A convertible bond (often called a convertible loan note in private companies) is a clever hybrid of debt and equity: it starts life as a loan but can later convert into shares. It is a popular way for companies (from start-ups to larger businesses) to raise money while postponing the question of valuation. Here is a plain-English guide for England and Wales.
Debt that can become equity
A convertible bond is, at the outset, a debt instrument: the company borrows money from an investor and usually agrees to pay interest and repay the principal at a maturity date. The twist is the conversion right: in defined circumstances, the loan converts into shares instead of being repaid in cash.
Until conversion, the investor is usually a creditor rather than a shareholder, and ranks ahead of shareholders in the insolvency waterfall. However, the practical value of that protection depends on the note terms and the company's overall insolvency ranking: an unsecured or subordinated noteholder may still recover little or nothing after secured creditors, preferential creditors and insolvency expenses have been paid. The investor also retains the upside of becoming a shareholder if the company performs well and conversion is triggered.
When does it convert?
Conversion is typically triggered by events set out in the loan note instrument, such as:
- the next qualifying equity fundraising (the loan converts into the shares issued in that round);
- a sale or exit of the company; or
- the maturity date, if no earlier trigger occurs.
To reward early investors for their risk, conversion often happens at a discount to the next round's price and/or subject to a valuation cap (a maximum company valuation at which the loan converts), meaning they get more shares for their money than later investors.
How it's documented
A convertible bond/loan note is set out in a convertible loan note instrument (and, for multiple investors, often a subscription agreement). It will cover the amount, interest, maturity, conversion triggers, discount/cap, conversion mechanics, and what happens on an exit or default.
When conversion happens, the company allots and issues shares to the investor, which must follow the Companies Act 2006 (directors' authority to allot, dealing with pre-emption rights, and updating the register and Companies House). The investor typically signs up to the company's articles and any shareholders' agreement at that point.
Convertible bond vs SAFE vs ASA
- A convertible bond/loan note is debt, it carries interest, a maturity date and creditor status until it converts.
- A SAFE (Simple Agreement for Future Equity) is not a loan (no interest or maturity) just a right to future shares. (SAFEs are US-origin and may not be SEIS/EIS friendly in the UK.)
- An Advance Subscription Agreement (ASA) is a UK-friendly alternative that can be structured to qualify for SEIS/EIS tax relief, because the money is a non-refundable advance subscription for shares to be issued within a short period.
The right choice depends on tax (SEIS/EIS), investor preference, and how you want to treat interest and repayment, take advice.
Pros and cons
Pros: raises money without fixing a valuation now; faster and cheaper than a full equity round; gives investors downside protection. Cons: it is debt until conversion (interest, repayment risk if it doesn't convert); dilution happens later; and the discount/cap can hand significant value to early investors.
Key takeaways
- A convertible bond / loan note is debt that can convert into shares, usually at the next funding round, a sale, or maturity.
- Conversion often carries a discount and/or a valuation cap to reward early investors.
- Conversion involves a share allotment that must comply with the Companies Act 2006 (authority to allot, pre-emption, filings).
- It differs from a SAFE (not a loan) and an ASA (which can be SEIS/EIS friendly), choose based on tax and structuring, with advice.
Sources
- Companies Act 2006 (allotment and issue of shares; authority to allot; pre-emption rights; filings)
- HMRC SEIS/EIS rules (and the ASA structure as a SEIS/EIS-compatible alternative)
- General practice on convertible loan note instruments in England & Wales
--- This article is general information about the law of England & Wales as at 2026, not legal or tax advice. For advice on your circumstances, consult a qualified solicitor or tax adviser.