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© Castrén & Snellman

1
Introduction
• Jaakko Lindgren
• Senior Associate, Castrén & Snellman Attorneys Ltd

• Various legal issues relating infor...
Facts
• Solutions for all your business law challenges
• Over 150 lawyers in total. Experts suited to all legal
needs

• O...
© Castrén & Snellman

4
© Castrén & Snellman

5
Hybrid Instruments in Startup Financing
Convertible notes and SAFE

© Castrén & Snellman

6
www.arcticstartup.com

© Castrén & Snellman

7
Hybrid instruments
• Balancing risks and profits
• Differ from pure equity or debt instruments e.g. in
their
• Distributio...
Covertible note – main features
• Loan, which can be converted into company shares
• Conversion launched by a set of event...
Background for developing SAFE
• YCombinator has been a forerunner in promoting
the use of convertible notes in startup fi...
Main features of SAFE
• Actually a further structured convertible note
• Includes a liquiditation preference structure
• M...
Conversion of SAFE
• Conversion into a special class of preferred
shares, ”SAFE Preferred shares”
• Conversion is launched...
Example calculations
Investor has purchased a SAFE for $100,000. The Valuation Cap is $5,000,000.
The company negotiates w...
Example calculations
• Investor has purchased a SAFE for $100,000. The
Valuation Cap is $7,000,000.
• The company grows, g...
Example calculations
• Example 8
• Investor has purchased a SAFE for $20,000. The
Discount Rate is 80%.
• The company has ...
The Finnish Companies Act in relation
to convertible notes and SAFE
• Both convertible notes and SAFE are ”special
rights ...
FCA chapter 10 section 3
A decision concerning the issue of option rights
or other rights referred to in section 1 shall
c...
The Finnish Companies Act in relation
to convertible notes and SAFE
• Need for multiple share classes (FCA 3:1) in case of...
SAFE Summary
•

Transaction costs are not as low as promoted
• Possibly high transaction costs of implementing necessary m...
In conclusion
• Hybrid instruments are recommendable form of
financing for startups
• However, especially in case of small...
Thank you!

Jaakko Lindgren
Senior Associate
Master of Laws
Phone +358 (0)20 7765 444
Fax +358 (0)20 7761 444
jaakko.lindg...
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Hybrid Instruments in Startup Financing, Convertible notes and SAFE

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Jaakko Lindgren, Senior Associate, Castrén & Snellman Attorneys Ltd.

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Hybrid Instruments in Startup Financing, Convertible notes and SAFE

