Convertible Debt is becoming popular in Poland and is most often used at a company’s early stage of development, in order to avoid the trouble of diluting the founders by establishing an unfavourable valuation for entry of the first investors.

Convertible Debt investment in early-stage development companies originates in the USA, however due to differences in the corporate legal system between Poland and the US, it looks much different in Poland and is not linked to the issue of bonds. In the US, this mechanism was established in the mid-19th century and was used by early speculators such as Jacob Little and Daniel Drew to counter market cornering (i.e. having the greatest market share in a particular industry without having a monopoly).


On the one hand, it is difficult to assess the real value of a company at the time of embarking on a new project. On the other, it is necessary to know a company’s valuation to obtain funding. This is a tricky situation, as it is practically impossible to put a value on a start-up (the company is only just getting started, usually it has no value at the beginning – no assets, no fixed income, no loyal customers.) Valuing such an entity is therefore arbitrary, different metrics are used, but the dilemma still remains, although typically it tends to be solved by the stronger party (a solution is imposed on the company) – the finance provider. 

In practice, unless the early-stage entry condition arrangements are well planned, for example thought the use of a convertible loan, the second and third rounds become a challenge for larger investors (venture capital, private equity, growth capital…) Before investing they examine the level of involvement of the founders in the business as expressed by the percentage of shares in the company and their decision-making power – if it is too low, then it means the founders have too little incentive to achieve the company’s goals. Each fund will be watching closely those investors who have a stake of more than 5% in the company and are unlikely to enter if an existing passive investor, for example an angel investor (who is not involved in running the company on a day-to-day basis) holds e.g. 30-40%. Therefore the question is: How to resolve this dilemma?


One way to solve this problem is to use a convertible debt, an instrument that has been widely used in the US for 150 years. It was created to allow start-ups without valuation to raise capital quickly and less expensively than through the sale of shares. 

Typically this type of loan is converted into shares during the follow-up round, and usually no longer than within 2 years of the company’s forward valuation using a preferential discount – usually 15-35%. This means that the investor investing in the company does not know the valuation at which they invest – this will be determined in the future. The investment can be contractually secured with a minimum valuation, and with positive company growth, the investor’s input may ultimately be at a much higher valuation than the minimum expected [which is the goal i.e. growth as planned]. By definition, a minimum valuation gives the investor, a greater influence on the company’s activities and, at the time of conversion, the possibility of more interference in its activities. If the company achieves rapid growth in value, the investor will have a smaller share, but also less investment risk due to the strength of the company. Ultimately, this share will also have a higher value. 

BEAR IN MIND THAT IN CONVERTIBLE NOTE AGREEMENTS, you may encounter provisions imposing a maximum valuation of the conversion of a loan into shares [CAP] – this is a dangerous condition which can stop a dynamically developing company in its tracks. For example, a CAP has been imposed on a company – maximum conversion valuation of say 30 million when the actual valuation at the time of conversion is 60 million, this means that the effective discount for the investor is 50%. It is much more advantageous to determine the investment premium for an investor coming in with a convertible loan through the level of discount from the forward valuation than the max CAP level, this is to avoid too high a percentage of the company’s share going to another passive investor. Care should be taken to ensure that, until a strategic investor enters or prepares for an exit, those who are actively involved in the growth of the company have a majority in it, this is for the reason previously mentioned, which is that their level of motivation for business growth should in that situation remain reasonably high. 


Panasiuk & Partners have had the opportunity to support the founders of a fintech start-up, which has been dynamically acquiring customer interest but is yet to reach the parameters allowing it to establish a fair valuation. P&P were asked to evaluate an investor’s proposed CONVERTIBLE NOTE.

The proposal of the investor who had already invested capital in the company required the company to recapitalise promptly. The investor, a conscious angel investor (which is still extremely rare), who knew the consequences of direct recapitalisation with acquisition of shares, offered a convertible loan.

Three problems needed to be addressed: 

  • No possibility to determine the real value of the company there and then. The founders applied a much higher valuation than the investor. They were looking at customer growth indicators juxtaposed with their much larger competitors. The company’s goal at that stage was to build awareness and obtain high customer ratings, as well generating a market push, which is why it used a strategy of acquiring new customers through aggressive product campaigns. The true picture was that of a start-up scaling its’ customer base and brand recognition without creating significant revenue. There were therefore no hard indicators allowing to carry out a proper valuation, and to retain a positive proportion of shareholder structure vs. capital raised vs. number of transferred shares.
  • Dilution. Entry with the required capital after a valuation that the investor could accept (at this stage) would have diluted the founders, therefore those who pushed the business forward. This raised the risk a drop in the founders motivation to continue to create value and of the passive investor holding too large a proportion of shares. As a result of this, in consequent funding rounds, there would be a risk of a passive investor acquiring a majority stake in the company (in the article we have described the consequences of such a move too early in the lifecycle of the business).
  • The problem with CAPs. The investor who came in with the loan wanted to define the conditions for determining the future valuation, a minimum value as well as a maximum CAP for the future conversion. The owners could not assess the proposed mechanisms and were afraid to lose the majority of their business in the future.

We developed an agreement specifying that the planned future valuation would require verification by reputable valuers (2 valuations) selected by the company. We established a minimum conversion valuation as well as the repayment terms of the loan without using conversion (company option). A healthy discount had also been added for the investor based on the future valuation on the date of the loan-to-equity conversion. Once this structure was put in place, the founders could safely carry on growing their business knowing that by building its value they would not lose the chance to attract more investors, and most importantly they would not lose control over their company.


What does a convertible loan instrument do? Firstly, this approach removes the need for the frequent and difficult discussions about valuation of an early-stage business. Founders usually chose convertible loans because they believe their company will gain in value. This allows them to limit capital dilution.

Secondly, founders and investors, by looking ahead and planning the next funding rounds, eliminate the barrier for future investors, who would not normally be interested in going into a company in which a passive investor holds a significant percentage of shares, whilst not actively contributing to the execution of the company’s plans.

Thirdly, this gives the investor time (approx. 2 years) to get to know the company, better evaluate it and value it. 

Investors like this solution too because the company pays interest on the loan until conversion. It is also possible to add a loan repayment mechanism instead of converting it to shares. This can provide investors with security in the event of the company defaults. The loan protects investors’ capital in the event of a fall in value and allows them to participate in profits if the company succeeds.

Here’s a quick summary for convertible debt:


  • Founders use capital without immediately diluting their shares.
  • Deferral of valuation – allows to obtain a more realistic understanding of the value of the concept and subsequently the associated scale of the transferred shares in exchange for a certain amount of capital.
  • Investors receive fixed-rate interest payments. With the view of converting a loan into shares and taking advantage of a future increase in the value of the company.
  • Companies may pay lower interest on their debt compared to non-convertible loans. 
  • Investors are provided with some hedge against the risk of default.


  • Future valuation – Most often the value at which the next investor enters is inferred, but it may also be necessary to deal with a conversion backdated to the date of the contract and then an external valuation may be necessary. The risk here is to ensure it is set at a level that is good for the business: taking into account the specificity of the industry, but also the internal potential. If the business operates in the local market (before a wider expansion) there is no real opportunity to compare it to the global market.
  • The Company/Founders take on the risk of having to repay a loan, although this risk can also be managed during negotiations.

We anticipate that the use of convertible loans will become more significant in Poland and will be particularly valuable at the ‘friends and family’ stage of fundraising where all parties wish to postpone determining the value. This is a good structure when the remuneration for the loan is fair and balanced and when the trade-off between debt and capital is beneficial to both the borrower and the lender.