Convertible loan notes are loans that can convert into shares under agreed conditions. In the UK, a convertible loan note (CLN) lets a company raise money before settling the valuation for its next equity round, while taking on debt obligations in the meantime.
For founders, the decision goes beyond securing the next cash injection. The conversion price, interest, share rights and repayment provisions determine what the funding ultimately costs. Before signing, model the ownership impact and check whether the business can manage a delayed round or a repayment demand.
Key takeaways
- A CLN starts as debt. Conversion happens only under the conditions agreed in the documents.
- Interest, discounts, valuation caps and share rights can all affect dilution.
- Maturity may trigger repayment even if the next funding round has not happened.
- Shares issued by converting an existing loan do not meet HMRC’s EIS or SEIS purpose-of-issue requirement.
- Check company authority before granting conversion rights, then complete the approvals, records and filings required when shares are allotted.
How do convertible loan notes work in the UK?
An investor lends money to the company under a convertible loan note agreement. The agreement sets out when the debt converts into shares, how the conversion price is calculated and what happens if the expected fundraising does not take place.
A qualifying funding round is one possible conversion trigger. Other outcomes, including conversion at maturity or repayment on a sale, need their own terms. Deferring the valuation does not remove the need to agree these commercial points now.
The CLN terms that determine the outcome
- Principal
- The amount the investor lends to the company.
- Interest
- The agreed charge on the loan. Check the rate, whether interest is simple or compound, when it is payable and whether it converts into shares.
- Qualifying financing threshold
- The minimum fundraising that triggers conversion. Confirm what counts towards that threshold and how a smaller round is treated.
- Conversion discount
- A reduction from the price paid by new investors in the qualifying round.
- Valuation cap
- A ceiling on the valuation used to calculate the noteholder’s conversion price. Its effect depends on the agreed share-count definition and whether it uses a pre-money or post-money basis.
- Conversion share class
- The rights attached to the shares issued, including voting rights and any priority over ordinary shareholders.
Convertible loan note example: calculating the shares issued
Assume a company borrows £100,000 at 8% simple annual interest and converts the note exactly one year later. New investors pay £1 per share. The note carries a 20% discount, principal and interest convert at the same price, and no valuation cap overrides the discount.
- Interest: £100,000 × 8% × 1 year = £8,000.
- Amount converting: £100,000 + £8,000 = £108,000.
- Conversion price: £1 × (1 − 20%) = £0.80 per share.
- Shares issued: £108,000 ÷ £0.80 = 135,000 shares.
These are fictional negotiated terms, not prescribed terms or market benchmarks. If the agreement selects a lower cap-based price, more shares would be issued. A cap and discount do not automatically stack: follow the contract’s pricing rule.
The share count alone does not show the investor’s ownership percentage. You also need the existing shares, new-round shares, other converting instruments and the agreed treatment of options and warrants.
What happens at maturity, during a funding delay or on a sale?
Maturity is the contractual deadline. Depending on the agreement, it can trigger repayment, conversion or a process for agreeing an extension. If an extension needs noteholder consent, the company cannot assume it will be granted.
A smaller, non-qualifying round may leave the loan outstanding or permit conversion under separate terms. Check this outcome before accepting a threshold that the company could struggle to reach.
A sale may trigger repayment or conversion before completion. In insolvency, recovery depends on security, creditor ranking and available assets; investors are not guaranteed repayment.
Build the repayment date into your cash forecast. Test slower revenue, delayed customer collections and a later funding round. If repayment depends on investment that has not been committed, make that dependency explicit before signing.
Convertible loan note, priced equity or ASA: which fits?
A CLN can provide a bridge to a commercial milestone: product delivery, contracted revenue or evidence that supports the next investment decision. The amount raised should fund that milestone and leave enough time to complete the next round.
It is less suitable where the business has persistent cash losses, no credible fundraising timetable and no repayment capacity. Deferring a valuation does not resolve those weaknesses.
| Funding route | What is agreed now? | Main consequence |
|---|---|---|
| Priced equity | The share price, ownership and shareholder rights. | Dilution is established at the investment date. |
| Convertible loan note | A loan and the terms for future conversion. | Interest, conversion and repayment obligations follow the agreement. |
| Advance subscription agreement (ASA) | A payment towards a future share subscription. | A genuine ASA is not a loan and does not carry equivalent debt repayment rights. |
The choice allocates risk differently. Priced equity gives earlier ownership certainty. A CLN defers the share price while adding debt obligations. An ASA intended for EIS or SEIS must meet HMRC’s conditions, including restrictions on refunds and interest.
Our guide to debt versus equity funding explains the wider cash-flow and ownership trade-offs.
How to negotiate conversion terms and model dilution
Agree the commercial terms before money is advanced. Strong fundraising preparation for UK founders connects the funding requirement, investor terms and supporting documents.
Model each note separately
Record principal, interest, discount, cap, maturity and side-letter rights for every note. Do not replace different instruments with a single blended assumption.
Establish which shares enter the cap calculation and whether it uses a pre-money or post-money basis. Where the agreement uses the lower of a discounted price and a cap-based price, calculate both. Check whether interest converts at the same price as principal or follows a different rule.
