Convertible loans

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Page written by Chris Godfrey. Last reviewed on June 5, 2025. Next review due April 6, 2026.

Need to raise cash for your start-up or early-stage business but are not ready to provide a company valuation? Convertible loans can be a good option to plug your funding gap. Receive cash as a loan, then convert the debt to equity when your business has matured.

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What is a convertible loan?

A convertible loan is a type of short-term debt that’s provided to businesses and gives lenders the option to convert the outstanding loan amount into equity (shares) in the company at a future date.

Convertible loans are especially popular with early-stage businesses and high-growth companies because they allow the business to raise funds quickly without the need for an immediate and potentially difficult company valuation. This flexibility is valuable when the company’s future prospects are uncertain or evolving rapidly.

There are two types of convertible loan:

Secured convertible loan: The loan is backed by company assets as collateral
Unsecured convertible loan: No specific assets are pledged. The agreement is based on trust and contract terms

How does a convertible loan work?

Every convertible loan is tailored to the situation of the borrower, but principal features include:

Cash loan: The investor (lender) provides a cash sum to the borrowing business. The funds are used to support the organisation as per the loan agreement
Conversion option: Instead of receiving the loan back as cash, the investor can choose to convert the loan into shares of the company
Trigger events: Conversion is usually triggered by specific events, such as a subsequent equity financing round, an acquisition, or reaching the pre-agreed maturity date (see below)
Discount rate: Investors are often given a discount (commonly 15–30%) on the share price when the loan converts, rewarding them for their early risk
Valuation cap: This sets a maximum company valuation at which the loan can convert, ensuring that early investors are protected from a very high share price if the company’s value rises sharply before conversion
Interest: Convertible loans usually accrue interest, which may also convert into equity or be paid in cash
Maturity Date: If conversion hasn’t occurred by a certain date, the company must either repay the loan with interest or convert it into equity, depending on the loan agreement

What can I use a convertible loan for?

Convertible loans are primarily used by early-stage and high-growth businesses as a flexible and rapid way to raise capital.

Use this type of loan for:

Bridging between funding rounds: Start-ups often use convertible loans to extend their financial runway between major equity funding rounds, allowing them to continue operations and reach key milestones before raising more substantial investment
Seed funding: Convertible loans are commonly used for initial seed funding when a business is too early to accurately value, enabling founders to secure investment without immediate valuation negotiations
Short-term development capital: Convertible loans provide quick access to short-term development funds, supporting activities such as product development, market expansion, or hiring, until a larger funding event can be arranged
Delaying valuation: For start-ups with uncertain or rapidly changing valuations, convertible loans allow them to delay setting a company valuation until a future funding round, reducing the risk of undervaluing the business early on
Faster and simpler funding: The structure of convertible loans is generally simpler and faster to negotiate than traditional equity deals, making them ideal for situations where speed is crucial

Who can benefit from a convertible loan?

Borrowers and lenders can both benefit from a convertible loan.

Start-ups and early-stage businesses

Start-ups and early-stage businesses can benefit from a convertible loan as it allows them to secure vital early funding without suffering immediate equity dilution – as they would with a pure equity investment. Convertible loans allow young companies to raise capital quickly while deferring valuation discussions until a later date. This can reduce pressure on the business and align investor interests with the company’s long-term success and growth.

Companies seeking flexible funding options

You don’t have to be a start-up to choose a convertible loan. More mature businesses can also use this type of funding to raise capital without immediate equity dilution. It’s ideal for companies planning a future valuation event, such as a funding round or acquisition. Convertible loans offer flexibility, fast access to funds, and can delay complex negotiations, making them a smart option for businesses in transition, scaling, or exploring strategic opportunities without giving up equity right away.

Investors looking for equity potential

Convertible loans benefit investors by offering the security of debt with the upside of future equity. It allows them to invest early with the potential to convert their loan into shares at a discount during a future funding round. This gives investors a stake in the company’s growth whilst reducing initial risk. If the business succeeds, they gain equity at favourable terms, maximising potential returns on their investment. If the business is less successful, they can get their cash back as loan repayments plus interest.

What are the pros and cons of a convertible loan?

