What is an Advanced Subscription Agreement (ASA)?
An Advanced Subscription Agreement (ASA) is an arrangement where an investor commits to purchasing shares in a company, providing equity funding upfront. However, the shares aren't issued immediately. Instead, the investor essentially prepays for their shares, which are only allocated when a specific event, known as a "trigger event," occurs.
The key advantage for an ASA investor is that when this trigger event happens—typically when the company embarks on its first equity funding round—the shares they receive will be at a discounted price compared to those offered to new investors in that round.
For companies, ASAs offer several benefits. Unlike Convertible Loan Notes (CLNs), there’s no requirement to pay interest on the funds received, and the funds do not need to be repaid. For investors, ASAs provide a right to receive shares at a discount and often qualify for tax advantages under schemes like the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).
How Do ASAs Work?
Under an ASA, an investor provides funding to a startup in exchange for the right to purchase shares at a later date, usually when the company is preparing for its first equity funding round. Since the shares aren’t issued immediately, there is no need to value the company to set the share price upfront. The ASA terms typically give the investor the right to receive shares at a discount compared to the price offered to later investors.
The ASA usually converts into shares when a "qualifying funding round" occurs, the company is sold, or at a fixed date known as a "long-stop date." A qualifying funding round is defined by the company reaching a specific fundraising target. It's crucial to strike a balance when setting this target to satisfy both investors and founders. Investors want a high target to ensure sufficient funds are available when their shares convert. Conversely, founders aim for a target that isn't too high, to avoid delaying the conversion of investment into shares despite having substantial funding.
When an ASA converts, shares are generally issued at a discount of 10 - 30% and are ordinary shares.
Pros and Cons of ASAs
Pros of ASAs
For startups, the main advantage of issuing an ASA is the ability to access funding quickly. While certain terms, like a valuation cap and defining a qualifying funding round, need negotiation, these discussions are usually less lengthy than those involved in a formal equity funding round. Additionally, the company doesn’t need to be valued until its first funding round. This is significant because valuing early-stage companies can be challenging, and low valuations can force founders to relinquish too much equity early on.
To protect their interests, founders should include a valuation cap in the ASA. This cap helps existing shareholders understand how much their shares might be diluted when the ASA rights come into effect. For investors, funds advanced under an ASA may be eligible for tax relief under the EIS and SEIS schemes, unlike CLNs, which are ineligible due to the potential repayment obligation. Additionally, ASA investors gain shares at a discounted price when they are eventually issued.
Cons of ASAs
However, ASAs have some drawbacks. For founders, issuing shares at a discount leads to further dilution of their own shares when the ASA shares are issued. Moreover, ASA investors, despite purchasing shares at a lower price, generally receive the same rights and protections as new equity investors.
The existence of outstanding ASAs might deter future investors in subsequent funding rounds, as ASA holders will receive shares at a discount, thus securing a greater equity percentage for their funds compared to new investors. From the investor's perspective, ASAs are slightly less advantageous than CLNs in a liquidation scenario, as CLN holders rank higher than shareholders. Additionally, unlike CLNs, funds advanced under an ASA do not accrue interest.
Differences Between Advanced Subscription Agreements and Convertible Loan Notes
Structure and Risk
ASAs are equity investments where investors provide capital upfront in exchange for future shares, usually at a discount in the next funding round or at a set price on a "long-stop date." This setup is riskier for investors since the investment is considered equity immediately and is non-repayable. In contrast, CLNs are debt instruments where investors lend money, earn fixed interest, and have the principal repaid if the investment does not convert into equity. This makes CLNs less risky, as they rank ahead of shareholders in liquidation.
Repayments and Interest
ASAs do not generate interest and are non-repayable; investors receive shares at a future date. CLNs, however, accrue interest until they are converted into equity or repaid, potentially providing income for investors.
Tax Benefits
ASAs may qualify for tax relief under EIS and SEIS if they meet certain requirements, such as having a long-stop date within six months and no loan element. CLNs do not qualify for these schemes due to their debt nature.
Complexity and Agreement Length
CLNs often involve longer, more complex agreements requiring detailed negotiations, while ASAs are generally shorter and simpler.
In summary, ASAs are riskier, non-repayable equity investments with potential tax benefits, whereas CLNs are less risky, interest-bearing debt instruments with repayment options. The choice between them depends on the specific needs and risk tolerance of the company and its investors.
Key Considerations When Drafting an Advanced Subscription Agreement
When drafting an ASA, several factors should be considered. Firstly, directors must have the authority to issue shares, and there should be clarity regarding any pre-emption rights, where existing shareholders have the first right to purchase new shares. It's crucial to review the company's articles of association, as ASA investors will be subject to these rules when shares are issued.
Additionally, if a shareholders' agreement exists, investors should understand how its terms apply to them. If there is no such agreement, investors should ensure they are comfortable investing without knowing the terms that may apply when shares are eventually issued.
Key terms of the ASA that require consideration and negotiation include
The long-stop date (often 12 months or less) by which shares must be issued, regardless of the funding round outcome. If tax benefits under EIS or SEIS are sought, this period may need to be shorter.
The valuation cap to ensure the investor receives a fair percentage of the shares issued.
The definition of the qualifying funding round that will trigger the conversion of funding into shares.
The trigger events that will lead to the ASA converting into shares.
Whether existing shareholders need to waive pre-emption rights.
Ensuring EIS and SEIS Compliance
While direct approval from HMRC for EIS or SEIS tax relief is not possible, compliance can be maintained if:
The ASA investment is non-refundable.
The shares issued are ordinary, fully paid-up, and purchased with cash.
The investor is not connected to the company (i.e., they do not have rights to acquire more than 30% of the company's share capital) for two years before or three years after the investment.
No investor protections are in place under the ASA.
The ASA cannot be varied, canceled, or assigned and does not bear interest.
The long-stop date is typically within six months from the agreement date.
These criteria ensure that ASAs align with EIS and SEIS requirements, making them a compelling option for both startups and investors.
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