Simple Agreement for Future Equity (SAFE) instruments (originally developed by Y Combinator, a startup accelerator and early-stage venture capital firm) are widely used in the US, while Advance Subscription Agreements (ASAs) are commonly used in the UK for early-stage bridge financing.
While they share a common goal of deferring valuation until a future funding "trigger event" determines the equity value of the company, the legal and tax implications of choosing one over the other are significant, particularly for those operating in the UK market.
The core proposition: Equity, not debt
Unlike traditional Convertible Loan Notes (CLNs), both SAFEs and ASAs are generally structured as equity-style instruments rather than debt. Each typically accrue no interest and have no maturity date which helps avoid the maturity-date pressure associated with debt instruments such as convertible loan notes.
In each case the investor provides upfront capital in exchange for the right to receive shares in the company at some future date. To incentivise investors to advance their capital ahead of a formal funding round the shares will often be issued at a discount to the price of the subsequent funding round which triggered the share issue.
Discounts can also be tapered depending on the funding round price achieved. Often, if no funding round occurs at all a maximum valuation is agreed which reflects the fact that the company has not been able to raise the hoped for funding within the expected time.
The investor will also usually receive shares of the most senior class in issue (or to be issued on the relevant funding round) when the shares are finally issued.
For VCs, SAFEs and ASAs can offer a streamlined path to deploying capital with reduced negotiation complexity compared to a full priced round as the investor understands that it will simply join the funding round alongside other investors.
The UK imperative: Why ASAs often lead
In the UK, SEIS and EIS considerations are often an important factor when structuring early-stage investments. These tax relief regimes however impose specific conditions on how investments must be structured to qualify.
In particular, for an ASA to support SEIS/EIS eligibility, HMRC requires that it represents a genuine advance subscription for shares and not a means of converting an existing loan or other debt instrument.
This itroduces several key constraints for ASAs when compared with SAFEs:
- Longstop requirement: HMRC generally expects a longstop date for shares to be issued of no more than six months since the longer the delay the more likely it is to be treated as a debt or a loan, although a longer period does not necessarily disqualify relief on its own. For ASAs that that are complex or have a longer period between the advance purchase and the issue of shares, the risk is higher. The Company can consider approaching the HMRC for advance assurance in such scenario.
- No repayment rights: The subscription amount must not be refundable under any circumstances.
- Limited investor protections: The agreement should not offer investor protections or benefits that risk it being treated as a loan and in particular it must not carry interest.
ASAs are therefore commonly used in UK transactions where tax structuring is relevant, as they tend to have fewer investor protections and so can be tailored to align with these requirements.
The 'invisible' risks for VCs
Beyond tax considerations, both instruments can present structural risks that require careful modelling.
- Dilution stacking: Multiple SAFEs or ASAs with different valuation caps can create layered dilution effects. Without careful cap table modelling, founders and early investors may face greater dilution than anticipated when a priced round occurs.
- Insolvency positioning: Under a standard SAFE structure, an investor’s right to payment in a liquidity or dissolution event typically ranks behind creditor claims but pari passu with preferred equity and senior to ordinary shareholders. In practice, this means recovery is uncertain and may be limited, particularly if the company fails before conversion can take place.
- Most favoured nation protections: Investors increasingly seek “most favoured nation” (MFN) style protections, particularly in SAFE structures, to address the inherent fragmentation of early-stage fundraising. As each SAFE or ASA is typically entered into as a standalone bilateral agreement, investors recognise the risk that subsequent instruments may be issued on more favourable commercial terms (for example, lower valuation caps, higher discounts or enhanced investor rights).
An MFN clause is therefore often included to ensure that, if the company agrees improved terms with later investors, existing holders may elect to have their own instrument amended to reflect those more favourable economics. Careful drafting is required to ensure that the scope and operation of any MFN mechanism is clear, and that it does not create unintended consequences for pricing certainty or the administration of the cap table on conversion.
- Longstop outcomes: Where a conversion event does not occur as/when expected, the fallback mechanics in an ASA (or similar instrument) may produce pricing or dilution outcomes that differ from the parties’ original expectations, particularly if the company’s valuation has not developed as anticipated. Furthermore, in circumstances where equity is issued as a fallback (for example, where a qualifying funding round does not occur within the anticipated timeframe), investors may also be required to accede to an existing shareholders’ agreement over which they have had little or no opportunity to negotiate or influence.
For the modern VC ecosystem, SAFEs and ASAs are important tools for facilitating early-stage investment. However, they are not interchangeable.
Despite their apparent simplicity, it is important that parties seek appropriate legal and specialist advice to ensure a SAFE or ASA operates as intended. This includes considering compatibility with local laws in cross-border transactions and, in a UK context, ensuring compliance with company law and regulatory requirements.
DWF has the largest venture and growth capital group in the UK with over 79 lawyers in 9 offices and supports investors and companies across several sectors including financial services, technology, media and telecommunications, life sciences and healthcare and real estate and infrastructure.
If you would like further information or assistance with a transaction, please contact any member of our specialist team.
