Alex is Sprintlaw's co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
Raising capital is exciting - but it can also be one of the most legally risky parts of growing a startup.
If you’re not quite ready to put a firm price tag on your business (or you want to close funding quickly), a convertible loan note can be a practical middle ground between “pure debt” and “selling shares today”.
This guide breaks down how convertible loan notes are commonly used in New Zealand, how they work, what you should negotiate, and the legal issues to think about before you sign anything. We’ll keep it plain-English and focused on what matters in the real world.
What Is A Convertible Loan Note?
A convertible loan note is funding that starts as a loan, but is designed to convert into equity (shares) later - usually when you raise your next priced funding round.
In simple terms, it’s a way for an investor to say:
- “I’ll lend you money now,”
- “but instead of you paying it back in cash, I’ll probably get shares later,”
- “and I’ll get some kind of benefit for investing early (like a discount or valuation cap).”
Convertible notes are popular with early-stage businesses because they can be faster and cheaper to implement than a full equity raise - but only if the document is properly drafted and matches how you actually plan to raise money.
Convertible Loan Notes vs “Normal” Loans
A standard business loan is typically about repayment: principal + interest, with clear repayment dates and default consequences.
A convertible loan note still is a loan (legally speaking), but it includes extra mechanics that deal with:
- when it converts into shares,
- how many shares the investor receives, and
- what happens if conversion never occurs.
Convertible Notes vs Other Convertible Instruments
You might also hear about instruments like SAFEs (“simple agreements for future equity”). These aren’t the same as a convertible loan note because a SAFE usually isn’t structured as debt.
If you’re weighing up alternatives, it can help to compare a convertible note to a SAFE Note early, because the risk profile (and legal consequences) can be quite different for both founders and investors.
Why Do Startups Use Convertible Loan Notes In New Zealand?
Most founders don’t choose convertible loan notes because they love complexity - they choose them because it’s often the most practical way to get funded right now.
Here are some common reasons startups use convertible loan notes in New Zealand.
1. You Can Raise Money Before You’re Ready To Value The Company
Early-stage valuations can be awkward. If you haven’t launched, don’t have reliable revenue, or are still proving product-market fit, agreeing on a valuation can cause delays (or blow up the round).
A convertible note can “kick the valuation can down the road” until a later priced round when you’ve got more traction.
2. It Can Be Faster Than A Full Equity Round
A proper equity raise typically involves:
- negotiating valuation and shareholder rights,
- updating your cap table,
- issuing shares and handling Companies Office steps, and
- often putting governance documents in place (or updating them).
With a convertible note, you may be able to close funding faster - but it still needs a well-structured document, especially if you have multiple investors or plan to raise again soon.
3. It Can Reduce “Early Dilution” (But Only If You Understand The Trade-Off)
Founders often like convertible notes because they delay issuing shares today.
But remember: the dilution doesn’t disappear - it’s just postponed. If you don’t model what conversion could look like (discounts, caps, interest), you can end up with a nasty surprise later.
4. Investors Get Downside Protection
From an investor’s perspective, convertible loan notes can offer:
- creditor-style rights while the instrument remains outstanding as a loan (which can be relevant if things go wrong),
- potential interest, and
- the ability to convert into equity at a discount or subject to a valuation cap.
However, any “downside protection” depends heavily on the note terms and the company’s circumstances. For example, notes are often unsecured, and even secured arrangements can be complex to enforce in practice. A note is only as good as the company’s ability to repay (or raise again).
How Do Convertible Loan Notes Work In NZ (In Practical Terms)?
A convertible loan note usually follows a simple life cycle. Here’s what it typically looks like in practice.
Step 1: The Company Issues The Note
The startup (often a limited liability company) enters into a convertible loan note agreement with one or more investors. The investor advances money, and the company records it as a loan on its books.
If you’re still setting up your company foundations, it’s worth getting your governance right early - for example, having a workable Company Constitution can make future fundraising and share issues much smoother.
