Loan note: the instrument a company issues, not the IOU it signs

A loan note is a debt instrument issued by a company: the company creates notes under a loan note instrument, subscribers pay for them, and each holder ends up with a certificate and an entry in the register of noteholders. It is a security, not a private IOU, and that distinction drives everything about how it is documented.

The confusion with a promissory note is common and worth clearing up early. A promissory note runs between two named parties. A loan note is created by a single document executed by the issuer, can be held by many people, and is normally transferable — which is why it turns up in acquisition consideration, in bridge financing and in crowdfunded lending.

What a loan note instrument sets out

• The maximum principal amount that may be issued under the instrument, and the denomination of each note.
• Interest: rate, payment dates, and whether it rolls up rather than being paid in cash.
• Redemption: the maturity date, any early redemption rights, and what happens on a sale of the company.
• Ranking: whether the notes are secured, unsecured, or subordinated to bank debt.
• Transfer provisions and the mechanics for updating the register.
• Events of default and what the noteholders may do about them.
• How the terms may be varied — usually a defined majority of holders.

Because the instrument binds every holder, including people who buy notes later and never negotiated anything, its terms have to stand on their own. There is no side correspondence to fall back on: a holder who bought a note on the strength of the instrument is entitled to read it as it stands.

The register is not paperwork

Title to a loan note passes by entry in the register, not by handing over the certificate. A register that has not been updated after a transfer means the company is paying interest to the wrong person and the actual holder cannot enforce. This is the same category of failure as an out-of-date statutory book — invisible until a transaction requires it, and expensive at exactly that moment.

Keep the executed instrument, the certificates issued and the register in one place, with the version history intact. In a sale process the buyer’s counsel will reconcile all three, and any gap between them becomes a disclosure item or a price adjustment.

Where loan notes are used

1. Deferred consideration in an acquisition: the seller takes notes instead of cash, often with security or a guarantee.
2. Bridge financing before an equity round, sometimes convertible into shares on defined events.
3. Investor lending into a company alongside a shareholders agreement, so that the debt and equity terms interlock.
4. Retail or crowdfunded lending, where many small holders need identical terms and a transferable instrument.

Drafting a loan note instrument is a document-control problem as much as a legal one: one instrument, many certificates, a register that has to track them, and amendments that must be applied to the version everyone actually holds. Ettex Docs keeps the instrument, its schedules and the amendment history in one versioned place, so the document circulated to noteholders is the document the company is bound by.

Asset-based lending sizes the facility differently. A borrowing base certificate reports eligible receivables and stock each period, and the lender advances a percentage of that rather than a fixed sum.

Conversion and subordination

Two terms cause most later disputes. Conversion — the right or obligation to turn notes into shares — has to specify the trigger, the price or discount, and what happens if the round is smaller than expected. Subordination has to say what is subordinated to what, whether payment is blocked entirely or only on default, and who can waive it.

Both are cheap to write carefully at issue and expensive to argue about later, usually at the moment the company can least afford the delay.