Convertible Loan into Shares

As an alternative to the traditional ways of investing in a company (capital contributions, acquisition of shares, investment by project), the figure of the loan convertible into shares of the company appears.

The convertible loan is, a priori, a quick and easy way to finance and, eventually, invest in a project or company.

Through this instrument, an investor lends money to an ongoing company (although it can also be a start-up) in order to finance its development for a specified period. After this period has elapsed and certain terms and conditions agreed in advance have been fulfilled, the investor has the possibility of obtaining the return of the initial investment plus interest or of converting his credit into shares of the company.

This mechanism allows you to control the risk of landing in a new business since you will only be forced to become a shareholder if the agreed conditions are met. For its part, for the company it will represent the opportunity to finance itself and demonstrate its virtues and growth capacity from the investment made and, eventually, the incorporation of a partner who will enhance its development.

The negotiation of the terms and conditions will be initially limited to the characteristics of a loan (disbursement, interest rate, terms, guarantees) and will additionally have specific components for the case that the conversion operates (valuation, voluntary or mandatory conversion, dilution, options of the parties, preferred shares). Furthermore, it will be necessary to incorporate customary financial clauses, such as material adverse change, negative pledge, convenants, cross default, and events of default, among others. If the partners of the company have a shareholders agreement in force, it will be convenient to agree to its modification to include political rights in favor of the investor (vetoes and standard exit clauses such as first offer, tag along, drag along, among others)

The due diligence process prior to disbursement will be limited to the essential business issues of the company being financed, so it will be quick and less expensive. The objective will be to identify liabilities or contingencies that put the “repayment” of the loan at risk, in the event that there is a conversion.

Depending on the transaction, everything that has to do with the “day after” may be deferred at the appropriate time, that is, at the time of the conversion of the loan into company shares (comprehensive due diligence; share subscription agreement with reps & warranties and other standard clauses of an M&A; shareholder agreement with the investor; indemnities and guarantees).

In possible investments where the parties need a greater knowledge process (either between them, or with respect to the business), the convertible loan in shares is a valid option that deserves to be analyzed.