SHAREHOLDER'S LOAN

Accelerate your business with these expert tips on "Convertible equity loan". Analyse and discover this TIP!

​​Equity and convertible loans are a type of financing designed for start-up companies. To really understand what a shareholder loan is, it is necessary to pay attention to the role of the lender. In this case, the lender not only hands over the money and waits for it to be paid back with a series of interest payments, but in addition, shares in the profits of the borrowing company. Thus, the interest is linked to the performance of the company and, in the case of convertible loans, you can even become a shareholder of the company. The equity loan, therefore, is a type of financing that combines loan and equity features.

In this type of loan, the lender (usually a public entity, ENISA, SODECAN...) receives a fixed remuneration, but also participates in the results of the borrowing company. This type of financing is more flexible than a conventional loan and allows companies to raise additional capital without giving up shares or control of the company. However, entrepreneurs must be aware that the equity loan is more expensive than a conventional loan and may be more difficult to obtain. The equity loan is one of the most widely used financing methods for start-up companies, especially those that have been set up in the past few years. startups (+). Moreover, this type of loan is not only a loan of money in the usual way, which will generate interest when the initially deposited amount is repaid, but in one of its forms (convertible equity loans) it also offers the possibility for the investor to convert his or her capital into shares.

What is the equity loan?

A participating loan is a corporate financing instrument characterised by the participation of the lending party, which may be an individual or a company, in the profits of the financed company. When you want to start a business, one of the first needs, in addition to an idea and a business plan, is the money to carry it out. loan in the vast majority of cases, but when start-ups or new enterprises startups In many cases, they encounter obstacles in their search for funding and have to look for alternatives. For this reason, we are going to explain this type of participating or convertible loans.

This method of financing involves a number of special features that differentiate it from more classical options such as bank loans. The most important is the role of the lenderIn certain cases, the borrower may no longer simply be the one who leaves the money and may become part of the borrowing company. It is usually agreed to charge a fixed interest rate for the life of the loan and a variable interest rate depending on the performance of the company benefiting from the loan. The criterion for valuing profits is usually based on net profit, turnover, total assets or any other freely agreed between the parties. It is considered an intermediate figure between the company's own funds and borrowed funds.

Article 20 of Royal Decree-Law 7/1996, of 7 June, on urgent tax measures and measures for the promotion and liberalisation of economic activity, establishes the characteristics of the participating loan, making it compulsory to receive variable interest depending on the evolution of the borrower company's activity, with the fixing of a fixed interest rate being optional, regardless of the evolution of the beneficiary company. An increasing interest rate can also be agreed, depending on the volume of business.

What types of equity loans are there?

As mentioned above, the main defining characteristic of a participating loan is the way in which the borrowed capital is repaid. The debt is not necessarily repaid in instalments with the corresponding fixed or variable interest, but there are different ways to settle the account. This is why there are two types of equity loans.

SHAREHOLDER'S LOAN

As mentioned above, being a participating loan means that the lender not only gives the money to be repaid with interest, but also shares in the profits of the company. This means that the instalments you will be paid will be variable and will depend on the growth and performance of the company. The specific conditions must be written down and signed in the loan contract. It should be made clear what the interest rate refers to, whether it is based on profit, equity, turnover, etc. However, in some cases, fixed interest payments can also be agreed.

CONVERTIBLE LOAN

The convertible loan differs from the equity loan in the way in which the lender takes a stake in the borrowing company. While in the former participatory model, whoever gives the money receives it back with interest depending on the company's situation, in this case the lender can become a shareholder of the company. In this case, the lender can convert the credit claim into units or shares in the company. In other words, the lender does not receive the money back, but gets shares in the company that borrowed the money. However, in order for the lender to join the company, this movement has to be approved by the company's board and a capital increase has to be carried out. Therefore, it is usual and advisable that the loan contract itself includes this approved agreement.

The convertible equity loan is conditional on the company's commitment to carry out a capital increase at a given time, for which it is important that the shareholders' meeting, at which the resolution on the capital increase and the date has been taken, has been held prior to the signing of the equity loan. Be careful because the law establishes penalties for early repayment, as the law only allows early cancellation of the loan if it is compensated by a capital increase of the same amount. This is to prevent the company from being undercapitalised, which could be detrimental to other creditors.

