Written by: Itay Sagie
If you are an Entrepreneur raising capital, you must have heard about these three investment vehicles: Share Purchase Agreement- SPA, Convertible Loan Agreement - CLA, and Simple Agreement for Future Equity - SAFE, and wondered what is the difference between them. More importantly how are they used and when should you consider each type of investment.
Share Purchase Agreement – SPA
Share purchase agreement means that the investor is buying shares in the company at this point in time in a certain price per share / company valuation. This is has been the conventional investment vehicle for Venture Capitalists for many years for investments in all stages.
Here are the main characteristics of a share purchase agreement:
In a Share Purchase Agreement, the investor buys shares today at a known price per share, thus there is a known company valuation today. This offers clarity for the investor.
The SPA is normally a very long and complex one, some are 300-400 pages long. These pages will include countless clauses that protect the investor in countless scenarios that may occur. Such as what if a competitor bids for an acquisition, what if the company valuation drops down the line, what if you, the entrepreneur don’t meet your goals, what if we want to sell our shares, what if the others don’t want to sell their shares. These may seem immaterial to the entrepreneur, however, they mean a great deal for an experienced investor. These complex clauses normally aim to protect the investor from cases of an exit at a low valuation or give them extra power to make sure the company will return more value for the investor.
The SPA's complexity also requires legal firms to represent both sides. The legal and financial processes that take place cost north of $60K and take a few months to complete. Therefore, it is usually executed in round post-seed rounds with larger check sizes to justify these expenses.
Convertible Loan Agreement - CLA
The CLA is essentially a loan which can be converted to equity. As with any loan, you will find an interest rate and a maturity date. The Entrepreneur accumulates the interest rates (often around 8% annually which is the normal IRR for investors). The investor can then choose if they want to be paid back the loan with the interest of if they want to convert their loan + interest into shares. If they choose the latter, then either there is an agreed upon price per share (company valuation) or there is a discount from a future investment round.
If there is an investment round, and the investor can buy shares at a discounted price, there is also a mechanism of a “Cap” or capped value. This means that beyond a certain valuation, the investor still buys shares at the capped value. This protects the investor from a very high valuation = less equity for the investor. It is important to note, the usually the interest is only paid or converted upon maturity and is not paid annually.
The characteristics of the Convertible Loan Agreement
The CLA does not include the current company valuation, so the negotiation is shorter, the agreement itself is pretty standard, which makes life more friendly for both sides, especially the Entrepreneur.
On the other hand, if the investor chooses not to convert the loan into equity, it may pose a large financial burden on the company.
Venture Capital firms tend to convert to equity, especially when the company is doing well, other more conservative investors and lenders, operate under a different business model and normally choose to collect their debt upon maturity.
Simple Agreement for Future Equity – SAFE
The SAFE was coined by Y Combinator in California back in 2013. As the title eludes to, this is a simple agreement, hence very entrepreneur friendly, it can be 2 pages long. Built as an alternative to the CLA, there is no current company valuation in this case as well. However, there is no debt aspect to this agreement. The investor simply postpones the valuation to the next round. This normally makes sense in Seed-stage investments where the check size is small, and it will not make sense to execute a full SPA.
The only two levers the investor has is the discount rate and Cap. Much like the CLA, the investor gets a discount rate from the valuation of the next round, and there is also a maximum valuation (Cap) to protect the investor from a very high valuation. The entrepreneur and investor can negotiate if there is a Cap and if so, what that Cap is. I normally see around 20% discount and around $8M cap for a $1M Seed-stage SAFE rounds.
Here are the main characteristics of the SAFE
Very Entrepreneur Friendly – short standard agreement, very little to negotiate now. In many cases this sits well with investors who wish to quickly invest small amounts in many startups, and would like to avoid the legal and financial hassle of a full SPA or even CLA.
Risky for investors – what if there is no next round? The investor gives money now, and gets nothing in return. I have seen cases where modifications were made to a SAFE. One modification I added myself, is a “No-Event Event” meaning if no future investment round occurs after a period of time, say 18 months, then the investor gets their shares at a known price per share / company valuation.
In summary, all three investment vehicles are valid, are negotiable, and should be fully understood by the Entrepreneur. While I urge every Entrepreneur to consult with a legal and financial advisor before signing an investment document, it is too often that I find Entrepreneurs simply throwing the responsibility on their advisors to handle the “small details”. These are no small details, these clauses may be the difference between being able to raise a next round or not, and between earnings millions of dollars upon selling your company or making no money at all.
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