Convertible Loan Notes Explained: A UK Founder’s Guide

Two founders and an angel investor spent six weeks arguing about whether a company with no revenue was worth £1.5 million or £3 million. Nobody could prove either number, because there was nothing yet to prove it with. In the end they stopped arguing and used a convertible note, which let the money go in that month and moved the valuation fight to a year later, when there would be customers to point at. That is the whole idea behind convertible loan notes — and in Britain there is one catch that changes everything.

Typical UK terms	What you usually see
Interest	3% – 8% a year
Discount on the next round	10% – 20%, with 20% most common
Maturity	Commonly 12 – 24 months
Valuation cap	Negotiated case by case
Qualifying round threshold	A minimum raise, so a tiny round cannot trigger conversion
SEIS / EIS relief	Generally not available

What a convertible loan note actually is

It is money lent to the company that everybody expects to turn into shares rather than be repaid. The investor hands over cash now, the company issues a note instead of shares, and when a proper priced funding round happens the note converts at that round’s valuation, with a reward built in for having gone first. The appeal for a founder is speed and cost: no lengthy valuation negotiation, far less legal work, money in the bank in weeks rather than months. The appeal for the investor is that they get in early on better terms than the people who follow, and if everything collapses they are a creditor rather than a shareholder.

The discount and the cap, and how they work together

Two levers decide how many shares the money buys. The discount is a percentage off the price the next round’s investors pay, usually somewhere between 10% and 20%, with 20% the figure most often seen. The valuation cap sets a ceiling: however high the next round prices the company, the note converts as though the valuation were no higher than the cap. Here is the part founders regularly misread. Where a note has both, the investor normally converts at whichever gives them the lower price per share. It is not one or the other, and on a round that goes brilliantly the cap is usually the one that bites.

What happens if no round ever comes

This is the risk nobody dwells on at signing. A convertible note has a maturity date, commonly twelve to twenty-four months out, and it is a loan until then. If no qualifying round has happened by that date, the note can fall due for repayment — and an early-stage company that failed to raise is almost never in a position to repay anything. Some notes convert at a fallback valuation instead, which is far kinder, but only if somebody negotiated that in. Interest has been quietly accruing the whole time too, usually at 3% to 8%, which adds to the amount that eventually converts. Read the maturity clause before the discount clause.

The British catch: SEIS and EIS

Now the part that matters more in the UK than anywhere else. Convertible loan notes generally do not qualify for SEIS or EIS relief, because the money goes in as debt rather than as a subscription for shares. For a British angel that is not a technicality — it is the difference between getting 50% of the investment back as income tax relief under SEIS, or 30% under EIS, and getting nothing at all. Plenty of experienced investors will simply decline a convertible note for exactly this reason, and a founder who does not know why is left wondering what went wrong with an otherwise willing backer.

Why most UK seed rounds use an ASA instead

The workaround British startups reach for is the Advance Subscription Agreement. Legally it is not a loan at all — it is money paid in advance for shares that will be issued later. Because of that it carries no interest, it can never be repaid, and crucially it is compatible with SEIS and EIS. It keeps most of the speed of a convertible note while preserving the tax relief that makes UK angel investing work. The trade-off is rigidity: HMRC requires an ASA to convert into shares within six months of being issued, so if no qualifying round lands in that window it converts anyway, usually at a fallback valuation.

Deferred dilution is still dilution

A convertible note feels painless because nothing appears on the share register on the day. That feeling is exactly the danger. A 20% discount stacked on a low valuation cap can hand over substantially more of the company than the founder pictured, and the bill only arrives at the priced round when it is far too late to renegotiate. It gets worse if you bridge twice: notes stack, interest compounds on top, and the combined conversion can be genuinely shocking. Build the conversion into a spreadsheet under a good outcome and a mediocre one before you sign, exactly as you would model any other equity round.

When a convertible note is the right answer

It suits a genuine bridge: you have a priced round in sight, you need money to reach it, and arguing about valuation today would waste months you do not have. It suits a small, friendly raise where legal costs would otherwise swallow the money. It suits investors who are not relying on tax relief — funds, corporates, overseas backers. It does not suit a first seed round from UK angels, where an ASA is almost always the better instrument, and it does not suit a company with no realistic route to a priced round, because then you have simply borrowed money you cannot repay. Weigh it against the other routes open to you before deciding.

Where it sits in the funding journey

A convertible note is rarely anybody’s first move and it should never be their last. Most companies start with their own money or a Start Up Loan, take a small equity round from angels, and only reach for a convertible when they need to bridge a gap between rounds. If you have not yet mapped out the whole route, the four funding structures and the order of operations for raising are the two things worth reading first. And because a note converts at the next priced round, everything about that round matters more than the note itself — how a funding round actually runs is where the real work sits. Have a credible plan for the money before you take any of it.

The question to ask before you sign

Those two founders did raise their priced round, fourteen months later, at a valuation well above both numbers they had argued over. The note converted, the angel did nicely out of the cap, and everybody was pleased — but that outcome was luck as much as design, because nobody had modelled what the cap would do if the round went well. So ask one question before signing any convertible instrument: what does my share register look like the day this converts, under three different outcomes? Get an accountant and a startup solicitor to check the answer. It is the cheapest hour you will spend on the round.

Frequently asked questions

What is a convertible loan note?

It is money lent to a company that is expected to convert into shares at a later funding round, rather than being repaid in cash.

Do convertible loan notes qualify for SEIS or EIS?

Generally no. The money goes in as debt rather than as a subscription for shares, so investors lose the 50% SEIS or 30% EIS income tax relief.

What discount is normal on a convertible note?

Usually between 10% and 20% off the next round’s share price, with 20% the figure most commonly seen in UK deals.

What is a valuation cap?

A ceiling on the valuation used when the note converts. However high the next round prices the company, the investor converts as if it were no more than the cap.

What happens if the company never raises another round?

The note can fall due for repayment at maturity, typically after 12 to 24 months. Some notes convert at a fallback valuation instead, if that was negotiated.

What is an advance subscription agreement?

Money paid in advance for shares. It carries no interest, cannot be repaid, qualifies for SEIS and EIS, and must convert within six months of issue.

This article is general information, not legal, tax or investment advice. Typical terms are drawn from published UK guidance as at September 2026 and vary widely between deals. Whether an instrument qualifies for SEIS or EIS depends on how it is structured and on the company and investor qualifying — take professional advice before issuing or accepting any convertible instrument.