Fortunately, every cloud has a silver lining, and in a deflationary environment, the return on cash deposits has dropped to such a low that there are “high net worth individuals” out there who are prepared to invest in start-ups and SMEs, rather than have their money sitting in a bank account somewhere doing essentially nothing. There are a cadre of people who made good money in the early part of this century who are experienced business people with cash and ideas to offer.
There is a clear trend emerging of finance by way of the Convertible Loan Note. This type of fundraising is limited in its amount, and certainly won’t replace large equity raising for bigger companies, but from deals I have done on behalf of our clients and from what I hear from fellow professionals, it is apparent that so called “high net worth individuals” are lending to companies, but the rules of the game have changed. At the moment, straight equity deals are hard to come by, but Convertible Loan Notes are very popular.
To the lender, the advantages of Convertible Loan Notes are that they rank as debt in the event that the company gets into financial difficulties. So, if we’re talking about a secured convertible loan note, then depending on what other charges are held by banks, the secured convertible loan note holder can rank first in the event of an administration or liquidation. If we are talking about unsecured convertible loan notes, then the loan holder ranks alongside other unsecured creditors, but ahead of the shareholders.
Convertible Loan Notes can carry quite a high coupon, and interest rates of 10-15% are quite common to reflect the risk being run.
The other attraction of the Convertible Loan Note to the investor is that (as its name suggests) it is often coupled with an opportunity to convert the debt into shares in the company at a later stage. This might also come at a discount to the current share price, or at a discount to any equity raising in the future.
I have been involved in convertible loan note fundraisings in the last few months that have been seen as an interim measure pending proposed equity raising, and as a way of getting a company through the next 12 months of difficult trading conditions. For the company and its existing shareholders, the benefits of the Convertible Loan Note are that it does provide cash at a time when cash is hard to come by. It does have the potential to dilute the shareholders if converted, but then the theory is that the providers of this type of finance, in this current climate, are taking a risk that banks and venture capitalists are reluctant to take and therefore there should be an appropriate reward.
The Convertible Loan Note is pretty flexible, but the usual formalities will need to be gone through:
• The Board will need to document that it has considered the terms offered, and believes they are for the benefit of the Company and its shareholders as a whole.
• As the Note is convertible into equity, the appropriate checks on available share capital and the Directors’ authority to issue convertible notes need to be undertaken and , if necessary, shareholder approval obtained.
• As the Note is convertible into shares, the Convertible Loan Note will fall under the “Financial Promotion” regime under the Financial Services and Markets Act , so the appropriate exemptions will need to be available in relation to the noteholders - this is most definitely not an investment for novices and therefore approaches for such investment in a company should be limited to “sophisticated investors” “high net worth individuals” and the like!
• If the Note is secured, a Debenture will need to be drawn up, and registered at Companies House and, if appropriate, the Land Registry.
The Convertible Loan Note is out there and there are networks of “Angel Investors” willing to lend on these sorts of terms……And the investors don’t just bring cash- a lot of them have valuable experience to offer SMEs too…
