This article was last updated 0 months ago and may not represent current law.
A loan note is a document issued by a company (or other borrower) which records a debt and the terms on which it will be repaid. Loan notes can be secured or unsecured, they usually carry interest, and they are repayable on an agreed date or by instalments.
Loan notes are often used in business sales, where part of the price is being paid later and the seller takes loan notes for the deferred amount.
In this article I’ll explain what loan notes are, how they work, and answer some of the most common questions about them.
Is a loan note the same as a loan?
No, a loan note is not the same as a loan, although it is similar.With a loan agreement, a lender agrees to advance money to a borrower and the agreement sets out the terms. A loan note is issued by the borrower as evidence of what it owes to whoever holds the note, and where there are several noteholders they usually all hold notes on the same terms, set out in a single loan note instrument.
Some of the key differences between loan notes and loans include:
- Who holds them: A loan is usually between one lender and one borrower. Loan notes can be issued to several people at once (for example, all of the sellers of a company) in whatever amounts are agreed.
- Transfer: Loan notes can be made transferable, so the holder can pass them to someone else if the terms allow it, although in practice there is rarely a ready buyer for loan notes in a private company.
- Security: Loan notes can be secured or unsecured, in the same way as a loan. Secured loan notes are backed by security such as a charge over property or over the company's assets, and unsecured loan notes are not.
- Interest: The interest rate on a loan note is typically fixed, although it can be variable. The same goes for a loan.
Are loan notes the same as bonds?
Loan notes are similar to bonds, but they typically have a shorter repayment period and are much harder to sell. Bonds are typically longer-term, often with a maturity period of 10 years or more, and they are usually issued by larger companies and governments and traded on a market, which makes them easier to sell. Both can be secured or unsecured, and both can have a fixed or variable interest rate.In general, loan notes suit private companies that need to raise money for a shorter period or, as in a business sale, need time to pay. Bonds are for much larger borrowers raising money over the long term.
Who issues a loan note?
The issuer of a loan note is the borrower, and it is responsible for repaying the principal amount of the loan note as well as the interest.For the businesses I act for, the issuer is almost always a company. It might be issuing loan notes to investors to raise money for the business, or it might be the buyer in a business sale issuing loan notes to the sellers for the part of the price it is paying later. Governments, banks and other organisations issue debt of this kind too, but that is a different world from owner-managed companies.
The loan note instrument will set out the amount of the notes, the interest rate, when and how they are to be repaid and what happens if the issuer doesn’t pay. If you’re being offered loan notes, read it carefully before you agree to take them.
What are the different types of loan notes?
There are a few different types of loan notes, each with its own features.- Secured loan notes: Secured loan notes are backed by security, such as a charge over property or equipment. This means that if the issuer of the loan note defaults on its payments, the noteholder can enforce the security to get its money back.
- Unsecured loan notes: Unsecured loan notes are not backed by security. If the issuer of the loan note defaults, the noteholder has no recourse other than to sue the issuer, and it will rank alongside the issuer's other unsecured creditors if the issuer is insolvent.
- Convertible loan notes: Convertible loan notes can be converted into shares in the company at an agreed price or on an agreed event, such as the next funding round. This gives investors the option of ending up with shares in the company, and not just getting their money back with interest.
- Floating-rate loan notes: Floating-rate loan notes have an interest rate that moves in line with a benchmark, such as the Bank of England base rate, so the interest payable will change over time. Older loan notes often refer to LIBOR, which no longer exists (the last sterling LIBOR setting was published on 28 March 2024), so if you hold or have issued notes like that, check what the document says should happen now.
- Zero-coupon loan notes: Zero-coupon loan notes do not pay interest along the way. Instead they are issued at a discount, or the interest rolls up, and the noteholder receives everything in one payment at maturity.
Either way, you should make sure that you understand the terms of the loan note and that you’ve thought about whether the issuer will actually be able to pay.
What are the disadvantages of a loan note?
There are some potential disadvantages to be aware of, namely:- Lack of liquidity: Loan notes can be difficult to sell if you need to cash out before maturity. There isn't really a market for loan notes in private companies, so you should assume you'll be holding them until they are repaid.
- Risk of default: The issuer of a loan note could default on its payments, which would mean that you don't get all of your money back. This is a risk with any type of debt, but it is particularly important with unsecured loan notes because there is no security to fall back on.
- Returns: The interest rate on a loan note is whatever has been agreed, and it doesn't always reflect the risk the noteholder is taking. In a business sale the rate on the sellers' loan notes is often modest, and sometimes there is no interest at all.
- Complexity: Loan notes can be complicated documents, and it is important to understand the terms before you take them. This includes the interest rate, the repayment dates, what counts as a default and what you can do about it.
Loan Notes in a Business Sale
As mentioned, loan notes are used regularly in business sales. Consideration loan notes or vendor loan notes, as they are sometimes known, are created where part of the overall purchase price (or consideration) is being paid at some later date.Vendor loan notes are typically issued by the buyer of company shares to the seller (or sellers) of those shares as consideration for the share sale. The loan notes represent the part of the purchase price that the seller has agreed to defer.
For a seller, a loan note is a promise to pay and is only as good as the buyer who gives it, so you’ll want to think about security or a guarantee and about what happens if a payment is missed. I’ve written more about that in my articles on deferred payments in business sales and on what sellers and buyers need to know about deferred payments.
Sellers who receive consideration loan notes may be able to avoid crystallising a taxable gain on completion and “roll it over” into the loan notes. Whether that deferral is to your advantage may depend on whether you’re entitled to claim Business Asset Disposal Relief (which used to be called entrepreneurs’ relief), and on what the rate is when the gain is eventually taxed. The rate of that relief has gone up to 18% for disposals from 6 April 2026, having been 10% when I first wrote this article. I don’t give tax advice, so take advice from your accountant on how the loan notes should be structured before the deal is agreed.
If you need to issue loan notes, are being offered loan notes as part of a share sale, or already hold some and want to understand where you stand, do get in touch.
Written by Steven Mather, a business solicitor acting on company sales and purchases. This is general information about the law, not legal advice on your situation. Law correct as at .
