TRC 040: Funding fight - Equity rounds vs ASAs, SAFEs and Convertibles

Read time: 6 mins

Fundraising can be one of the most stressful times as a founder.

There always seems to a bewildering array of things to do and new concepts to grasp, on top of the exhausting work of finding and convincing new investors to join your journey and give you money.

One of the topics that comes up a lot with founders raising money for the first time is what type of funding structure to go for.

This is an area splattered with confusing acronyms and generous helpings of legal detail.

Choosing the wrong approach for your business can make it more difficult to attract investors and make you feel like you are wading through mud to get anywhere.

To help you think through what might be the best option for you, here is our breakdown of the main options and their relative pros and cons….

1. Advanced Subscription Agreement (ASA)

What It Is: An ASA is an agreement where investors provide funding in exchange for future shares in your company.

The shares are issued at a later date, typically during your next equity funding round.

Key Benefits:

• Simplicity: ASAs are relatively simple to execute compared to other instruments, with fewer legal formalities and associated costs.
• Flexibility: Investors commit to future equity at a discounted price, but you don’t need to set a valuation immediately, giving you more time to build value before a formal equity round.
• Speed: The streamlined process (and relatively simple documentation) means you can secure funding quickly, which is crucial in early-stage rounds.
• SEIS/EIS Tax Benefits: One of the major advantages of ASAs over Convertible Notes, particularly in the UK, is their compatibility with the Seed Enterprise Investment Scheme (SEIS) and Enterprise Investment Scheme (EIS). Investors can claim valuable tax reliefs on their investments if the ASA qualifies, which isn’t possible with Convertible Notes.
• Long Stop Date: ASAs typically include a "long stop" date, ensuring that the funds will eventually convert into equity, giving investors a clear path to ownership.

Potential Downsides:

• No Repayment Option: Unlike convertible notes, ASAs do not offer the option to repay the investment as a loan. The investment must convert to equity, which can limit your flexibility if your business becomes cash-generating and you wish to avoid dilution.
• Investor Pressure: The requirement to convert to equity by a specific date might create pressure to raise another round, potentially at an inconvenient time.

When to Use ASAs vs. SAFEs: ASAs are often used in the UK due to their compatibility with SEIS/EIS, whereas SAFEs (Simple Agreements for Future Equity) are more common in the U.S. ASAs offer the added advantage of qualifying for SEIS/EIS, making them a better choice if your investors are seeking tax-efficient investment options for UK investors.

2. Convertible Note

What It Is: A convertible note is debt funding that converts into equity at a later date, usually during a future funding round.

Investors loan money to your startup, which eventually converts into shares at a discounted rate.

Key Benefits:

• Deferred Valuation: Like ASAs, convertible notes allow you to delay setting a company valuation until a later round, which can be advantageous if you expect significant growth.
• Interest Accumulation: While it’s a debt, interest is typically accrued rather than paid out immediately, reducing immediate cash flow pressures.
• Discount Rate: Investors usually get a discount when their notes convert to equity, rewarding them for taking early-stage risks.
• Repayment Flexibility: Although it’s rare in practice, a convertible note does offer the possibility of being repaid as a loan instead of converting into equity. This could be advantageous if your business becomes more cash-generating and you decide that you no longer need the funding (or as much of it) to continue growing.

Potential Downsides:

• Debt Risk: Convertible notes are technically debt until they convert, which can add financial risk to your startup. If the note doesn’t convert (e.g., if you fail to raise a qualifying round), you may be obligated to repay the loan.
• Complexity: Convertible notes can be more complex to structure than ASAs, particularly around setting interest rates, discount rates, and capped conversion valuations. This can lead to higher legal costs and longer negotiation times.
• Investor Relations: The dual nature of debt and equity in convertible notes can create complications in managing investor expectations and relationships.

3. Equity Round

What It Is: An equity round involves selling shares of your company directly to investors in exchange for capital. This typically requires a formal valuation of your company.

Key Benefits:

• Clear Ownership Structure: An equity round establishes a clear ownership and control structure from the outset, which can simplify future investment rounds and governance.
• One and done: Whilst ASAs and convertible notes can be simple to start raising money, the complexity of conversion is only deferred. Equity rounds, whilst more complex in the moment, get all of the paperwork out of the way in one go so you can focus on building the business.
• Potentially Higher Valuation: If your startup is already showing traction, an equity round might allow you to secure a higher valuation and, thus, raise more capital for less dilution.

Potential Downsides:

• Dilution: An equity round results in immediate dilution of your ownership stake, which can be significant, especially in early stages.
• Complex and Time-Consuming: Raising an equity round is typically more complex and time-consuming than ASAs or convertible notes when you get going. It involves setting a formal valuation, negotiating terms, and often requires significant legal and financial due diligence.
• Loss of Control: Depending on the amount of equity sold and the investors involved, you may lose some control over your company’s decision-making process, particularly if the round includes large venture capital firms.

Which Option Is Right for You?

Choosing between an ASA, a convertible note, and an equity round depends on various factors, including your startup’s current stage, your growth projections, and your appetite for dilution and control.

• If you need quick, flexible funding without the pressure of immediate valuation, an ASA could be ideal, especially with its SEIS/EIS tax advantages and the certainty of eventual equity conversion.
• If you want the flexibility to potentially repay the investment as a loan if your business becomes cash-generating, a convertible note might be the best fit, offering both deferred valuation and repayment options.
• If you’re ready to establish clear ownership and governance structures, and your startup has sufficient traction, an equity round could offer the best long-term benefits.

I hope that this is a useful primer for your thinking on what might be right for you and your business.

As always, it’s good to read a little deeper and get some advice from any legal and financial advisors you have close at hand.

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