Alternative Structures to Fund Investment Deals
In these uncertain times, valuations have also become uncertain. We consider below some of the innovative and alternative investment structures which allow for a quick injection of cash when valuations are uncertain.
Advanced Subscription Agreement (“ASA”)
An ASA is a short agreement whereby the investor agrees today to make his/her investment upon closing of the next formal equity fundraising round. The valuation of the company is only finally determined at that next equity fundraising round (although a cap and ceiling are included in the ASA to ensure both investor and company are protected from any wild swing in valuation).
Once the equity round takes places, the shares issued in connection with the ASA are typically issued at a discount of between 10-30% in return for taking the early risk. The ASA will also include a longstop date (no later than 6 months to maintain SEIS/EIS status) so that if a fundraising does not complete by that date, the shares are nevertheless issued to the investor at the ball-park pre-determined valuation and applying the agreed discount.
Investors may wish to tranche their investment over a set period, and will invest at different valuations depending on the company meeting certain milestones and KPIs. Given the current Covid19 climate, this might be a two-edge sword for the company, because projections might be based on the status-quo, and those agreed milestones may not be achievable meaning the company may be forced to accept later tranches at a lower valuation as a result.
Investors may be willing to pay for the option to invest at a future point in time. A call option may be appropriate as it gives the investor the opportunity to “wait and see”. Alternatively the company may want a “put option” to give itself certainty that it can oblige the investor to make the investment at a future point in time (ie: longstop date).
Secured convertible loan notes
A convertible loan note (“CLN”) is often used as a short term bridging loan prior to raising funds under a first round of a venture capital investment, but equally has its used where valuation is not easily determined. The loan note holder (investor) provides finance in the form of a loan that typically bears interest at an agreed rate, until such time as the loan converts into equity or the loan note holder decides to redeem it. The price at which the loan converts into equity is usually agreed in the CLN and the conversion itself can be upon fixed events, such as a fund raising or a change of control or company sale. In effect, a CLN works as a call option for the loan note holder over shares in the company at a fixed price.
Interest is typically payable at a comparatively high rate such as between 8% and 10% per annum. CLNs can also be secured via debenture lowering risk for the loan note holder, particularly if the security can be first ranking within the company’s existing debt obligations. Both these aspects are an advantage for the company as it can use CLNs as a vehicle to more easily and quickly attract investor funds.