Securing finance can be tricky in any climate, but this is particularly true where the economic climate is so uncertain that it leads to the introduction of a variation to a traditional business performance measurement, notably EBITDAC (earnings before interest, taxes, depreciation, amortisation and “coronavirus”), an extension of the well-known EBITDA.
Coronavirus has undoubtedly forced companies to seek some form of interim or bridge finance to tackle the financial hardships presented by the effects of Coronavirus, and this is frequently done in the form of convertible loan notes and Advanced Subscription Agreements (“ASA”). Whilst this article focuses on ASAs, we will explore convertible loan notes separately in a future article in our series of “That Lightbulb Moment”.
ASAs have been a popular method for growth companies and early-stage companies to achieve a quick injection of funds, or to bridge finance requirements until a future funding round, but what are they, what are the recent changes that are impacting their use, and what are the pros and cons of using them?
We are all familiar with the conventional fundraising process. Pursuant to the terms of an investment agreement, the investor transfers investment funds to the company in consideration for the issuance to it of a specific number of shares in the company, at a price per share agreed between the parties. This process is not always practical for early-stage companies who need cash fast and do not have the time nor the resources to determine the company’s share value at such an early stage.
An ASA is an equity document which introduces flexibility and efficiency for companies seeking to raise quick and easy funds. Pursuant to the terms of the ASA, the investor will transfer the investment funds to the company in consideration for the company agreeing that it will issue shares to the investor at some specified time or event in the future, or otherwise on a future sale or liquidation of the company. This time or event is normally the earlier of a defined longstop date, say 6 months following the date of the ASA, and a future ‘qualifying’ funding round. The qualification of that round will typically be linked to the amount of capital raised in that future funding round.
There are several reasons why a company might want to use an ASA, but principally it is because the value of the shares being issued in the company cannot be easily ascertained. The share value would subsequently be obtained to enable the future qualifying funding round referred to in the ASA.
But why would an investor want to invest funds in a company without immediately receiving the shares? Typically, an investor will receive a discounted share value compared to the value of the shares issued in the next qualifying funding round or will otherwise negotiate a capped share value. This discount or cap is entirely discretionary and would form part of the negotiations between the company and the investor. Such discount acts as a powerful tool for companies to attract potential investors and receive a quick injection of funds without being concerned about valuing its shares at that stage.
However, two recent changes mean that start-ups need to be increasingly vigilant about whether an ASA is the right tool for them when raising equity finance.
The first change was brought in on 30 December 2019 when HMRC issued new guidance in relation to ASAs concerning two headline tax reliefs: Seed Enterprise Investment Scheme (“SEIS”) and Enterprise Investment Scheme (“EIS”). The HMRC guidance states that the company will not qualify for SEIS or EIS relief unless the ASA:
- does not permit the subscription payment to be refunded;
- cannot be varied, cancelled, or assigned;
- bears no interest charge; and
- has a longstop date.
A company must apply to HMRC for advance assurance prior to entering into an ASA. This gives the company confidence that the terms of the proposed ASA do not prejudice its ability to qualify for SEIS and EIS relief. It would be too late to make such an application after entering into the ASA. This point can be critical as some investors may only invest in companies that are eligible for SEIS / EIS relief. We will talk more about these tax reliefs with a guest accountant in a future article of this series.
The second change is that the longstop date for the issuance of shares must not be more than 6 months from the date of the agreement. This change fundamentally impacts the value of the ASA for companies looking to organise bridging finance where it is expected that the next qualifying funding round will not be within 6 months from the date of the ASA.
ASAs carry two key benefits. The first is that they will, to the extent they comply with updated HMRC guidance, enable UK-resident investors to benefit from SEIS and/or EIS tax relief. Secondly, they are less complicated and costly as they involve fewer negotiations between parties than a full equity investment exercise.
However, the benefits of ASAs can be lost in certain circumstances. An obvious circumstance is where an investor requires a cap on the share valuation (careful consideration needs to be given to this cap to avoid unintentionally reducing share prices to be paid in future investment rounds), or where shares will be issued automatically on a longstop date under the terms of the ASA. In these specific circumstances, the parties will need to negotiate at the outset how the share values will be determined in the future, increasing the time and costs of negotiating the ASA.
Perhaps the headline disadvantage of an ASA for a company, and a matter which frequently introduces complexity to future fundraising, is the discount or capped share value given to an investor on conversion (i.e. the issuance of shares to the investor). That cap may have a potentially significant impact on share valuations for the new investors who introduce funds via the future qualifying funding round, and whom may subsequently be disincentivised to invest or who will add pressure on the ASA investors to renegotiate the terms of their investment.
Start-ups also have the option of raising funds from existing shareholders or traditional borrowing, although this is difficult for early-stage companies as they usually have poor balance sheets, poor cash flow and a lack of assets to leverage as security.
Legal and tax advice should be sought from the outset where companies or investors are proposing to take advantage of the SEIS or the EIS schemes to ensure that the ASA is drafted in such a manner that complies fully with HMRC guidance.
The Banking and Finance team at Greenwoods GRM is on hand to work closely with you and your business to raise equity finance on the best possible terms, and to navigate the specific issues identified above when raising funds using an ASA.