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Advanced Subscription Agreements – The New Alternative Funding Mechanism?

Written by Jon Cooper

A traditional route for companies to raise investment in the start-up and early stage has been to offer investors shares in the business in return for their funding.

In the United Kingdom, this can usually be underpinned by the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS) which offer the investor some hugely attractive tax breaks.

The downside of this approach is that, by offering a number of shares for the investment, the company is explicitly attributing a value to the business.

Whilst friends and family are likely to base their judgement on the people, proposition and plan, for private investors this business valuation is pivotal.

However, for start-ups and early stage businesses, quantifying this value is notoriously subjective. For instance, you have a great idea and have developed a prototype. You have worked out that you need £1m of investment to get to market and are prepared to offer a 25% equity stake in return. In essence, you have given your business at pre-money value of £4m even though you have not generated any revenue.

Until recently, the common alternative has been the use of Convertible Loan Notes. Here the investment is initially in the form of debt with the option to convert into to shares or for the loan to be repaid. The conversion is usually triggered by a future event such as the next funding round or an exit and the conversion price determined at that point. For example, the price per share at the next funding round discounted by 20%.

The beauty of Convertible Loan Notes is that this postpones the contentious issue of valuation plus it gives the investor some protection as the debt ranks above the shareholders in the event of an insolvency.

The problem is Convertible Loan Notes do not allow the investor to claim the tax reliefs under SEIS or EIS.

An Advance Subscription Agreement is a funding mechanism aimed to resolve this. In essence, the funds provided to the company at the date of the agreement convert to shares upon a future event.

However, the investment is not a loan with the right of repayment. Neither is there the right to earn interest. Essentially, it is a prepayment for share capital that must convert at some point. Should there be no next funding round nor exit, this would be on a defined date or on insolvency.

As the investment no longer has the downside protection of a convertible loan, if structured correctly, it could become eligible for SEIS or EIS relief.

An Advanced Subscription Agreement usually is underpinned with the following clauses:

The combination of the SEIS and/or EIS tax reliefs and safeguards plus a defined future share price is an extremely attractive option for the investor.

However, the structure of the Advanced Subscription Agreement is critical to ensure SEIS and EIS eligibility and HMRC look at this on a case-by-case basis. For instance, if the terms stipulate a conversion to anything other than Ordinary shares, the investment would automatically be outside the scope.

At CooperFaure, we have vast experience of helping business start-ups to secure funding and, in particular, benefit from government schemes. So far this year, we have supported clients in raising over £3m in investment finance through numerous channels.

If you would like an initial call or meeting to discuss your circumstances, please email us at startup@cooperfaure.co.uk to arrange a time.  It is absolutely free and there is no obligation.

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