Introducing the Convertible Note and Advanced Subscription Agreement
When Seedsummit started back in 2009 the investor landscape was fairly fragmented and there was very little in the way of standardised documentation. Since then, with the help of some fantastic advisors and the investor community, we’re incredibly proud of having released multiple documents and rolled out jurisdiction specific term sheets in six different countries across Europe to date.
But enough with the history lesson, we’re not one to rest on our laurels and that’s why we’re delighted to team up with 500 Startups and JAG Shaw Baker in launching a new set of documents; the Convertible Note and Advanced Subscription Agreement (ASA). In addition to the term sheets we’ve previously released, these documents provide an alternative way to structure a financing round.
Debt vs. Equity
Although there are certain specific differences, both the Convertible Note and ASA can broadly be defined as convertible debt instruments.
In order to set the scene, we wanted to quickly touch upon some of the things to consider when deciding between a convertible debt structured round (using a Convertible Note) Convertible Equity Structured Round (using ASA, Simple Agreement for Future Equity round (SAFE) etc.) and an equity priced round (using a term sheet, subscription letter or agreement, amended articles of association etc.).
A lot has been written on debt vs. equity priced rounds, so we’re not going to dive into the pros and cons of each in detail in this post (see here for a more detailed post). However, broadly speaking the following are considerations that should be front of mind when deciding whether to structure as debt / pre-equity or equity:
- Valuation – by going down the convertible note / advanced subscription route the explicit question of company valuation is delayed until a future point in time (i.e. the next equity financing round). However, care must be taken should there be a valuation cap (see the guidance notes in the convertible note / ASA for a more detailed description of how this provision works) because investors may hone in on this as a quasi-valuation.
- Time – it is often quicker to do a form of convertible ASA than an equity priced round. This is mainly because there are fewer documents to draft and negotiate compared with an equity priced round. This is an important consideration because it can have a material difference on when the investment money hits the account.
- Cost – although early stage equity documents can be drafted for minimal cost it is still usually less expensive to use a standard form of convertible or ASA as there are less documents involved and fewer terms to include. Word of caution here, we would never recommend founders optimise wholly around cost above all else – good legal counsel can and will save you money in the long run.
- Cap table issues – it may be necessary to clean up the cap table and equity structure of the company before issuing any more shares to new investors. This might require a share split (to create more shares and therefore allow for the ability to grant more precise equity allocations in the future) or some form of re-allocation. Doing a convertible round will give the company time to get this stuff sorted prior to a future equity round.
- Investor preference – investors may have a specific preference for one structure over the other because they are more familiar with it or it is important because of their specific circumstances (i.e. tax treatment).
By releasing these documents to the community we’re not saying that one way to structure a round is better than the other. We just want to try to arm founders with as much information and optionality so they are best placed to make the choice that’s right for their given situation.
Convertible Note or Advanced Subscription Agreement?
The main difference between the two documents is that the ASA has no interest rate and no requirement to repay the amount within a set period of time. The ASA therefore provides a way to obtain certain benefits of going with a convertible debt structure without some of the confines associated with a typical convertible note.
A further consideration when choosing between the two is tax. Investors will not be able to be eligible for SEIS/EIS tax treatment if the Convertible Note document is used. Whilst specific tax advice should always be obtained, by using the Advanced Subscription Agreement it may be possible for investors to be eligible to obtain SEIS/EIS tax relief.
Finally, certain investors may prefer the convertible note format over the ASA because it is more familiar. Convertible notes have been around in the market for longer and have therefore been more widely used.
How to use the documents
As you’ll see, we’ve tried to add as much guidance as possible throughout the documents. Items between brackets are optional and are there to provide transparency. The final form that the document will take will often depend on the relative negotiation position of the parties.
The terms in both documents have been validated by some of the most active seed investors and include all major commonly used terms found in documents of this type. While many of the terms that are typically found within financing rounds, the eventual users of these documents ultimately decide which terms to include.
As with other Seedsummit documents, these are meant to serve a common goal for the community: making seed funding easier to access, better to understand, and fair for all parties. We are looking forward to them being used, adapted, and spread. Likewise, please keep us up to date on what you think about them, when you use them and how they helped you take your companies forward.