Convertible loan notes for UK startups: a practical guide to the paperwork

When you raise money before you have a clear valuation, a convertible loan note can be a practical tool. It’s a loan from an investor that converts into shares at a future funding round, usually with a discount or a cap to reward the investor for going early. This post walks you through the documents involved, the key terms to watch, and what a founder needs to do to close the round cleanly.

Before you start, remember: this isn’t legal advice. You should work with a solicitor who understands early-stage fundraising, but knowing the paperwork building blocks will make those conversations faster and cheaper.

What is a convertible loan note?

A convertible loan note is a short-term loan that automatically converts into equity when certain trigger events happen. The most common trigger is a qualifying funding round — an equity raise above a set threshold. Until then, the money sits on your balance sheet as debt. Once the trigger happens, the loan plus any accrued interest turns into shares at a pre-agreed price per share.

Key terms you’ll need to pin down

Before any documents are drafted, you and your investor should agree on the commercial terms. Understanding these helps you brief your solicitor and review the paperwork later.

• Principal amount: the sum the investor is lending.
• Interest rate: usually between 5% and 10% per annum, accruing until conversion or repayment.
• Discount rate: a percentage reduction on the share price in the next qualifying round. For example, a 20% discount means the investor buys shares at 80% of the round price.
• Valuation cap: a maximum company valuation used to calculate the conversion price, protecting the investor if the round valuation jumps. If the cap is lower than the discounted price, the cap applies instead.
• Qualifying round: the minimum amount of equity funding that triggers conversion and what types of instrument count.
• Longstop date: the date by which, if no qualifying round has happened, the notes either convert at a default price or become repayable. This protects the investor from an indefinite waiting period.
• Conversion mechanics: how interest is treated (converted into shares or paid in cash) and whether the investor gets the most favourable class of shares in the round.

The paperwork you’ll need

A clean convertible loan note round typically involves three core documents. Smaller, friendly rounds might combine them, but it’s safer to keep them separate.

1. Term sheet

A non-binding summary of the deal points. It sets out the principal, interest, discount, cap, qualifying round definition and longstop date. While it’s not legally binding on the main commercial terms, it helps everyone align before money is spent on drafting. Expect to cover confidentiality, exclusivity and costs provisions, which are often binding.

2. Convertible loan note instrument

This is the main governing document. It creates the loan notes, defines the terms and conversion mechanics and includes the rights of the noteholders. It will also cover:

• Representations and warranties from the company (e.g. valid incorporation, authority to borrow).
• Events of default (like insolvency) that may accelerate repayment.
• Transfer restrictions to make sure the notes stay with approved investors.
• Information rights, so investors receive updates on the company’s progress.

Your solicitor will draft this based on the agreed term sheet, usually starting from a market-standard template like the BVA or SeedLegals model, adapted for your deal.

3. Board minutes and shareholder resolutions

To issue the notes, the directors must approve the borrowing and authorise one or two individuals to sign the instrument. If your articles require shareholder approval for borrowing above a certain threshold, you’ll also need a shareholder resolution. Even if not strictly required, it’s good practice to pass a written resolution of the shareholders to confirm the board’s authority, particularly if you have multiple shareholders who aren’t directors.

4. Side letters or subscription letters

Sometimes a short subscription letter is used to record each investor’s commitment and the amount subscribed. If there are multiple investors with slightly different terms (unusual but possible), a side letter can also vary certain provisions for one investor without altering the main instrument.

Practical steps for closing the round

A small convertible note round doesn’t need to be messy. Follow a simple sequence:

1. Agree the term sheet with your investors. Treat it as a conversation document, not a final contract.
2. Instruct a solicitor to draft the loan note instrument. Provide a clear brief with the agreed terms.
3. Prepare board minutes authorising the directors to approve the instrument and, if needed, director resolutions to convene a shareholder meeting or circulate a written resolution.
4. Circulate the final instrument, minutes and resolutions to all parties. Check that all signatures are properly witnessed or executed.
5. File any required documents at Companies House. Most convertible note rounds don’t need immediate filing, but you must update your register of members only once conversion happens. You should still record the loans in your statutory registers and accounting records as debt.
6. Keep all executed documents in your startup’s document hub, clearly labelled and dated. A clean paper trail makes future due diligence much easier.

One more thing about the cap table

A convertible loan note doesn’t appear as equity on your cap table until conversion, but it does create dilution down the line. Model the fully diluted shareholding under different scenarios — with and without the cap, and with interest applied — so you’re not surprised when the conversion maths lands. A simple cap table model helps you explain the picture to future investors.

When to get your solicitor involved

Convertible loan notes can look straightforward but the drafting of the instrument and the interaction with your existing articles and any prior investment agreements deserve professional attention. A mistake in the conversion language can lead to messy disputes later. Use your solicitors for the instrument and, if needed, to review the term sheet before you sign it, not just to draft at the last minute. It’s a false economy to copy a friend’s old note without checking it still fits your company’s situation.

For the supporting company documents — board minutes, resolutions and the record-keeping — StartupDocs can give you compliant templates to keep your corporate governance in order without starting from scratch.