We are seeing more and more companies undertaking an emergency bridge round to finance operations until the next official “round” is completed. In many circumstances companies simply cannot afford to wait and undertake the lengthy process of a formal financing round. Fortunately, there are alternatives and here at MBM Commercial we have helped many of our clients navigate these structures and facilitate a smooth bridge financing round.

So, what are the alternatives?

Advance Subscription Agreements (ASAs)

ASAs are becoming increasingly popular because these instruments allow the company to obtain funding quickly, without the need for lengthy negotiations. The legal agreements are concise and easily agreeable, and at the same time they maintain SEIS/EIS qualifying status.

How do they work?

The ASA is a short agreement whereby the investor agrees today to make his/her investment upon closing of the next formal equity fundraising round at a pre-determined valuation. Only then will that investor be issued shares in the company, typically at a discount of between 10-30% in return for taking the early risk. The ASA will also include a longstop date (no later than 6 months to maintain SEIS/EIS status) so that if a fundraising does not complete by that date, the shares are nevertheless issued to the investor at the pre-determined valuation and applying the agreed discount.

As soon as the ASA is signed, the investor will advance funds to the company.

There are no lengthy negotiations with lead investors, no warranties to discuss. These issues are postponed until the formal fundraising round. In the meantime, funds are released to the company quickly to allow the entrepreneur to continue to grow the business.

It should be noted that the investor can only claim SEIS/EIS relief when the shares are issued, not when the funds are advanced.

Convertible Loan Notes (CLNs)

CLNs are similar to ASAs in that they have a pre-determined valuation, facilitate a quick advance of funds and use concise legal documentation. The two major differences between CLNs and ASAs are: 1) CLNs are debt instruments (i.e. the company is obliged to repay the investor); and 2) CLNs are non-EIS qualifying instruments.

How do they work?

CLNs are issued by the company to investors as a debt obligation on the company which then converts into shares (thereby removing the debt obligation) at a pre-agreed valuation upon the closing of the next equity fundraising round. The valuation is normally at a discount. The kicker for the company (and one of the reasons why CLNs are used less frequently nowadays) is that, if the equity fundraising round is not closed by the agreed longstop date, the obligation to repay the debt (and any interest) remains. This debt obligation could also be secured by the company by way of a legal charge, however in practice this is not usually done as it could be prohibitive on the next fundraising round.

The other decisive factor as to why ASAs are being favoured over CLNs is that, given CLNs are debt-like instruments, they will not qualify for SEIS/EIS relief.

Subscription Letters

The simplest method of all is for investors to simply subscribe for shares in the company at a pre-agreed valuation.

How does it work?

The investor signs a one-page letter stating how many shares he/she is subscribing for and advances the funds to the company at the same time. If a shareholders’ agreement is already in place, the investor will need to become a party to that agreement.

The company then immediately issues the investor those shares.

A word of warning, the company will need to ensure all its current shareholders have waived their pre-emptive rights and obtained all necessary consents before it can issue the shares to the investor.

If the class of shares being issued to the investor are SEIS/EIS qualifying, then the investment should qualify for SEIS/EIS relief. In contrast to ASAs, SEIS/EIS relief may be claimed as soon as funds are advanced to the company because shares are issued to the investor contemporaneously with the investment.

Conclusion

In most bridge rounds, one or more of the above structures are typically used by companies. Careful review of the company’s current articles of association and shareholders’ agreement should be undertaken prior to deciding which of the above instruments to use.