;
- The long stop. What happens if no round arrives by a given date — conversion at a default valuation, repayment, or an extension. This is the term founders skim and later regret, because it is where the instrument turns back into debt.
Interest is typically modest and rolls up into the conversion rather than being paid in cash. An advance subscription agreement is the close cousin: the investor pays now for shares to be issued later, with no repayment right at all.
The tax point that decides the instrument
SEIS and EIS relief requires shares to be subscribed for wholly in cash and fully paid up at the time they are issued. Money advanced as a loan and later converted does not meet that test — the cash was consideration for the debt, not for the shares. So a convertible loan note does not attract SEIS or EIS relief on conversion, and an investor who assumed it would has lost 30% or 50% of their investment in relief.
This is the single most important practical distinction between a convertible note and an advance subscription agreement. HMRC accepts that an ASA can qualify, provided it is genuinely a subscription for shares rather than a loan: the money must be non-refundable in any circumstances, carry no interest, and have a long stop date by which the shares must be issued. On that longstop, note precisely what the six-month figure is: HMRC's stated expectation when it considers an advance assurance application, not a statutory condition that voids a longer agreement. Relief turns on whether the actual conditions are met, and advance assurance is not compulsory — but going beyond six months means losing the comfort of assurance and arguing the point later. An ASA with a repayment clause is a loan wearing a different name, and it fails on the substance.
Where investors are UK individuals who care about relief — which is most angel money — the answer is usually an ASA drafted to those constraints, or simply a priced round. Convertible notes remain appropriate for investors who cannot claim the relief anyway: corporates, funds, overseas investors, and existing shareholders topping up beyond their relief capacity.
What it does to the cap table
Convertibles are popular because they defer the valuation argument, and expensive because they do not remove it. A note converting at a 20% discount with a £3m cap, issued alongside three others on different terms, produces a conversion calculation that nobody models until the term sheet for the next round arrives — at which point the incoming investor works out that the existing notes will take a larger share than the founders expected, and the round price moves to compensate.
Two disciplines prevent that. Model the conversion on the actual note terms at the point of issue, at two or three plausible round valuations, and keep the model current. And resist issuing a series of notes on inconsistent terms; the administrative cost of four different discounts and caps is trivial compared with the negotiation it produces later.
Accounting and disclosure
A convertible instrument is not simply a creditor. Under FRS 102 a convertible loan issued by a company is often a compound instrument, split between a liability component and an equity component at inception, with the liability accreting to its redemption amount over the term. That produces a finance cost in the profit and loss account for an instrument on which no cash interest may ever be paid — a result that startles founders reading their first set of accounts after a note round.
The liability also sits on the balance sheet until conversion, which affects net assets and therefore any covenant, grant condition or R&D claim that looks at them. Where the notes are repayable within twelve months, they are current liabilities, and the going concern assessment has to address them honestly.
Choosing between the three routes
A convertible note suits a bridge between rounds, a genuinely uncertain valuation, and investors indifferent to SEIS and EIS. An advance subscription agreement suits UK angels who need relief and can accept non-refundable money with a six-month horizon. A priced round suits anyone who can defend a valuation — and is almost always cleaner than people assume, because the legal cost difference is smaller than the eventual cost of unwinding a stack of inconsistent notes.
Acumon advises founders and investors on instrument choice, SEIS and EIS qualification and advance assurance, with valuations where a round needs one and startup accounting alongside. If a note is being drafted this month and any investor expects tax relief, that is the conversation to have before it is signed — not after.