In the dynamic world of startups and entrepreneurship, securing funding is a crucial step towards success. One of the most common ways for startups to raise capital is through funding rounds. These involve investors purchasing shares in the company. However, as the startup landscape has evolved, so have the methods of funding. In recent years, advanced subscription agreements (ASAs) have emerged as an innovative alternative or addition to traditional funding rounds. In this article, we will explore the relationship between Advanced Subscription Agreements (ASAs) and funding rounds.
Understanding Funding Rounds
Before we dive into Advanced Subscription Agreements, it is important to have a basic understanding of traditional funding rounds. A funding round is a process in which a company raises capital from investors by selling newly issued shares (sometimes called ‘equity’) to them. These rounds typically occur in the early stages of a company’s growth, with the goal of providing the necessary funds to scale and expand the business. It’s a critical phase in a startup’s life-cycle, often determining the trajectory of the company’s future growth and success.
There are typically three main types of funding rounds: seed, series, and late-stage. Seed rounds are the initial round of funding for a startup, usually involving smaller investments from angel investors or venture capitalists. Series rounds, such as Series A, B, and C, occur as the company grows and requires more capital to continue expanding. Late-stage rounds are typically the final round of funding before a company goes public or is acquired. Each of these rounds plays a unique role in a company’s development, providing the necessary resources at different stages of growth.
The Rise of Advanced Subscription Agreements
While traditional funding rounds have been the go-to method for startups to raise capital, ASAs have gained popularity in recent years. ASAs are a type of investment agreement that allows companies to raise capital without going through a traditional funding round. Instead, investors provide funds in exchange for the right to purchase equity in the company at a later date as part of a funding round. This innovative approach to funding has been gaining traction due to its flexibility and efficiency.
Here’s a step-by-step explanation of how Advanced Subscription Agreements typically work:
- Agreement: The company and the investor enter into an Advanced Subscription Agreement. This agreement outlines the terms and conditions of the investment, including the amount to be invested by the investor, the mechanism for determining the price at which the shares will be purchased, and the future date at which the shares will be issued.
- Capital Injection: The investor provides the agreed amount of investment to the company. This injection of funds allows the company to finance its operations and growth.
- Equity Conversion: At a later date, typically during a future funding round or a predetermined trigger event, the investment converts into shares. The conversion is based on the terms agreed upon in the Advanced Subscription Agreement.
- Share Issuance: Once the investment converts into shares, the company issues the shares to the investor. The investor becomes a shareholder and gains ownership rights in the company that are attached to the class of shares acquired.
It’s important to note that the specific details of Advanced Subscription Agreements can vary depending on the terms agreed upon by the company and the investor. This flexibility is one of the advantages of Advanced Subscription Agreements, as it allows companies to tailor the agreements to their specific needs and circumstances.
Pros and Cons of Advanced Subscription Agreements for the Company
While Advanced Subscription Agreements offer many benefits, they also have their drawbacks. Understanding these advantages and disadvantages can help startups make informed decisions about their funding strategy.
Pros:
EIS and SEIS Compliant: See below in relation to Investor Appeal.
Flexibility: Advanced Subscription Agreements do not require a set valuation of the company (and therefore the shares to be issued in return for investment) at the time of investment, allowing for a more fluid and adaptable investment process. This flexibility can be particularly beneficial for early-stage startups that may not have a clear valuation.
Efficiency: Advanced Subscription Agreements can be completed quickly, allowing companies to fund growth and product development. This can help startups maintain momentum and avoid the potential delays in receiving investment that are associated with traditional funding rounds.
Lower costs: Advanced Subscription Agreements do not require the same legal and administrative fees as traditional funding rounds, making them, in the short term, a more cost-effective option. This can be a significant advantage for startups looking to maximise their capital efficiency.
Cons:
Dilution of ownership: Advanced Subscription Agreements, like the shares that are issued in accordance with them, involve the company issuing more shares, which usually leads to dilution of the shareholdings of the existing shareholders, including the founders. This can be a significant consideration for founders who want to maintain control over their company.