  1. 1. © Castrén & Snellman 1
  2. 2. Introduction • Jaakko Lindgren • Senior Associate, Castrén & Snellman Attorneys Ltd • Various legal issues relating information technology • Legal Counsel, Tieto Corporation 2009-2013 © Castrén & Snellman 2
  3. 3. Facts • Solutions for all your business law challenges • Over 150 lawyers in total. Experts suited to all legal needs • Offices in Helsinki, Moscow and St Petersburg • Top-rated in Chambers, IFLR 1000, Legal 500 EMEA and PLC: Which Lawyer © Castrén & Snellman 3
  4. 4. © Castrén & Snellman 4
  5. 5. © Castrén & Snellman 5
  6. 6. Hybrid Instruments in Startup Financing Convertible notes and SAFE © Castrén & Snellman 6
  7. 7. www.arcticstartup.com © Castrén & Snellman 7
  8. 8. Hybrid instruments • Balancing risks and profits • Differ from pure equity or debt instruments e.g. in their • Distribution and control rights • Payment priorities • Liquidation and dilution preferences • Permanent • Conflicts between different fields of law • E.g. corporate law, tax law, accounting © Castrén & Snellman 8
  9. 9. Covertible note – main features • Loan, which can be converted into company shares • Conversion launched by a set of events or maturity date • Creditor’s receivable is set off against the subscription price • Treated as debt in accounting until conversion • Accrues interest • Pre-determined valuation – conversion ratio decided, when entering into contract • Usually conversion ratio = principal of the loan / conversion ratio at the moment of issuing the note © Castrén & Snellman 9
  10. 10. Background for developing SAFE • YCombinator has been a forerunner in promoting the use of convertible notes in startup financing • Aim to lower the transaction costs • Simplicity as a target • The mechanisms and options are actually variable • SAFE was created to address certain problems with convertible notes, such as: • Maturity date (creating a threat of insolvency) • Accrued interests (complicated calculations) © Castrén & Snellman 10
  11. 11. Main features of SAFE • Actually a further structured convertible note • Includes a liquiditation preference structure • Main differences compared to a traditional convertible note: • Conversion launched by only circumstances, not by a maturity date • No accruing interest • Appreciation of stock price controlled with a valuation cap or discount rate • Permanent investment? © Castrén & Snellman 11
  12. 12. Conversion of SAFE • Conversion into a special class of preferred shares, ”SAFE Preferred shares” • Conversion is launched in case of: • Equity Financing • Liquidity Event • Change of Control or IPO • Dissolution Event © Castrén & Snellman 12
  13. 13. Example calculations Investor has purchased a SAFE for $100,000. The Valuation Cap is $5,000,000. The company negotiates with investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000. The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue and sell 220,022 shares of Series A-1 Preferred to the SAFE holder, at $0.4545 per share. In the SAFE, the Series A Preferred is referred to as “Standard Preferred Stock” and the Series A-1 Preferred is referred to as “SAFE Preferred Stock.” The table below sets forth a comparison between the Standard Preferred and the SAFE Preferred, as each would be described in the company’s certificate of incorporation: Standard Preferred Stock SAFE Preferred Stock Liquidation preference on a per share basis: $0.90 $0.4545 Aggregate payout in a change of control transaction (each series pari passu with the other): $1,000,000 $100,000 Conversion price and original $0.90 issuance price at the time of (initially converts into 1,100,110 the Series A Preferred fishares of common stock) nancing: Dividend Rate per share (based on an 8% dividend): $0.072 $0.4545 (initially converts into 220,022 shares of common stock) $0.036 © Castrén & Snellman 13
  14. 14. Example calculations • Investor has purchased a SAFE for $100,000. The Valuation Cap is $7,000,000. • The company grows, generates revenue and becomes cash flow positive, and therefore does not need to raise outside capital. The company has no acquisition offers and no plans to go public. • The SAFE will remain outstanding until the company has a liquidity event, even if that liquidity event doesn’t happen for years after the original date of purchase. • Or it never happens? © Castrén & Snellman 14
  15. 15. Example calculations • Example 8 • Investor has purchased a SAFE for $20,000. The Discount Rate is 80%. • The company has negotiated with investors to sell $400,000 worth of Series AA Preferred Stock at a $2,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing is 10,500,000. • The company will issue and sell 2,105,263 shares of Series AA Preferred at $0.19 per share to the new investors. The 20% discount applied to the per share price of the Series AA Preferred is $0.152. Accordingly, the company will issue 131,578 shares of Series AA-1 Preferred to the SAFE holder, at $0.152 per share. © Castrén & Snellman 15
  16. 16. The Finnish Companies Act in relation to convertible notes and SAFE • Both convertible notes and SAFE are ”special rights entitling to shares” according to the FCA • Issuing special rights requires ”a weighty financial reason” • The General Meeting can decide on issuing special rights or authorize the board to decide on the issuance © Castrén & Snellman 16
  17. 17. FCA chapter 10 section 3 A decision concerning the issue of option rights or other rights referred to in section 1 shall contain the following information: for payment for the shares; • • (1) the shares to which each option right or other right referred to in section 1 pertains, as well as whether new or treasury shares are to be issued; • (2) the number or maximum number of option rights or other rights referred to in • section 1 to be issued; • (3) who has the right to receive or to subscribe for option rights or other rights referred to in section 1; • (4) if the option rights or other rights referred to in section 1 are to be issued against consideration, their subscription prices or other consideration for them, the subscription period and the deadline for payment; • (6) justification for the existence of the weighty financial reason for the issue of the rights, as referred to in section 1(1), as well as justification for the determination of the subscription price or the other consideration for the rights and of the subscription price of the shares; and (5) the subscription prices, subscription period and the deadline © Castrén & Snellman (7) the status of the rights in a share issue, in the issue of rights under this chapter in accordance with some other decision, in the distribution of company assets in accordance with chapter 13, section 1(1), in the reacquisition of rights under this chapter, in the merger of the company into another company, in the demerger of the company and in the redemption of minority shares in accordance with chapter 18. 17
  18. 18. The Finnish Companies Act in relation to convertible notes and SAFE • Need for multiple share classes (FCA 3:1) in case of SAFE • Share class description in the articles of association needed Basically description according to the SAFE –agreement. However, if the concepts within the agreement are not well established in Finland, there is a problem in defining them  impact on transaction costs • Probably still interpreted as convertible note according to FCA • Price of the SAFE -instrument credited into debt account © Castrén & Snellman 18
  19. 19. SAFE Summary • Transaction costs are not as low as promoted • Possibly high transaction costs of implementing necessary measures to comply with FCA, because • Number of scenarios under the instruments is high • Definitions in the articles of association and in the decisions made by the shareholders and the board must cover the scenarios • • If executed, registration issues with the Finnish trade register Not recommended for small investments due to the possibly high transaction costs • If the compliance with the FCA provisions can be ”standardized” this might change • Altough promoted as ”simple” and including only ”few” issues to negotiate, requires expertise to understand the effects of those few negotiable parameters © Castrén & Snellman 19
  20. 20. In conclusion • Hybrid instruments are recommendable form of financing for startups • However, especially in case of small investments, high rate of standardization is needed in order to keep transaction costs low • Standardization is not just a matter of the contract between the investor and the company • GM decisions, articles of association, registrations © Castrén & Snellman 20
  21. 21. Thank you! Jaakko Lindgren Senior Associate Master of Laws Phone +358 (0)20 7765 444 Fax +358 (0)20 7761 444 jaakko.lindgren@castren.fi © Castrén & Snellman 21

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