Over the last 12 months, our venture capital team has seen increasing use of 'advance subscription' arrangements being used for making investments in early stage companies, both in early seed rounds and later stage Series A.
Most equity raises consist of what's known as a 'priced round', i.e. shares are issued at an agreed price per share at the point that the investment is made. Alternatively, the company or the investors may use a convertible loan note, under which the investment is initially made by way of debt, which later converts to shares when a future event takes place (for example, the next financing round or an exit).
The conversion price is usually set by that future event, for example a discount of 15-25% on the share price associated with that transaction. This has the advantage of postponing the difficult and contentious question of valuation. It also provides some downside protection for the investor, as the investment remains a debt that may become repayable, and also ranks ahead of shareholders in the event of an insolvency.
Whilst convertibles are used extensively in the US, they are not that common in the UK, largely because they don't allow the investor to claim Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS) relief on the investment. The UK government considered extending these valuable reliefs to cover convertibles around a year ago, but decided against it. Read our article on raising finance through convertible loan notes.
The advance subscription agreement seeks to address this. If structured correctly, it enables the investor to subscribe for shares, with funds being provided to the company at the date of the agreement, but with that investment converting to shares upon a future event (e.g. the next financing round).
However, the investor has no right to demand this money back. The investment has to convert to share capital at some point, which in the absence of another equity raise or exit, will be a specified date or an insolvency. This would mean that the investment no longer has the downside protection of a convertible loan, and may therefore be eligible for SEIS/EIS relief.
These arrangements can involve a variety of terms, although the core features to look out for are:
In our experience many early stage investors value the ability to agree specific terms governing their relationship with their investee company through a priced round. In particular, a detailed warranty and disclosure process appeals, though of course these advantages could be delivered through a bespoke advanced subscription arrangement if needed. It is certainly an interesting tool for both investors and fast growing companies to be aware of.
If you'd like more information about any aspects of advance subscription agreements, please get in touch.
This publication is intended for general guidance and represents our understanding of the relevant law and practice as at October 2016. Specific advice should be sought for specific cases. For more information see our terms & conditions.