Early Stage Investments - Forms of Venture Capital Investment
Many start-ups will find themselves turning to venture capital firms (a “VC”) for financing. In this series of briefings we are attempting to demystify the process and assist start-ups with navigating the VC waters. We have already touched on what venture capital means and some key rights and protections that form the basis of negotiation in a minority investment by a VC, which can be found here. In this briefing we provide a short description of the primary forms of instrument utilised in a venture capital investment that are available to start-up and early stage companies.
Convertible Loan Note
A VC may wish to invest in a company through a convertible loan note. A convertible loan note is a type of short-term debt that is converted into equity shares at a later date and usually in its next round of financing. The note will have a maturity date and will bear interest. No valuation is set for the company at the date that the note is issued. An investment into a start-up via a note will often give the investor the right to convert their notes into the stock issued at the next round of financing at a discounted share price based on the company’s future valuation, sometimes with a cap on the valuation of the company for the purposes of the conversion rate.
An equity investment is money that is invested in a company by purchasing shares of that company. Investors purchase shares of a company with the expectation that they will either rise in value in the form of capital gains, generate capital dividends or both. An investor will make a gain if an equity investment rises in value and the investor sells their shares.
Simple Agreement for Future Equity (SAFE)
In recent times, a new form of investment instrument has emerged – a Simple Agreement for Future Equity (SAFE). The SAFE emerged from US seed accelerator, Y Combinator in late 2013, and since then, it has been used with increasing regularity as the main instrument for early-stage fundraising. Although Ireland took a while to embrace the SAFE, it has become increasingly popular in recent times. The SAFE is an agreement by which the investor invests money into the company which converts into shares of the company in a future equity round subject to certain parameters set in advance in the SAFE. The intention of a SAFE is to be an alternative to convertible notes, however unlike a note they are not debt instruments. A SAFE is non-interest bearing and it there is no maturity. A similarity between a SAFE and a loan note is that they both can convert at discounts and/or at capped valuations.
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Also contributed by Ashley Braham.
This document has been prepared by McCann FitzGerald LLP for general guidance only and should not be regarded as a substitute for professional advice. Such advice should always be taken before acting on any of the matters discussed.