Include the conversion share class, fractional-share treatment, existing options and warrants, and any proposed option-pool increase. The ownership percentage is only part of the result: different share classes may have different economic rights.
Test the outcomes before signing
Run an expected round, a lower-valuation round and a delayed round. Include a raise below the qualifying threshold and a maturity repayment scenario. Compare the resulting ownership, cash requirement and remaining runway.
Our cap table management guide explains how to present the ownership position and reconcile it to the underlying records.
What company approvals and share records are needed?
Review authority before the company grants conversion rights. The Companies Act rules cover both allotting shares and granting rights to subscribe for, or convert securities into, shares. The precise authority required depends on the company and its documents; see Companies Act 2006, section 549.
Ask your solicitor to check directors’ authority, board approvals, shareholder consents and any applicable pre-emption rights or waivers. The articles and shareholders’ agreement must support the intended share class and conversion terms.
When conversion takes place, complete the required allotment steps, update the company’s register of members and reconcile the shares issued to the conversion calculation. An accounting entry alone does not complete a valid allotment.
Companies House requires the SH01 return within one month of allotment, as explained in its guidance on company filings. Assign responsibility for approvals, records and filings before conversion is due.
Do convertible loan notes qualify for EIS or SEIS?
The loan advance does not qualify, and shares issued by converting an existing loan do not meet HMRC’s purpose-of-issue requirement. EIS and SEIS relief attach to qualifying share subscriptions, not simply to money entering the company.
HMRC’s EIS purpose-of-issue guidance excludes shares issued by converting loan stock or settling a loan. Its SEIS guidance applies the equivalent restriction. Those shares clear an existing obligation rather than raise fresh money for the company.
A separate share issue for fresh cash must be assessed independently against the relevant scheme conditions. Do not promise tax relief on a CLN or assume that rewriting the documents changes the substance of an existing loan.
How does an ASA differ for EIS and SEIS?
A genuine ASA starts with money paid towards a future share subscription. HMRC’s EIS ASA guidance and SEIS ASA guidance require no refund entitlement, no interest, no variation, cancellation or assignment, and a longstop date for issuing shares.
HMRC generally expects the longstop to be within six months. A longer period does not automatically make the investment ineligible, but makes advance assurance unlikely. Relief arises from the qualifying share issue, not from signing the ASA or advancing the money.
What does advance assurance confirm?
Advance assurance is HMRC’s conditional opinion on the proposed share issue, based on the information supplied. It does not confirm an individual investor’s entitlement to relief. See HMRC’s advance assurance overview and guidance on its limitations.
If seeking advance assurance for an ASA, apply before entering into the agreement. Our guide to EIS advance assurance explains the preparation involved.
Separate the loan advance, interest and eventual share issue when considering tax. Obtain instrument-specific advice on interest, disposal and qualifying corporate bond status; the label “convertible loan note” does not settle those questions.
Frequently asked questions
Is a convertible loan note debt or equity?
It starts as debt and may become equity when the agreed conversion conditions are met. Accounting classification needs separate consideration under the applicable framework; the commercial label does not determine its presentation in the accounts.
Do convertible loan notes always have interest?
No. The parties can agree an interest-free note. Where interest applies, the documents should state the rate, accrual method, payment dates and whether it converts alongside principal.
Do a valuation cap and conversion discount apply together?
Only if the agreement says so. Where it uses the lower of the discounted price and the cap-based price, calculate both and select that lower price. Do not automatically apply the discount to the capped valuation.
What if there is no qualifying funding round by maturity?
Apply the note’s repayment, extension and conversion provisions. An extension may require noteholder consent. Model the cash needed for repayment, including outstanding interest, before signing.
Can a UK investor claim EIS or SEIS relief on a CLN?
The loan advance does not qualify, and conversion shares fail HMRC’s purpose-of-issue requirement. A separate fresh-cash subscription may qualify if it independently meets the scheme rules. Keep the transactions clearly distinguished in the documents and records.
Can a convertible loan note be changed into an ASA?
Changing the name does not change the transaction’s substance. An eligible ASA must be a genuine advance subscription, not a mechanism for converting existing debt. Take professional advice before replacing or amending an instrument.
Make the funding work beyond the signing date
A convertible loan note can bridge a funding gap when the conversion, dilution and repayment outcomes are clear and affordable. Give repayment capacity and ownership impact the same attention as the amount raised.
Consult EFC supports cash forecasts, funding models, cap tables and investor preparation. We connect the funding terms with the numbers so you can assess the next round and the alternatives if it is delayed.
Book a Consult EFC consultation to discuss your funding plan.
Guidance checked 7 November 2026. Official sources are linked alongside the relevant tax and company-law points.
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Over 12 years across Big Four audit, Investment Banking, and corporate advisory. Kish works with SaaS founders, tech companies, and ambitious UK SMEs from £1M to £50M in revenue on fundraising, valuations, exit planning, and financial strategy. ICAEW regulated. Big Four trained. Based in London.