ASA or convertible loan note? Taking money before a priced round

A priced round means agreeing what the company is worth, issuing shares at that price, and signing a full set of documents: subscription agreement, shareholders' agreement, new articles. That takes weeks and costs money. Early investors often want to get in before that, and founders want the cash. So the money goes in now, and the shares are issued later at a price set by the next proper round, usually with a discount to reward the early investor for taking the risk.

An ASA is a subscription for shares, paid in advance. The investor pays now; the shares are issued at the next qualifying round, at that round's price less a discount (typically 10 to 30 per cent), or at the price implied by a valuation cap if that is lower. If no round happens by the longstop date, the shares are issued anyway at a fallback valuation written into the agreement.

Three things make an ASA an ASA, and all three matter for tax: the money cannot be repaid, it carries no interest, and it must convert into shares. HMRC's published view is that an ASA can qualify for SEIS and EIS only if it has those features and a longstop of no more than six months, with no investor protections that would let the money come back. That is why UK angels, who nearly always want SEIS or EIS relief, ask for an ASA.

A convertible loan note is a loan that converts into shares on a trigger, usually the next round, at a discount or cap. Until then it is debt: it can carry interest, it can have a maturity date on which it is repayable in cash if no round has happened, and it ranks ahead of shareholders if the company fails.

That flexibility is the attraction and the cost. A note is better for an investor who wants the option of getting money back, for a bridge from an existing investor between rounds, or for anyone outside the UK tax system. It is useless for SEIS and EIS, because relief is given on shares and a loan is not shares. Converting the note into shares later does not fix that: the shares were not subscribed for cash at the time of issue in the way the rules require.

• UK angel who wants SEIS or EIS: ASA, with a longstop of six months and no repayment right. Get HMRC advance assurance before you take the money.
• Existing investor bridging you to the next round: loan note. They already hold shares, relief is not the point, and they may want interest and seniority.
• Investor abroad, or a fund that does not use EIS: either; a note is more familiar to most of them.
• Founder or family lending money: a simple loan, not a convertible, unless the lender genuinely wants shares.

Discount. 10 to 30 per cent off the next round's price per share. Higher than that and the next round's investors will push back.

Valuation cap. A ceiling on the valuation used for conversion. If the next round values the company at £5m and the cap is £3m, the early investor converts at £3m. Caps protect investors who come in before a big jump; founders should keep them realistic, since a very low cap hands away a large slice.

Qualifying round. The size of round that triggers conversion. Set it so that a small top-up does not force conversion at an accidental price.

Longstop or maturity. What happens if no round comes. For an ASA, conversion at a fallback valuation within six months. For a note, either repayment or conversion at the holder's option.

Information and consent rights. Keep these light. An investor holding an ASA is not yet a shareholder, and giving them a veto over the next round defeats the purpose.

If your investor wants SEIS or EIS, use an ASA. If repayment matters more than relief, use a convertible loan note. Both are in the Seed round pack alongside the term sheet and the three documents of the priced round that follows. Tax relief is unforgiving of drafting errors, so if the amounts are material, have the finished ASA checked for a fixed fee before signature.