What is a convertible loan agreement and why do startups use them?
A convertible loan agreement (CLA) is one of the most widely used financing instruments for early-stage startups. Here’s how it works: an investor lends money to your startup, with the agreement that the loan will convert into equity (shares) at a later point — usually at the next funding round. The big advantage? You don’t need to set a valuation for your company at this early stage, which is virtually impossible at pre-seed or seed when there’s little to no revenue. In the Netherlands, early-stage CLAs typically range from €25,000 to around €500,000 for pre-revenue startups.
At Legalloyd, we regularly guide founders through their first CLA. In practice, two scenarios come up again and again: the very first funding round (usually from friends & family or angel investors) and bridge financing between two equity rounds.
Who invests via a CLA — and does it matter for the terms?
In the earliest stage, founders typically raise money from friends, family, and — as the saying goes — fools. The track record of startups is not great: many fail, and even survivors often need years to become profitable. But you also see semi-professional angel investors who specifically target early-stage startups.
The type of investor does matter for the terms. A professional angel will want more safeguards: information rights, sometimes even security interests over the startup’s future assets. Stay alert here — a CLA is meant to be risk-bearing capital that converts into equity, not a bank loan with collateral. But even with family investors, clear agreements are essential. That uncle who lends you €50,000 may want his money back in a few years — for a caravan rather than shares in your scale-up.
The four biggest pitfalls with convertible loans
1. Giving different investors different terms
When assembling a group of investors, give them all the same terms. Unequal terms breed resentment and can cause problems later, at conversion.
2. Making no arrangements for later amendments
The most favoured nation principle prevents complications at conversion or when terms are amended. By including a majority clause (e.g., 80% of committed capital decides), you avoid having to negotiate individually with each investor.
3. Stacking CLAs with different conditions
Founders often get the best terms in the initial, optimistic phase. Later — when challenges mount — new investors sometimes get more favourable conditions. This frustrates earlier backers. Be transparent about this and set frameworks in advance.
4. Vague formulas for the discount and cap
The discount is the reduction (10%–25%) the early investor gets at conversion. The cap is the ceiling valuation for conversion. It sounds simple, but the devil is in the details: how is the fully diluted share capital calculated? Are earlier CLA holders counted as if already converted? Always model the formulas in an Excel spreadsheet before you sign.
Term length: founders are almost always too optimistic
Three years sounds long, but even five years often proves too short in Dutch practice. Think you need two years? Set the term at five. Equally important is what happens when the term expires without conversion. Many CLAs barely address repayment conditions. A practical solution: if a conversion opportunity is offered but the investor declines, an additional repayment period of the same length as the original term applies.
Watch out: what rights does the investor get after conversion?
A major red flag is when a CLA investor demands the same rights as a Series A investor upon conversion, without investing at that round themselves — think anti-dilution protection, liquidation preferences, or veto rights. CLA investors typically hold a small stake after conversion. Don’t grant them disproportionate rights that scare off future investors. Lock this down in the CLA itself.
The counter-intuitive insight: legal precision matters most when you succeed
When a startup fails, the contract is often less relevant — investors understand they took a risk, and a subordinated loan yields little in bankruptcy. But when a startup becomes a major success, every clause matters. There’s a lot to fight over, and a sloppy CLA can block your startup’s future growth. So invest in proper documentation now, at the early stage.
How Legalloyd helps founders with CLAs
At Legalloyd — based in Amsterdam and specialising in startups and scale-ups — we offer two paths. For smaller rounds, you can generate a specialised CLA template via legalflow.ai that covers all essential elements. For more complex rounds with diverse investors, we draft a bespoke agreement and negotiate on behalf of the founder.
The most important advice
The golden rule is not legal but practical: extend your runway. You always need more money than you think, and it always takes longer than you expect. If you think you need €100k, ask for €150k to €200k. And choose a generous term. We’ll handle the legal fine-tuning.
Looking to set up a convertible loan for your startup? Schedule a free consultation or create a CLA template directly via legalflow.ai.