German start-ups use convertible loans as a standard way to raise capital easily, cheaply and quickly, without having to immediately carry out a notarized capital increase. However, Simple Agreements for Future Equity, or SAFEs for short, developed in 2013 by U.S.-based accelerator Y Combinator, are now also becoming increasingly popular .<\/p>\n
The objective of both instruments is the same. From their contractual design they are also quite similar. But what are the decisive differences for founders or investors?? This article provides an overview of the key similarities and differences between SAFEs and convertible loans. As a basis for decision-making for founders and investors, the advantages and disadvantages for the different parties of the two financing instruments are also presented.<\/p>\n
The basic regulatory content of convertible loans and SAFE is the same: The company and the investor enter into a contract under which the investor provides money to the company in exchange for shares in the company. In short, a SAFE instrument is a cash deposit combined with the option to subscribe for shares in the company. The convertible loan is a classic loan combined with a conversion right agreed under the law of obligations.<\/p>\n
The following topics show the main similarities and differences between the two instruments:<\/p>\n
Convertible loans have a finite term. At its end, there can be either the repayment of the loan or the optional or mandatory conversion of the loan amount into shares in the company. A conversion outside of a financing round means additional costs for the company, as a capital increase may be necessary for its implementation. with adjustments to an existing shareholder agreement required. This can usually only be averted if a term extension of the loan can be agreed with the lender.<\/p>\n
In contrast, a SAFE regularly runs for an indefinite period, which is extremely convenient for the company compared to the convertible loan, as there are no additional costs for a conversion and there is no need to negotiate a contract extension.<\/p>\n
In the context of convertible loans, interest must be paid on the loan amount provided for the benefit of the investor. In the event of a conversion, the interest claims are added to the conversion amount and thus also converted into shares in the company. If there is no conversion, the interest must be repaid together with the loan amount.<\/p>\n
In SAFEs, there is usually no interest agreed on the amount of the investment. This is beneficial to the founders and other potential investors and shareholders to the extent that their dilution is kept lower by the amount not increasing. The investor, on the other hand, thus receives no additional return in the form of further shares or interest for the risk he has taken on.<\/p>\n
As already mentioned, in the case of convertible loans, the investor has a repayment claim. Provided that no conversion takes place, this receives at the end of the running time its investment amount together with interest back from the society. On the one hand, the repayment claim has the advantage that the amount provided does not simply evaporate unless a financing round takes place with the company. On the other hand, the lender's interest-bearing repayment claim is intended to compensate for the disadvantage that the lender, unlike the shareholders, has no voting or control rights with regard to the company. the company has, even though it works with his money. However, the agreement of a (qualified) subordination considerably reduces the significance of such a repayment claim, as the loan amount is thus treated as equity in the result. If the investor is interested in exercising control in the company at an early stage, participation as a shareholder would be a good idea, if necessary. preferable to a convertible loan.<\/p>\n
In the case of SAFEs, on the other hand (except in the case of contractually defined liquidity or dissolution events, such as z.B. Change of control, liquidation or dissolution) no claim for payment of the loan. of the amount provided. The company is not obliged to pay back the investor's money. If no funding round takes place at any time, the money is "lost" so to speak. For the company, this arrangement is extremely beneficial, as it can use the money without having to factor in a possible repayment.<\/p>\n
In both forms of investment, financiers are rewarded for their willingness to take risks compared to shareholders who had previously invested in the company: according to the last-in-first-out principle, they are given a higher-ranking liquidation preference than those who directly or. previously invested in the company. The later the conversion is completed, the more likely it is for the investor to recover some of the proceeds in the event of an exit.<\/p>\n
The right to ordinary termination is generally excluded in the case of convertible loans for their term. This does not affect the possibility of terminating the contract for good cause. There are usually a few scenarios named in the contract that are important reasons in any case. For example, if the financial circumstances of the borrower deteriorate or certain if necessary. Agreements made between the parties (e.g.B. Intended use) of the loan is not met. Through the latter, the investor can secure himself at least to the extent that certain pre-agreed goals must be achieved by the company. However, due to the agreed qualified subordination, even an exercised right of withdrawal in the event of a deterioration of assets no longer helps to overcome the fact that the repayment claim must be serviced after the claims of the other creditors.<\/p>\n
