Equity investments in a capital increase is the traditional and prevalent method of venture capital (VC) and start-up financing (i.e. capital in exchange for equity). As alternative or bridge financing instruments, convertible loans (CLA) or simple agreements for future equity (SAFE) are commonly used in VC and start-up practice.
CLAs and SAFEs are designed to allow investors to provide capital to a start-up while deferring the determination of the company's valuation until a later date.
- CLA: A CLA is a debt instrument. A loan disbursed under a CLA converts into equity in the start-up at a future specified date or upon specified triggering events, typically a subsequent traditional equity financing round. Conversion of the loan amount occurs at a predetermined conversion price upon a triggering event. The conversion price is usually set at a discount to the valuation established in the next financing round, rewarding early investors for their risk and supporting the start-up's growth. The terms and conditions of CLAs can vary widely, leaving room for discussion and negotiation between investors and start-ups. For example, CLAs may provide for mandatory or voluntary conversion events, with interest on the loan amount either converting into equity or not. Additionally, the conversion price may be subject to a floor (minimum conversion price) or cap (maximum conversion price), and the catalogue of warranties provided by the company can range from comprehensive to minimal. Furthermore, the maturity date of the loan may be set in the near or distant future, and a discount rate may apply or not apply to the conversion price among other potential variations.
- SAFE: A SAFE is a more streamlined and founder-friendly alternative to a CLA. SAFEs represent a promise that investors will receive equity in the start-up at a future specified date or upon specified triggering events. Unlike loans disbursed under CLAs, SAFEs do not accrue interest, and there is no repayment option for the investment. Instead, investors receive a mandatory delivery of new shares as consideration for the pre-payment of the investment, making SAFEs simpler in structure. While the fundamental concept of SAFEs is straightforward, other terms in a SAFE do not significantly differ from those found in CLAs. Once again, a wide variety of terms is possible and subject to negotiations between investors and start-ups. Please refer to the information provided above. The tax treatment of SAFEs under Austrian law remains somewhat uncertain. Nonetheless, there is a good argument that SAFEs may offer certain advantages over CLAs from an Austrian tax standpoint.
Both CLAs and SAFEs are popular options for start-ups and investors, as they provide flexibility in terms of issuing new shares while allowing start-ups to secure financing without immediately determining a fixed valuation. However, the specific terms and conditions of such financing instruments can vary, so it is essential to carefully negotiate and document the terms in legal agreements to ensure clarity and alignment between investors and start-ups. Although it is not a common practice in Austria, it is advisable to conclude CLAs and SAFEs in the form of a notarial deed.
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