A loan note is a written promise to repay money on agreed terms. That is the whole of it. What makes one loan note sound and another one dangerous is everything written around that promise, and most investors read the interest rate before they read any of it.
This is a plain explanation of how loan notes work, what the terms mean, and what to check before you sign one.
What a loan note actually is
A company needs capital. Rather than sell shares, it borrows. The loan note is the instrument recording that loan: how much, for how long, at what return, and what happens if the company cannot pay.
The investor is a creditor, not an owner. They have no vote, no share of the upside if the business triples, and no say in how it is run. In exchange they sit ahead of shareholders if things go wrong, and they know what they are owed and when.
That trade is the point. Equity investors buy possibility. Loan note holders buy a defined claim.
The terms that decide whether it is sound
Security
A secured note is backed by an identifiable asset. An unsecured note is backed by nothing but the company’s ability to pay.
The word "secured" on its own tells you very little. Secured against what, valued by whom, and when? Who holds that security, and on whose behalf? Is there a trustee, or is the company effectively holding it for itself? If there is existing debt, where does this note rank against it?
Often the security is perfectly real and nobody wrote the chain down properly. Ask for the chain: from your money, to the asset, with each link named.
Ranking
If the company fails, who gets paid first? Senior debt sits above subordinated debt, which sits above shareholders. A first charge over an asset ranks ahead of a second charge over the same asset.
Two notes advertising the same return can occupy completely different positions in that queue. The queue is the risk.
Term and repayment
When does the capital come back, and from where? A note repaid from trading profits depends on the business performing. One repaid from the sale of a specific asset depends on that sale completing at a price. One repaid by refinancing depends on somebody else lending at the right moment.
Those are three different risks wearing the same label. Ask which one you are taking.
Default provisions
What counts as a default, and what can you actually do about it? Enforcement on paper and enforcement in practice are rarely the same thing. If the security is a property in another jurisdiction, recovering it is a project, not a remedy.
Convertible loan notes
A convertible note starts as debt and can turn into equity, usually at a later funding round and often at a discount to that round’s price.
Its appeal is that it defers the valuation argument. The company does not have to agree what it is worth today; the next round settles it. For young businesses without a defensible valuation that is genuinely useful.
The thing to watch is what happens if the next round never comes. Read the maturity terms before the conversion terms.
Where loan notes suit a business
They work where the funding need is specific and time-boxed. Bridging a development to completion. Funding a purchase order. Carrying a business to a milestone that will re-rate it.
They suit issuers who can service a fixed payment and would rather not sell equity to do it. They do not suit businesses with no revenue and no asset, whatever the paperwork says, because a coupon falls due whether or not the quarter went well.
The register
One practical point that costs companies more than any other. Loan notes are flexible, which means they accumulate. Different investors, different dates, different terms, issued over two or three years by people who have since left.
The next investor will ask for the register in diligence. If it cannot be produced cleanly, that is what the conversation becomes about. Keep one register, keep it current, and reconcile it before anyone asks.
Related reading
- Bonds or loan notes: which suits your raise?
- Convertible loan notes explained
- What investors look for in a loan note
Mark Johnson is a Director of BDM Wealth Management, which introduces capital raising opportunities across bonds, loan notes, IPOs and SEIS/EIS. To discuss a raise, get in touch.
BDM Wealth Management is an introduction business and is not regulated. This article is general information, not financial, tax or legal advice, and does not constitute an offer or invitation to invest. Capital is at risk and you may get back less than you invest. For high-net-worth and sophisticated investors only. Take independent professional advice before making any investment decision.