Step 2: The Note “Runs” Until A Trigger Event
During this period:
- interest may accrue (depending on the note),
- the startup uses the funds to grow, and
- both sides watch for a “conversion trigger”.
Common conversion triggers include:
- Qualified Financing: you raise a priced equity round above a certain amount.
- Exit Event: the company is sold or lists.
- Maturity Date: the note reaches the end of its term.
Step 3: Conversion (Or Repayment) Happens
If a trigger event occurs, the note usually converts into shares based on the agreed conversion formula (discount / valuation cap / other terms).
When conversion happens, you’ll typically also need the legal mechanics for issuing shares, updating registers, and recording shareholder rights properly. Exactly what’s required can vary depending on your constitution, any shareholders’ agreement, the share class being issued, and how the conversion is structured. This is where documents like a Share Subscription Agreement may become relevant, depending on how the conversion is structured and what your new investors require.
What If You Never Raise Again?
This is the uncomfortable question many startups avoid - but it’s exactly why you need to understand the maturity mechanics.
If the business doesn’t raise a priced round before maturity, the note will usually require one of the following outcomes:
- Repayment (principal + any interest),
- Conversion at maturity (often at a pre-agreed valuation or a mechanism set out in the note), or
- Extension (if both sides agree).
This is one of the biggest reasons you shouldn’t rely on generic templates. The “what if things don’t go to plan” clauses are where real disputes tend to start.
Key Terms To Negotiate In A Convertible Loan Note
Most convertible loan note negotiations come down to a handful of core terms. If you’re a founder, understanding these helps you protect your cap table. If you’re an investor, these terms shape your risk and upside.
Valuation Cap
A valuation cap sets the maximum company valuation used to calculate the noteholder’s conversion price, even if the next funding round values the company higher.
Why it matters:
- For investors, it rewards early risk.
- For founders, it can create more dilution than expected if the company grows quickly.
Discount Rate
A discount gives the noteholder a cheaper share price than new investors in the next round (e.g. 10–25% discount is common in many markets, but it always depends on the deal).
Founders should model the impact of both cap and discount - because many notes convert using whichever gives the investor the better outcome.
Interest
Some convertible notes accrue interest, and that interest may also convert into equity.
Even “low” interest can matter if:
- the note runs for a long time, or
- there are multiple notes stacking up before a priced round.
Maturity Date
The maturity date is when the loan becomes repayable (unless it converts earlier).
From a founder’s perspective, a maturity date can become a pressure point. If you can’t repay and can’t raise, you may have limited negotiating leverage.
Conversion Mechanics And “Qualified Financing” Thresholds
Notes often define what counts as a “qualified financing” (for example, an equity raise of at least $X). This avoids conversion on a small friends-and-family round that wasn’t meant to set the valuation.
If you’re putting your fundraising plan into writing, a Term Sheet can also be useful to align expectations before anyone starts paying legal fees.
Investor Protections (Events Of Default, Information Rights, Most-Favoured Nation)
Convertible loan notes may include:
- Events of default (e.g. insolvency, breach of key obligations).
- Information rights (e.g. regular reporting).
- Most-Favoured Nation (MFN) clauses if you later issue notes on better terms.
None of these are “bad” by default - but they need to be proportionate, and they need to match how your startup actually runs.
Security (Secured vs Unsecured Notes)
Some investors request security over company assets. If security is involved, you may need a General Security Agreement and to think carefully about priority and enforcement.
For founders, “secured” funding can feel like a win because it helps close the round - but it may restrict your ability to raise other finance later, and it can create real consequences if the business struggles.
Legal And Compliance Issues For Convertible Loan Notes In New Zealand
Convertible loan notes sit in the intersection of contract law, company law, and (sometimes) financial markets regulation. Getting the legal foundations right from day one is crucial - because mistakes here can be expensive to unwind later.