SAFEs, on the other hand, usually do not provide for the possibility of their termination. If the investor wants to unilaterally withdraw from the contract, the only legal provisions available to him to do so are as follows.<\/p>\n
In the context of convertible loans, there are several scenarios that lead to a conversion of the loan amount. Usually a conversion is foreseen in case of a financing round, sometimes also at the end of the term of the contract. In both cases, a unilateral right of the lender or company or a bilateral right or general conversion obligation is possible. In case of conversion at the end of the term, the company does not have to repay the loan amount including interest and thus remains attractive for future investors. This is because they are usually very concerned that their new investment not be used to repay claims on outstanding convertible loans.<\/p>\n
In comparison, SAFEs stipulate that the issuance of shares must take place at the next financing round following the conclusion of the SAFE. Unlike the submission of Y Combinator, the "conversion" takes place in business shares resp. whose output is not "automatic" as under U.S. law. After this, shares in the company are issued there directly by the Board of Directors. Under German law, a capital increase with the participation of all shareholders is required instead. When drafting the contract for a SAFE, it must also be remembered that the investor must additionally pay the nominal amounts attributable to his shares to the company anew after he has taken them over.<\/p>\n
In both convertible loan agreements and SAFEs, the following arrangements may be made in favor of the investor when calculating the unit price:<\/p>\n
– Cap: this sets the maximum price at which the investment amount is to be converted into shares in the company. In the case of Y Combinator's templates, there are sog. "Pre-Money" and "Post-Money" SAFEs with a sog. "Valuation Cap". The valuation cap of the pre-money SAFE refers to the pre-money and that of the post-money SAFE to a post-money valuation of the company. The calculation of the shares to be issued to the investor is based on whether either (i) the application of the agreed valuation cap or (ii) the application of the share price paid by investors in the corresponding financing round leads to more shares for the investor.<\/p>\n
The advantage of agreeing a post-money valuation cap for the investor is that he already knows at the time of his investment how high his future participation in the company will be. Nevertheless, such an agreement is rather rare in Germany.<\/p>\n
– Discount: For the benefit of the investor, a discount (valuation discount) can be granted on the share price paid by the other investors when converting their investment amount into business shares. The discount is mostly granted as compensation for the higher investment risk of the previous investor.<\/p>\n
– Most Favored Nation (MFN): Likewise, a so-called conversion price can be agreed. "The most-favored-nation clause can be agreed upon. This enables the investor to obtain the same conditions as investors who have invested in the company after him\/her. This ensures that the investor also receives the best conditions offered to other investors.<\/p>\n
In convertible loans, the pre-money valuation of the company used as a basis in the financing round is generally used to calculate the share price in the event of conversion. Although it is possible to agree a fixed value in the convertible loan agreement, this is rarely used by the parties, as it is unclear at this stage which valuation of the company is actually to be used as a basis.<\/p>\n
If no fixed value is used as a basis for convertible loans or SAFEs, the conversion price is generally based on the share price used as a basis in the associated financing round, if applicable. taking into account the amounts shown in item 2.7 deductions shown. In principle, the share price is calculated by dividing the pre-money valuation by the share capital (subscribed capital) of the company and subtracting the nominal amount of the share that still has to be newly paid in. However, some items can be fictitiously added to the calculation (fully diluted), e.g., the amount of the loan.B. by the number of shares already issued and, if applicable. the not yet issued as well as u.U. any increases in option pools from employee stock option programs existing convertible loans and SAFEs. Which components are to be included is to be determined by the parties in each individual case.<\/p>\n
As shown by the above illustration, SAFEs basically do not bring any significant advantages for investors compared to convertible loans. For founders, on the other hand, SAFEs are a very attractive option due to the lack of a repayment claim, term, interest, etc. may be more attractive. At present, however, SAFEs are still fraught with great uncertainty due to a lack of relevant legal literature and case law. In contrast, convertible loans are now the subject of a large number of essays and also some judgments. In their case, there is thus no all-encompassing legal certainty, but at least greater legal certainty than in the case of SAFEs. Business angels also like to make use of INVEST funding for their investments. Unlike convertible loans, however, SAFEs are not INVEST-eligible, which is a further disadvantage of this type of financing.<\/p>\n
Finally, it should be noted that none of the provisions described above need be agreed by the parties simply because this is customary for the respective type of contract. Instead, the parties are free to stipulate in their individual contract (within the limits of what is legally permissible) what they deem expedient, feasible and reasonable in a specific case.<\/p>\n","protected":false},"excerpt":{"rendered":"
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