When launching a startup, securing funding is a top priority. Two popular methods to raise funds are the Advanced Subscription Agreement (ASA) and Convertible Loan Notes (CLN). Both options help early-stage companies obtain equity funding before determining a full company valuation. But which one suits your needs? Let's explore the differences to help you decide.
What Is an Advanced Subscription Agreement (ASA)?
An ASA is a contract where an investor provides money now in exchange for shares issued later. The shares are issued during a future funding event, known as a qualifying funding round. This could be when the company raises more capital down the line.
Key Features of ASA:
Equity Investment: Funds are treated as equity, not debt.
Converted into Shares: The investment will convert into shares at a future date.
No Interest Accrual: Unlike loans, ASAs don't accrue interest.
SEIS/EIS Eligibility: Often qualify for the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS), offering tax benefits to equity investors.
No Longstop Date: Typically, there's no fixed date by which the shares must be issued.
What Is a Convertible Loan Note (CLN)?
A CLN is a loan that can convert into shares in the future. It's a debt instrument that becomes equity under certain conditions, like a future funding round or on a specific longstop date.
Key Features of CLN:
Debt Instrument: Initially recorded as a loan on the company's balance sheet.
Interest Accrual: The loan may accrue interest over time.
Conversion into Equity: The loan is converted into equity during a future event.
Repayment Option: If conversion doesn't occur, the investor may get their money back, sometimes with interest.
Longstop Date: A set date by which the loan must be repaid or converted.
Comparing ASA and CLN
SEIS/EIS Eligibility
ASA: Often qualifies for SEIS and EIS, making it attractive for investors seeking tax relief.
CLN: Generally doesn't qualify because it's a loan, not an equity investment.
Risk and Security
ASA: Higher risk for investors since there's no guarantee of repayment.
CLN: Lower risk for investors due to the loan structure and potential for interest.
Impact on the Company
ASA: Doesn't add debt to the company's balance sheet.
CLN: Adds debt, which could affect financial statements and borrowing capacity.
Pre-emption Rights
ASA: May avoid triggering pre-emption rights because shares are issued later.
CLN: Conversion might trigger pre-emption rights, impacting existing shareholders.
Key Terms to Understand
Valuation Cap: The maximum company valuation at which the investment will convert into shares. Protects early investors if the company's value increases significantly.
Price per Share: The cost of each share when they're eventually issued.
Qualifying Funding: A future event where the company raises more money, triggering the conversion of investments into shares.
Convertible Debt: Another term for instruments like CLNs that start as loans and can become equity.
Practical Examples
Scenario 1: Seeking Tax-Incentivized Investors
If you're targeting investors who want tax relief through SEIS or EIS, an ASA is likely the better choice. For example, an early-stage tech startup might use an ASA to attract angel investors looking for tax benefits, making the investment more appealing.
Scenario 2: Investors Want Security
If your investors are cautious and prefer a lower-risk option with potential interest, a CLN might be more appropriate. A biotech startup, for instance, might offer CLNs to institutional investors who prefer the security of a loan with the upside of equity conversion.
Scenario 3: Uncertain Valuation
When a company is unsure about its current valuation but needs immediate funding, both ASAs and CLNs can be useful. They allow the company to defer valuation discussions until a later funding round when the company's worth is clearer.
How to Choose Between ASA and CLN
Consider Your Investors' Preferences
Tax Benefits: If investors value tax incentives, ASAs are more suitable due to SEIS/EIS eligibility.
Security: If investors are risk-averse and prefer the option of repayment, CLNs may be better.
Assess Your Company's Financial Position
Balance Sheet Impact: If you want to avoid debt, an ASA keeps your balance sheet cleaner.
Interest Obligations: CLNs may accrue interest, increasing your financial commitments.
Think About Future Funding Rounds
Dilution: Consider how issuing new shares will affect ownership percentages.
Pre-emption Rights: Be mindful of existing shareholders' rights when new shares are issued.
Legal and Regulatory Considerations
Compliance: Ensure that your chosen method complies with financial regulations.
Documentation: Proper legal agreements are crucial to protect both the company and investors.
Tips for a Successful Funding Round
Clear Communication
Be transparent with your investors about the terms and conditions. Make sure they understand how and when their investment will convert into equity.
Professional Advice
Consult with legal and financial advisors experienced in startup financing. They can help draft agreements and ensure compliance with all regulations.
Plan Ahead
Consider how this funding round fits into your long-term business plan. Think about how it will impact future fundraising efforts and company growth.
Frequently Asked Questions
Can I Use Both ASAs and CLNs?
While it's possible, mixing both instruments can complicate your capital structure. It's generally advisable to stick with one to keep things straightforward.
What Happens If a Qualifying Funding Event Doesn't Occur?
ASA: Since there's often no longstop date, funds may remain unconverted until an event occurs.
CLN: The loan may need to be repaid by the longstop date if conversion hasn't happened.
Are There Alternatives?
Yes, alternatives include:
Equity Investment: Selling shares at an agreed valuation.
SAFE Notes: Similar to ASAs but more commonly used in the U.S.
Revenue-Based Financing: Investors receive a percentage of future revenues until a certain amount is repaid.
Both ASAs and CLNs are valuable tools for raising finance in the early stages of a company. An ASA is suitable if you want to offer tax incentives and avoid debt. A CLN is better if investors seek more security and you're willing to accept debt.
Before making a decision, consult legal and financial advisors to ensure you choose the best option for your company's growth and compliance with regulations. Understanding these financing methods will help set your startup on the path to success.
