An Introduction to Advance Subscription Agreements

Advance Subscription Agreements are becoming increasingly popular as a quick and cost-efficient way to raise investment.  Structured properly, investment under an ASA can also qualify for SEIS/EIS tax reliefs. Read more about what Advance Subscription Agreement are, what terms need to be negotiated and their benefits but also their downsides.

Introduction to Advance Subscription Agreements

Advance Subscription Agreements (ASAs) are a quick and cost-efficient way in which companies can raise investment.   They have become increasingly popular as a means for companies to receive much needed cashflow in advance of a larger fundraising exercise. 

Structured properly, investment under an ASA can also qualify for SEIS/EIS tax reliefs, which may increase the range of potential investors for the company.

What is an Advance Subscription Agreement?

In summary, an ASA is an agreement by an investor to provide investment funding to a company in the form of an advance subscription and on the basis that the funding will convert into shares in the company at the point of the company’s next investment round.  The ASA does not need to specify the price or rate at which the advance funding will convert – this will be determined by reference to the investment round price and valuation. 

An advance subscription is usually not repayable by the company, nor will interest be paid by the company on the advanced funding.  To acknowledge the investment risk of an advance subscription, the ASA may provide:

• that the price at which the advance subscription will convert at the time of the company’s next investment round will be at a discount to the investment share price of that round.  This means that the advance subscription investor will receive more proportionately more shares for the money invested than the normal investors in that round
• for a valuation cap on the company’s value at which the advance subscription will be converted into shares in the company.  This protects the advance subscription investors from a potentially high valuation of the company at the next investment round.

When are Advance Subscription Agreements used?

An Advance Subscription Agreement is a way in which a company can raise investment quickly and in a cost-efficient manner prior to an anticipated investment round.  This can bring much needed cash to the company pending the completion of a full investment fundraising process.  

An ASA is much simpler from a legal perspective than a typical investment agreement or subscription agreement.    The target company can also enter into a series of Advance Subscription Agreements over a period of time with different ASA investors – they need not be done simultaneously.

On the other hand, an investment fundraise by a company will usually involve the preparation, negotiation and completion of a number of legal documents and steps.  These include:

• agreement in principal on the investment terms, including the company’s pre-investment valuation. This stage might also involve preparing, discussing and agreeing a non-binding investment term sheet or heads of terms
• investor commercial, financial and legal due diligence on the target company and its ownership, business, assets and finances
• agreement of the principal investment documents, which will typically include a subscription agreement and related documents, a shareholders agreement and ancillary transaction documents such as founder service agreements, assignments of intellectual property rights and corporate shareholder and board authorities.

This takes time and requires the target company to incur legal and other professional expenses, often at a time when cashflow is tight or even running out.  The legal documents need to be reviewed, agreed to and entered into by the company, its existing shareholders and the new investors. The company only receives funding on completion of the investment, which can take several months to achieve from start to finish.

What are the benefits of an ASA?

For ASA investors, the benefits of an ASA include:

• speed and cost: ASA investors do not have to negotiate detailed legal terms for their investment (or pay lawyers to do so) – when the advance subscription converts into shares, the ASA investors benefit from the investment terms negotiated for the investment round
• valuation: ASA investors do not have to come to their own view on the current company valuation – they can effectively piggy-back off the company valuation at the next funding round
• discount: the ASA can provide that the shares issued to ASA investors on the closing of the next funding round are priced at a percentage discount to the share price of that funding round
• valuation cap: to protect ASA investors from the future funding round being at too high a company valuation, the ASA can include a valuation cap (though this will need to be fixed at the time that the ASA is entered into)
• SEIS/EIS reliefs: ASAs (on conversion into shares) can qualify for SEIS/EIS tax reliefs if the ASA terms meet HMRC’s requirements for advance subscription agreements (and assuming the company and the investor both meet the usual eligibility requirements for SEIS/EIS reliefs)

For the target company, the benefits of an ASA include:

• timing and cost: a company can simply and quickly raise funds under one or more ASAs, which is particularly important for start-up companies or companies which are running out of cash prior to an investment round.  Funding can be received from a series of ASA investors, without having to wait until the full legal documents required under a formal funding round have been prepared, negotiated and agreed with investors
• valuation deferral: deferring a company valuation by raising money under ASAs may result in the founders of the company being diluted less in the future than they might have been by agreeing to an early valuation
• SEIS/EIS reliefs: being able to offer investment which may qualify for SEIS/EIS tax reliefs increases the range of potential investors for the company

What are the disadvantages of an Advance Subscription Agreement?

