When writing about early stage businesses, there is no better person to think of than Richard Branson who explained ‘poor cash flow is the biggest killer of start-ups’. Every company we speak to is laser-focussed on cash - we have written before about cash being King back when HMRC was taking up to 3 months to pay credits. However, over the past few months we have seen the continued growth in ASAs as a route for founders to get capital quickly. They can work really well but they can also provide significant risks management, existing investors and to businesses.
It’s important to note that getting any sort of investment is not simple – especially when multiple investors are involved who are looking for different valuations/agreements or rights. An ASA can therefore be the solution to give a company a further cash runway to resolve these issues. Great – but it can be very high risk for EIS monies.
There are options available to companies – they could bridge using convertible loan notes – but this gives no SEIS and EIS tax relief – and it gives the owners the right to demand repayment of the loan (plus interest) should they decide not to convert into equity. It is debt and sits high on the seniority ranking. Alternatively, they could borrow against R&D tax credits (full disclosure – we provide this service and thus cannot claim to be totally impartial here).
So why do we feel that ASAs are risky?
· First, when making the decision you often don’t know how many shares you will get on conversion or at what price. The usual SEIS and EIS requirements apply to any shares being issued pursuant to an ASA. Shares must be ordinary shares and cannot have any preference or redeemable rights attached to them
· Ordinary shares are issued on the occurrence of particular events (qualifying fundraise, sale, insolvency, longstop date). The unknown factor is what the price will be.
· For EIS investors, remember that it is the date on which the shares are issued that matters (this is important for the connection tests, investments limits, maximum permitted age requirement, qualifying company tests). This is all important as the issuance may no longer be SEIS or EIS qualifying - the conversion date is the time the clock starts ticking. The company could seek advanced assurance on the ASA from HMRC but this is time consuming and often defeats the point of the whole thing.
· For founders, why would they dilute with a discount rate of up to 25% if only for a short period (less than 12 months maximum)? The long stop date refers to a time limit for the conversion. HMRC policy is that this should be no longer than 12 months from the date of the agreement. If the short stop conversion has not been triggered by this date, then the money will convert into equity based on an agreed pre-money valuation. The long stop valuation may be the post-money valuation from the company’s most recent investment round or the valuation at the time of the agreement. The short stop valuation should be higher to reflect the company’s growth which has, or is expected to, attract the required investment that will trigger the ASA conversion.
· Often these discounts are up to 25% for as little as 3 months’ money (this should be looked at on an annualised rate and compared to debt or other funding methods).
So – founders and investors – think carefully before you look at ASAs for EIS and SEIS raises. There may be alternative options which are better suited and cheaper - (see previous disclosure for the Finstock solution… )