Understanding Advance Subscription Agreements (ASAs) and Convertible Loan Notes (CLNs) for Startup Investments

Posted Wednesday 24th May 2023

ASAs (Advance Subscription Agreements) are equity instruments whereby investors pay a company subscription funds in advance for shares, which will be issued at a later date and are used by companies to obtain quick investment prior to completing its next “qualifying” funding round. To ensure the ASA remains SEIS/EIS compliant shares must be issued to raise money for the purpose of the qualifying business activity and unlike a CLN (Convertible Loan Note), cannot be considered as a loan whereby the investor can charge interest and request their principal  sum back. It is also important to ensure the terms of the ASA:

1. cannot be varied, cancelled or assigned and that it
2. has a longstop date of no more than 6 months from the date on which the ASA is entered into.

The shares subscribed for under an ASA must be ordinary shares, which carry no preferential right to distributions. Additionally, there can be no arrangements in place to protect the value of the advance subscription, including for example any protection for the investor against making a loss.

A convertible loan is a debt instrument issued by startup companies to raise capital from investors. However, investors typically expect their instrument to convert into the company’s equity securities at a future date on certain triggering events, such as the maturity date, a future equity financing or a sale of the company, rather than receiving their principal amount plus interest.

Like ASAs, the terms of a CLN will be subject to negotiation and usually contain the following terms:

1. principal amount due at a maturity date;
2. a fixed rate of interest, which accrues on the principal balance; and
3. security over the company’s assets that is senior to other shareholders, benefitting the CLN investor.

ASAs and CLNs incentivise investors to invest under these instruments by granting them a discount to the price paid for shares by new investors during the company’s next equity round and benefit the company because they typically incur lower legal fees than those required to complete an equity investment round due to shorter, simpler documents.

It is also worth remembering that “unconverted” ASAs or CLNs will often need to be factored into the fully diluted share capital when ascertaining the share price during the company’s next investment round.

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This article is for reference purposes only. It does not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking or deciding not to take any action.

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