A convertible loan is similar to a commercial loan, only the lender on a convertible loan has the right to convert the loan into an equity share of a business or commercial property.
The ability to convert the loan into equity offers the lender the ability to benefit from the gains and profits as an equity shareholder. The terms of converting the loan into equity are specified per agreement between the lender and borrower.
What Are The Advantages of A Convertible Loan?
Convertible loans can be useful in situations where funding is necessary for a new enterprise or project, but the endeavor is not established yet. There may be little financial information, and there is risk a project might not cash flow enough over the loan term to service the loan.
The ability to convert the loan to equity and realize gains above the returns of a standard commercial loan compensates the lender for the additional risks taken, particularly if the lender gets a discount on the equity share. The lender also initially has the advantage of being a creditor versus making an initial investment in a company or property as an equity owner.
In addition to the advantage of needing less financial information, convertible loans can be setup quickly. As a result, they have become attractive to startup companies in quick need of cash.
Given their flexibility and speed, convertible loans have become a tool in which investors and lenders can finance businesses and projects when borrowers are in quick need of bridge or startup financing.