Uncertainty: Without a set valuation, it can be difficult to determine the true value of the company and the potential return for investors. This uncertainty can make Advanced Subscription Agreements a riskier proposition for investors.
Limited investor rights: Advanced Subscription Agreements typically do not come with the same rights and protections for investors as traditional funding rounds. This can make them less attractive to investors who value these protections.
The Investor Appeal
Advanced Subscription Agreements (ASAs) offer several benefits to investors.
EIS and SEIS Compliant: Advanced Subscription Agreements are compatible with the benefits of the UK’s Enterprise Investment Scheme and Seed Enterprise Investment Scheme and the tax benefits that those schemes offer.
Increased flexibility: Advanced Subscription Agreements provide investors with the flexibility to invest in startups without the need to go through a traditional funding round. This means that investors can choose the timing and amount of their investment, allowing them to tailor their investment strategy to their preferences and risk appetite. This flexibility can provide investors with unique investment opportunities and the potential to support innovative ideas from an early stage
Potential for higher returns: Advanced Subscription Agreements allow investors to purchase equity in the company at a later date often at a discount to the following funding round. If the company’s value increases between the time of the agreement and the equity purchase, investors can benefit from potential capital appreciation.
Diversification: Advanced Subscription Agreements provide investors with the opportunity to invest in a range of startups without committing a substantial amount of capital. This allows for diversification of investment portfolios and spreading the risk across different companies.
Advance Subscription Agreements versus Convertible Debt
Convertible loan notes or convertible loans (Convertible Debt) and Advanced Subscription Agreements are commonly used in business funding, but they have some key differences. Here’s how they compare:
Taxation
EIS and SEIS Compliance: Advanced Subscription Agreements are compatible with the EIS and SEIS schemes. Convertible Debt is not. This means that Advanced Subscription Agreements are more attractive to UK based business angel investors.
Structure
Convertible Debt is debt finance that can be converted into equity at a later stage, usually during a future funding round. On the other hand, Advanced Subscription Agreements are agreements where investors commit to subscribing for shares in the future, but the specific terms and conditions are not finalised at the time of investment.
Valuation
Convertible Debt typically has a predetermined valuation cap or a discount rate applied to the future share price. This provides investors with some certainty about the potential return on their investment. Advanced Subscription Agreements, however, do not have a set valuation, although they may benefit from a discount, making it more challenging to determine the true value of the company and the potential return for investors.
Investor rights
Convertible Debt usually comes with certain rights, in some cases, being secured and rights to receive information about progress of the business. Advanced Subscription Agreements , on the other hand, may not offer the same level of investor rights and protections, making them less attractive to some investors.
Dilution
Both Convertible Debt and Advanced Subscription Agreements involve new shares in the company being issued to investors, which usually leads to dilution of the shareholdings of the existing shareholders, including the founders.
Flexibility
Advanced Subscription Agreements are known for their flexibility, allowing startups to raise capital quickly without the need for a full funding round. Convertible Debt also offers some flexibility, as it provides a bridge between debt and equity financing, but the documentation process, particularly for convertible loan notes, is more complex.
Convertible Debt and Advanced Subscription Agreements offer different benefits and considerations for startups seeking funding. They are also attractive to different kinds of investors. Convertible Debt usually provides more certainty in terms of valuation and potential return, while Advanced Subscription Agreements offer flexibility and efficiency. Ultimately, the choice between the two depends on the specific needs and preferences of the startup and its investors.
Legal Advice for Funding Rounds
When it comes to advance subscriptions agreements, convertible debt or funding rounds, seeking legal advice is crucial for startup and scaleup companies. Working with an experienced firm of commercial solicitors can provide you with the necessary guidance and professional support to navigate the legal aspects involved in raising capital.
Book An Introductory Call
By partnering with a reputable firm of commercial solicitors, such as JPP Law, you can benefit from our expertise in funding rounds and ensure that your legal needs are met. Book a free introductory call with a JPP solicitor to discuss your specific requirements and gain valuable insights into the legal elements involved in funding rounds.
