The year 2022 will not be remembered fondly in the world of venture capital. Valuations took massive hits, established venture-backed companies were reducing costs and headcount and deals took longer to close as investors were concerned (and rightfully so) about the rapidly changing macroeconomic conditions.
Raising capital was difficult for founders in 2022 and for the early part of 2023 it is likely to be challenging. In order to obtain that much needed cash injection, without the formality and lengthy process of a traditional equity fundraising round, founders could consider some of the below innovative and alternative investment structures.
Advanced Subscription Agreement (“ASA”)
Under an ASA the investor makes their investment today (ie: cash is injected immediately upon signing the ASA) however the investor is only issued equity in the company upon closing of the next formal equity fundraising round. Valuation is not determined at the time of the ASA, although a cap and ceiling are included in the ASA to ensure both investor and company are protected from any wild swing in the eventual valuation when the equity round completes.
Negotiating and closing an ASA is usually very fast (often within a week) as the investor will typically only undertake a light due diligence and agree a ballpark valuation. The investor is relying on the lead investor’s diligence and valuation in the next equity fundraising round.
Once the equity round takes places, the shares issued in connection with the ASA are typically issued at a discount of between 10-30% in return for taking the early risk. The ASA will also include a longstop date (no later than 6 months to maintain SEIS/EIS status) so that if a fundraising does not complete by that date, the shares are nevertheless issued to the investor at a pre-determined valuation.
A convertible loan note (“CLN”) is often used as a bridging loan prior to an equity fundraising round, but equally is useful where valuation is not determined and cash is needed swiftly in the business. CLNs are similar to ASAs in that funds are advanced immediately upon signing, there is only light due diligence and equity is issued at a discount upon closing of the next equity fundraising round.
The fundamental difference between a CLN and an ASA is that under a CLN the investor is providing the company with a loan (that may need to be repaid) which typically bears interest at an agreed rate. Whereas under an ASA, the funds are advanced interest-free and there is no expectation or possibility that the investment be repaid.
For added protection, the CLN can also be secured via a debenture or charge, however most investors typically do not take this step as optically it looks unattractive to potential new investors for the next equity fundraising round.
To mitigate uncertain economic conditions, we are seeing more investors tranche their investment over a set period, and will invest at different valuations depending on the company meeting certain milestones and KPIs. Given the current macroeconomic climate, this might be a two-edge sword for the company, because projections might be based on the status-quo, and those agreed milestones may not be achievable meaning the company may be forced to accept later tranches at a lower valuation as a result.
Investors may be willing to pay for the option to invest at a future point in time. A call option may be appropriate as it gives the investor the opportunity to “wait and see”. Alternatively the company may want a “put option” to give itself certainty that it can oblige the investor to make the investment at a future point in time (ie: longstop date).
There has been a recent trend for investors to syndicate their investment with other investors to help de-risk their investment. Syndication though can often lead to a delay in the investment round as investors’ interests are not always aligned. If cash is needed quickly, we have seen founders stagger the closing dates and offering the investor that closes first better terms (for taking the earlier risk) than investors who are dragging their heals.
The above are just some of the alternative fundraising structures used by founders outside of a traditional equity fundraising round. If you would like more information or need any assistance with your fundraising please contact Bryan Shaw.
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