For an ASA investor, the downsides of an ASA include:

• risk: as a future payment for shares, the investment is not treated as debt, is not repayable and does not carry interest.  An alternative form of investment would be a convertible loan, which is both repayable and can bear interest but which will not qualify for SEIS/EIS tax reliefs
• long-stop date conversion: an ASA will usually include a long-stop date at which, if an investment round has not then been completed, the advance subscription will convert into shares at an agreed default valuation of the company
• insolvency: on insolvency of the company, the holders of ASAs will not rank with the ordinary creditors of the company but equally with shareholders.  Had the investment been made by way of convertible loan, the ASA investors would rank equally with other ordinary creditors

For the target company, the existence of one or more ASAs may have a negative impact on the future investment round.  Investors in the funding round may reduce their valuation of the company to take into account the discounted price and any valuation cap which the company may have agreed with ASA investors, resulting in a lower company valuation pre-investment and increased dilution for the founders and other existing shareholders.

What terms are negotiated prior to signing an ASA?

ASAs can be negotiated and signed relatively quickly compared to other investment arrangements. Nevertheless, there are a number of terms which will need to be discussed and agreed between ASA investors and the company before the ASA can be entered into. 

These include (and depending on the discussions and negotiations between the company and ASA investors):

• discount rate: the discounted price per share (expressed as a percentage) at which the holders of ASAs will receive shares in the future funding round
• valuation cap: whether the ASA should contain a valuation cap on a future funding round (to protect ASA investors from a high valuation)
• qualifying financing round: the minimum amount of funding which a company must raise before that funding round will count as the future funding round under the ASA which results in the conversion of the advance subscription into shares
• long-stop date: the long-stop date after which (and in the absence of a prior qualifying financing round) the ASA will automatically convert into shares, together with the default conversion price/valuation which would then apply

ASAs as SEIS/EIS qualifying investments

Investment via an ASA can be a form of investment which, for the ASA investors, qualifies for the tax benefits under SEIS or EIS. However, care should be taken on the terms of the ASA, as these might result in the SEIS/EIS reliefs being unavailable.

HMRC has issued guidance on ASAs and their use as qualifying SEIS/EIS investment arrangements. A company can also apply to HMRC for advance assurance before the ASA is entered into. 

In summary, the HMRC guidance includes the following:

• ASA terms should not be complex – the more complex the ASA, the higher the risk that qualification rules for SEIS/EIS relief will not be met
• the ASA should not offer other benefits for the investor, such as investor protections
• the advance subscription should not be a loan or used as a means of converting a debt or other obligation to shares
• the advance subscription should not bear interest
• the company will need to demonstrate how the timing and terms of the ASA fits into the company’s business plan and its planned expenditure on growth and development
• the ASA should not permit the advance agreement to be refunded under any circumstances
• the ASA should not be capable of being varied, cancelled or assigned
• the ASA should have a longstop date by which the shares must be issued. HMRC expects this to be not more than 6 months from the date of the ASA

Paper Rock Advance Subscription Agreements

Paper Rock has a selection of different forms of Advance Subscription Agreement, depending on the circumstances and terms agreed between the company and proposed investors. 

The alternative forms are:

• Advance Subscription Agreement Percentage Discount – the advance subscription will convert into shares at a discount to the price achieved by the company in its next funding round
• Advance Subscription Agreement Valuation Cap – the advance subscription conversion price will be subject to a cap on the company valuation in its next funding round, protecting the advance subscription investors from a potentially high future valuation
• Advance Subscription Agreement Fixed Price – the advance subscription will convert into shares at an agreed fixed price

Visit our Advance Subscription Agreement page for more information and details on our Advance Subscription Agreement template document options. Each one is clear, easy to use and legally up-to-date and is accompanied by a detailed guidance note.