When the company is incorporated, the company’s investors receive a short-term debt instrument called a convertible loan. However, once the company is operational, these convertible loan notes can be converted into equity, or they can repay to the investor as the case may be.
As per the relevant clause amended under the Company’s Rules, 2014, any start-up acknowledged by the Department for Promotion of Industry and Internal Trade can raise initial funds in a single transaction from the investor and issue a CLN against it. Subsequently, as mutually agreed, the convertible loan note can be converted into shares or repaid.
Why is CLN so popular?
Every start-up firm requires a strong backing of funds to start operating and expand its business; however, it is difficult to raise capital. Therefore, the promoters or owners of the star-up issues a convertible loan note as a return of funds offered by the investor
On the other hand, the investor funds the start-up with the initial capital in the form of a loan, with the condition of repayment in 1 or 2 years. He received CLN in return; this instrument contains all valid information regarding the maturity, interest on the loan, conversion conditions, etc. The convertible usually gets converted into the equity for want of additional capital.
On maturity, if the start-up organization is not in a position to pay the loan, it is up to the investor to extend the loan further for up to 5 years as a statutory limit or ask for repayment. This decision, however, depends on the overall performance and growth of the start-up.
It doesn’t require any company valuation to fund the start-up, so it avoids all the hassles. Convertible notes can be issued quickly by any start-up firm with minimal formalities.
They make deal closures at a faster rate.
CLN helps to nullify the role of existing shareholders until the time they get converted into equity.
It is a quick getaway for a start-up to raise the initial capital for its business.
A convertible loan note is not the only option for raising funds for a start-up though it is one of the easiest; however, there are other options for raising capital. Therefore the start-up firm should go through all its possibilities and analyze the best suits it’s needed and which it finds relevant depending on their cash flow.