Much is being written on the difficult economic conditions presently facing businesses, caused by a higher rate of inflation than has been seen for decades, the spectre of a recession as well as the war in Ukraine and continuing effects from the COVID pandemic, and many have needed to downgrade their forecasts.

For those companies on a growth journey and wanting to use venture capital and/or private equity, this has curtailed their cash runway giving rise to a need to raise additional investment quickly but with the economic winds turning and resulting uncertainty in the market company valuations are proving difficult to agree. 

In this article we set out a couple of ideas to approach this challenge. 

Convertible Loan Notes

We are seeing an increasing use by companies and investors of convertible loan notes (convertibles), being investor loans that have the right and obligation to convert into shares in the company borrower upon the occurrence of certain future events. These events are typically an equity fundraising or an exit, with the loan being either repaid or converted at the maturity date for the loan if neither has occurred.

The price of conversion is calculated by reference to the conversion event, and so the difficult question of valuation is essentially postponed to that time (and controlled by the third party investor or buyer). The investor in the convertible typically benefits from a discount to that price (e.g. 20%) in return for making finance available at an earlier stage, and occasionally an interest rate that accrues and rolls up. 

Convertibles generally have the advantage of being less complicated from a documentation perspective, and so can be agreed quicker than their straight equity counterparts, and have therefore often been used in a bridging finance situation to extend cash runway ahead of a next round of equity finance.

In a market where many more companies are looking for bridging finance in short order, convertibles can provide an ideal solution, although companies need to bear in mind the following: 

  • by setting the conversion rate by reference to the future “priced” round, entrepreneurs need to be confident that that future round can be raised on acceptable terms. Whilst the private equity and venture capital markets are showing resilience in some sectors at present, a future “down round” (where new money is raised at a lower company valuation than one that has been agreed for the purposes of raising capital in the past) will result in additional dilution for founders and existing investors if a discount applies on conversion;
  • the convertible is, by definition, a loan and so will need to be repaid at maturity if a conversion event does not transpire. Founders will therefore want to build in a prudent time buffer to ensure that they can make the progress needed in the business, to deliver the next fundraising round before that date;
  • as downside protection, investors may insist that the loan is secured against the assets of the company. This is understandable given the economic conditions at present, but founders should be vigilant as to the circumstances in which the loan may be enforced. The granting of security may also make other forms of finance (e.g. R&D tax credit loans) more difficult to obtain.

Advance Subscription Agreements

Investors should also note that, as the convertible is a loan, the shares which are acquired through the convertible will not qualify for the Seed Enterprise Investment Scheme (SEIS) or Enterprise Investment Scheme (EIS), important tax reliefs which, at the time of writing, it is understood have survived Jeremy Hunt’s U-turn on many of the measures announced by his predecessor and in fact are planned to be extended. 

It is however possible to structure the investment through an Advance Subscription Agreement (ASA), under which the investor commits capital on the basis that it will always be invested in equity (and not repaid), with the price at which that equity is acquired being calculated in a similar manner to the convertible option, that is by reference to a future event (e.g. an equity fundraising or exit) and sometimes including a discount. 

If structured correctly, the ASA can qualify for SEIS or EIS relief (and we are seeing companies launch parallel offers of convertibles and ASAs depending on whether the investors wish to claim such reliefs).

The ASA will need to have a default conversion price which will apply at the agreed long stop date. HMRC issued guidance previously to the effect that the long stop date should be no more than 6 months – this was, however, in a more benign economic environment and many companies are asking HMRC to approve an extension on a case by case basis.


Despite the current macro-economic turbulence and a somewhat inevitable overall decline in the rate of private equity investment so far this year, we have seen a number of transactions complete across our national team in recent months as investors continue to sit on, and look for appropriate opportunities to deploy, historic amounts of capital. Instruments such as convertibles and ASAs add valuable flexibility to deal with these tough times (whether that be supporting existing portfolio companies or making new investments), and we expect to see further growth in their use during the coming quarters. 

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at November 2022. Specific advice should be sought for specific cases. For more information see our terms & conditions.

Date published

14 November 2022


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