Like all financial products, convertible loans have their advantages and disadvantages:

For borrowers:

Pros

Quick and flexible access to capital
Avoids immediate dilution or complex negotiations over business valuation
Can be used to bridge funding gaps between major investment rounds

Cons

If not converted, the loan must be repaid with interest, which can strain the borrower’s finances
Conversion can lead to significant dilution for founders if the company’s value increases sharply
Terms such as high discounts or low valuation caps may be unfavourable to the company in the long run

For investors:

Pros

Convertible loans allow investors to lend money with the option to convert to equity later. If the company fails, investors may still recover their loan, offering more protection than a direct equity investment
Investors typically receive a conversion discount, enabling them to acquire shares at a lower price than new investors in a future funding round
A valuation cap can guarantee investors a minimum percentage of equity, even if the company’s valuation rises sharply before conversion
Convertible loans usually accrue interest, which can increase the value of the investment, especially if the loan is converted into equity

Cons

Investors typically have very few rights prior to conversion, such as limited or no voting power and minimal influence over company decisions
Convertible loans do not qualify for Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) tax relief
The final conversion price depends on the company’s future valuation, which can be unpredictable and may lead to disagreements or less favourable outcomes for investors if the valuation is unexpectedly high
If the company does not achieve a qualifying funding round or trigger event, the loan may not convert, and investors may have to settle for repayment and miss out on any equity upside

Convertible loan vs. traditional loans

How do convertible loans stack up against traditional business loans? It boils down to complexity and predictability.

Convertible loans blend debt and equity features to provide early-stage and high-growth potential businesses with funding. As a result, these types of loan can be highly complex – and they can also be unpredictable, as they aim to give investors a potentially lucrative upside through future equity conversion – an outcome that is not guaranteed. In comparison, traditional business loans are typically straightforward – the business borrows a sum of cash and then pays it back over time plus interest and any fees. These types of loans provide predictable returns and carry less complexity. However, they lack the growth participation potential of convertible loans and will usually involve greater due diligence of the borrower by the lender.

How to apply for a convertible loan

Unlike traditional business loans that borrowers may obtain from their high street bank, convertible loans are provided by venture capitalists, angel investors, existing shareholders, corporate lenders and some online lenders.

To apply for a convertible loan from these sources, especially as a startup or early-stage business, follow these steps:

Prepare a solid business plan: Investors need to understand your business model, growth strategy, and financial projections
Identify suitable investors: Target angel investors, venture capitalists, etc
Draft a convertible loan agreement: In a convertible loan, the borrower drafts the loan agreement – this is your ‘funding offer’ and it sets out what you need and what you are prepared to pay to obtain the funds. The agreement should include key terms such as the loan amount, interest rate, maturity date, conversion trigger, discount rate, and valuation cap
Negotiate terms: Discuss and refine terms with potential investors to align interests
Conduct legal and financial due diligence: Investors will assess your legal structure, finances, and risk
Finalise the agreement: Sign the contract after mutual agreement and legal review
Receive funds: Once executed, funds are transferred, and the loan begins, potentially converting into equity at a later date

Alternative funding options to convertible loans

If a convertible loan is not for you, there may be other ways to get the funding your business needs.

Equity funding

Provided by the same investor sources as convertible loans, equity funding involves selling shares of your company to raise cash. This type of funding doesn’t require repayment, but it does give investors partial control of the business.

Venture capital

Venture capital (VC) is similar to equity funding, where you sell shares in your business to raise cash, except VC funding is typically provided by investors who focus on high-growth start-ups. This type of investment supports early-stage companies with strong potential but comes with higher risk for investors. Many venture capitalists can also provide mentorship and networking. Returns are earned when the start-up scales, is acquired, or goes public with an IPO.

Business term loans

Business term loans are the most common form of commercial borrowing and it’s available from banks, building societies and online lenders. Businesses borrow a lump sum of cash and repay it over time by regular instalments. Interest and fees apply.

Typically, the longer your business has been in operation and the more profitable it is, the easier it is to obtain this type of funding. In most cases, early-stage companies who usually have little history and zero profits must provide security to qualify.

Get started with Swoop's business funding platform

Working with business finance experts can make all the difference when applying for a loan. Contact Swoop to discuss your borrowing needs, get help with your application and to compare high-quality convertible loans from a choice of lenders. Get your start-up off the ground or give your business the financial boost it needs on terms to suit your planning.

Written by

Chris Godfrey

Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Barclays Bank, Metro Bank, Wells Fargo, ABN Amro, Quidco, Legal and General, Inshur Zego, AIG, Met Life, State Farm, Direct Line, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of consumer and business finance and insurance.

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