Here are the key legal areas to keep in mind in New Zealand.
Companies Act Issues (Share Issues And Director Duties)
If the note converts into shares, the company needs to be able to legally issue those shares and record them properly.
This often involves thinking about:
- whether the constitution restricts share issues,
- whether shareholder approvals are required,
- how pre-emptive rights (if any) apply, and
- the directors’ duties when approving the transaction.
If you already have multiple shareholders, a well-drafted Shareholders Agreement can help prevent misunderstandings about dilution, voting rights, and what happens when new investors come in.
Financial Markets Conduct Act Considerations
In New Zealand, fundraising can trigger obligations under the Financial Markets Conduct Act 2013 (FMCA), depending on the nature of the offer, who you’re offering to, and how the fundraising is marketed.
Many early-stage raises rely on exclusions (for example, offers to wholesale investors), but you should be cautious about assuming you’re exempt without checking. The way you present the deal, who you approach, and what you send to potential investors can all matter.
It’s also important to ensure your statements to investors are accurate - misleading or unsubstantiated claims can create risk under the Fair Trading Act 1986.
Contract Clarity (And Avoiding Disputes Later)
A convertible note is ultimately a contract. In New Zealand, contracts are governed broadly by the Contract and Commercial Law Act 2017 and common law principles.
Disputes often happen when the note is vague about:
- how conversion price is calculated,
- what counts as a qualifying round,
- what happens at maturity, and
- what happens if the company sells before conversion.
The goal is to avoid a situation where everyone thought they agreed, but the document doesn’t clearly support either side’s expectations.
Tax Treatment And Accounting
Convertible notes can have tax and accounting implications, including how interest is treated and how conversion is recorded.
Because tax outcomes depend heavily on the specifics of the arrangement (and the parties involved), it’s wise to get tailored advice from your accountant and legal team before you sign. (And to be clear: Sprintlaw can help with the legal structure and documentation, but you should speak to an accountant or tax adviser for tax advice.)
Due Diligence And “Clean” Fundraising
Investors (even friendly ones) often want comfort that the business is well run. Founders sometimes underestimate how much time a messy cap table or undocumented obligations can cost in the next round.
It’s worth doing a quick legal tidy-up before fundraising - and if you’re on the investor side, a Legal Due Diligence process can help you understand what you’re actually buying into.
A Quick Reality Check: Convertible Notes Still Need Proper Drafting
Convertible loan notes are sometimes marketed as “simple”, but the reality is that they’re only simple if:
- the conversion mechanics are clear,
- the terms match your fundraising strategy, and
- the company’s structure and shareholder arrangements support the deal.
If you want the funding to help your startup grow (instead of becoming a future dispute), it’s worth having a lawyer draft or review the note so it’s actually fit for your business - and so you can confirm any FMCA position based on your specific investor base and how the offer is made.
If you’re ready to explore options, a properly drafted Convertible Note can be a strong tool - as long as you understand the moving parts.
Key Takeaways
- Convertible loan notes used by New Zealand startups are loans that are designed to convert into shares later, usually at the next priced funding round.
- They can be a faster way to raise early capital when you’re not ready to set a valuation, but the dilution is often delayed rather than avoided.
- Core terms to negotiate include the valuation cap, discount rate, interest, maturity date, conversion triggers, and investor protections.
- If the note is secured, you should understand the practical and legal consequences (including how security may affect future fundraising).
- Convertible notes can raise legal issues under company law, contract law, and potentially the Financial Markets Conduct Act 2013 - and FMCA exclusions shouldn’t be assumed without advice that’s specific to your raise.
- Clear drafting is crucial, especially around “what happens if you don’t raise again” and “what happens if there’s an exit before conversion”.
If you’d like help drafting or reviewing a convertible loan note (or planning your next capital raise), you can reach us at 0800 002 184 or team@sprintlaw.co.nz for a free, no-obligations chat.