In the event of the liquidation or insolvency of the borrower, the loan would be placed after the preferential creditors and the common creditors of the borrower, in relation to the ranking of claims against the insolvency estate. This implies that the lender is placed after the unsecured creditors and will only be paid ahead of the shareholders (disadvantage). Therefore, it is often required that the equity is higher than the amount of the loan so that the lender does not have to assume a risk similar to that of the owners. This type of loan is considered as equity for the purposes of capital reductions or liquidation of companies under commercial law. Accrued interest, both fixed and variable, is deductible for corporate income tax purposes (advantage).

WHAT IS A CONVERTIBLE LOAN?

The meaning of a convertible loan is that if the loan is not repaid at the time of repayment, the loan is automatically converted to the agreed Pre Money Value of the shares or units, whereby the lender becomes the holder of shares or units, as the case may be, for the value of the money lent. The law considers this type of loan to be a very open format from a commercial point of view, given that it is subject to the will of the parties, where the different conversion options are fixed, and it is even agreed in advance what percentage of capital will correspond to the lender in the future if he decides to exercise the conversion option.

This alternative is interesting from a guaranteeing point of view for the lender, since in any case it ensures its investment, either by recovering its money with the interest agreed in the loan, or, in the event of insolvency of the beneficiary entity, by participating in it as an additional shareholder. It should be borne in mind that a convertible loan does not necessarily have to be a participating loan, but a participating loan may contain the option to exercise the conversion, i.e. to agree on conditions that would be of variable interest (and fixed if desired), in the case of not converting the loan, and also to agree on conditions for a bonus on the capital invested, for example, in the case of exercising the option to convert the loan into shares or units of the company.

FORM OF DOCUMENTING THE EQUITY LOAN AND MINIMUM CONTENT:

It is advisable to draw up a commercial loan contract, with a clause that specifies as precisely as possible the conditions of the loan, and where it is clear that the nature of the loan is that of a shareholder's loan, foreseeing, above all, the consequences in the event of possible breaches by the parties. The document may be private, or it may be made public.

The minimum content of the shareholder loan agreement shall be as follows:

• Company name and/or identification details of the contracting parties, stating their respective addresses and the form in which they are involved in the legal transaction.
• Borrowed capital and disbursement deadline.
• Fixing the borrower's share capital.
• Duration of the loan and repayment period.
• Amortisation schedule and early redemption option.
• Grace period: which is usually agreed in this type of loan to facilitate the start-up of the operation for which the loan is granted.
• Interest that will accrue on the loan (variable, and if applicable, if there is fixed interest), how it is calculated and periodicity.
• Conversion and non-conversion may be agreed in the same document, i.e. a clause may be included granting the lender the possibility of converting the loan or the possibility of not converting it, establishing the conditions for both cases. As well as possible bonuses depending on when the conversion is exercised.
• Restrictions on the borrower in the event of capital increases, capital reductions, bankruptcy proceedings, liquidation due to the company's definitive closure, etc.
• Penalties in the event of non-compliance with the obligations, in particular the repayment of the loan capital.
• Lender's pre-emptive rights.
• It shall be established for whose account the expenses and taxes arising from the granting of the operation shall be borne.
• Grounds for termination of the contract.

APPLICABLE LEGISLATION

Royal Decree-Law 7/1996 of 7 June 1996 on urgent tax measures and measures to promote and liberalise economic activity.

CONCLUSION

Participating loans and convertible loans are loans that usually include a reservation of those matters that would generally be left to the general meeting of partners or shareholders, and to the company's management itself, to vote in favour of the lenders. For example, this is usually agreed on matters related to the sale of company assets, the creation of subsidiaries or capital reductions, in order to guarantee the investment.

• TECH FOR EQUITY (+)
• SALES FOR EQUITY (+)
• IT FOR EQUITY (+)
• MEDIA FOR EQUITY (+)
• LOGISTIC FOR EQUITY (+)
• DIGITAL MARKETING FOR EQUITY (+)
• CTO FOR EQUITY (+)
• STOCK OPTIONS (+)
• CONVERTIBLE BOND TO INVEST IN STARTUPS (+)