This is the second part of a two part article about SAFEs (Simple Agreement for Future Equity) or ASAs (Advance Subscription Agreements), for part 1 please see here .
I’ve made an advance subscription for shares. What’s the status of the subscription funds before I get shares?
SAFE/ASA investments are generally not intended to be redeemable like debt. Once the subscription funds have been paid to the company, investors won’t get the money back, and it instead converts into shares at a future event. If the cash cannot be repaid to the investor then the company can treat the funds as capital (but if there are any circumstances in which the investor receives cash back, then under general accounting rules the company cannot treat the funds as part of its capital).
When will my subscription convert into shares?
The SAFE or ASA will set out various ‘conversion events’, upon which the subscription money will convert into shares in the relevant company. The most common conversion events included in SAFEs/ASAs are as follows:
- Qualifying Fundraising – the company raising at least £x amount (excluding the value of any SAFEs/ASAs
- Non-Qualifying Fundraising – the company raising and amount less than £x (excluding the value of any SAFEs/ASAs)
- ‘Exit’ – ie. a share sale resulting in a change of control of the company, an asset sale of substantially all of the assets of the company or a listing of the company’s shares on a recognised stock exchange
- At the election of the SAFE/ASA holder on an ’event of default’, such as the insolvency of the company or its material breach of the SAFE/ASA (this may be particularly relevant if the SAFE or ASA contains warranties, for example)
- Longstop date – if none of the other conversion events have occurred by a set date, then conversion will occur at that date. If the investment is intended to benefit from SEIS or EIS relief, the longstop date would usually be no more than 6 months
- Insolvency – if the company enters into some form of insolvency.
In practice, most SAFEs/ASAs convert on a fundraising or at the longstop date.
What class of shares will I get?
SAFEs/ASAs generally specify that investors will be entitled to be issued the “most senior” class of shares in issue upon conversion – i.e. the shares which have the most favourable rights. If the conversion event is a new fundraising where the lead investor is getting a new class of senior preferred shares, the SAFE/ASA investors will also benefit from receiving shares of this class.
If SAFE/ASA investors are seeking SEIS/EIS relief, they may want their subscription funds to convert into a different share class (usually ordinary shares) to ensure they get the SEIS/EIS tax benefits, for example if the most senior share class has rights which would mean it doesn’t qualify for SEIS/EIS.
How many shares will I get upon conversion?
The number of shares an investor will end up receiving in exchange for their investment will depend on the conversion price, i.e. the price per conversion share. This may vary depending on the conversion event, but it is typical for SAFE/ASA investors to be rewarded for an early subscription with a discount.
For example, it would be typical for the conversion price to represent a discount to the lowest price per share being issued / sold or listed where the conversion event is a fundraising or an ‘exit’. If the conversion event is at the election of the SAFE/ASA holder on an ’event of default’ or as a result of reaching the longstop date, there would ordinarily be a default price specified in the SAFE/ASA at which the subscription funds will convert in these scenarios.
Ordinarily, there would also be a cap on the share price to protect SAFE/ASA investors, so that the conversion price never exceeds a certain level, or, to put it another way, to ensure that there is a minimum number of shares which the SAFE/ ASA investor receives for their investment.
Will my SAFE/ASA give me any other rights before my subscription funds convert into shares, or subject me to any restrictions?
Generally, the shortest-form SAFEs/ASAs do not include much in the way of additional terms (they are intended to be very simple and quick documents). However, we do see SAFEs/ASAs occasionally including the following clauses:
- Information rights – a right for SAFE/ASA investors to see the annual budget and/or monthly management accounts, for example
- Board appointment rights – the right for a SAFE/ASA holder to appoint someone to the board or a board observer
- Warranties – the company and founders may give a suite of warranties pursuant to which the advance subscription is made (subject to corresponding limitations)
- Most favoured nation – a entitlement for any SAFE/ASA holders to ‘upgrade’ their advanced subscription terms to any more favourable terms on which the company enters into a new agreements for future equity after the date of the original SAFE/ASA
- Consent rights / reserved matters – sometimes a SAFE/ASA will provide the holder with certain consent rights over the company carrying out certain matters
- Transfer – SAFEs/ASAs will almost always be non-transferable
What happens to these rights and restrictions once the subscription money converts into shares?
Once the subscription money advanced under a SAFE/ASA converts into shares, the SAFE/ASA will fall away and the shares will be held subject to the terms of any investment agreement, or subscription and shareholder agreements, as well as the Articles of Association of the relevant company.
Does that mean I will get a say in the drafting of those documents?
This will usually depend on the point at which subscription funds are converted into shares. If the conversion event is a significant fundraising, there is likely to be a new investors / shareholders’ agreement and articles of association which SAFE/ASA holders will sign-up to. This could mean that SAFE/ASA holders have the chance to review and comment on the documents during negotiations. However, these would usually be drafted by the lead investor in a new fundraising and there may not be much scope for SAFE/ASA holders to influence negotiations between new investors and the company, particularly as they have already invested their subscription money.
Generally speaking SAFE/ ASA holders are relying on third party investors to negotiate a reasonable set of rights for investors which the SAFE/ ASA holders benefit from by signing up to the same documents.
If the conversion event is not a new fundraising, it is more likely that SAFE/ASA holders will sign-up to the existing documentation via deed of adherence when the subscription money converts into shares.