- Investors may take ordinary shares, preference shares, convertible notes or SAFEs.
- Institutional investors usually ask for preference shares with extra rights.
- Convertible notes and SAFEs defer the valuation question to a later priced round.
- A term sheet sets the commercial deal; most of it is not binding.
Shares
The simplest route is to issue new shares. Early investors may take ordinary shares, but institutional and venture capital investors usually ask for preference shares, which carry extra rights such as getting their money back first on a sale or winding up.
Convertible notes
A convertible note is a loan that converts into shares at the next funding round. Like any loan it carries interest and has a maturity date, and if it has not converted by then it may have to be repaid.
SAFEs
A SAFE (simple agreement for future equity) was created by Y Combinator in the United States. The investor pays now for shares to be issued at a later priced round. Unlike a note, a SAFE carries no interest, has no maturity date and does not have to be repaid. Because it comes from American practice, a Singapore company should have its terms reviewed against Singapore law before using it.
Valuation caps and discounts
Notes and SAFEs usually reward early investors in two ways. A valuation cap sets the highest valuation at which their money converts, and a discount lets them convert at a lower price than new investors pay in the round. Many instruments have both. With a 'post-money' SAFE the cap includes the new money, which makes it easier for founders to see how much of the company they are giving away.
The term sheet
For a priced round, the investor and the company usually agree a term sheet first. Most of it is not legally binding, though clauses on confidentiality and exclusivity typically are. It sets out the main points that the full documents will follow, including:
- The valuation, and whether it is pre-money, post-money or fully diluted.
- The investor's liquidation preference, and whether the investor also shares in what is left after it is paid back.
- Protection against dilution if shares are later issued at a lower price.
- Reserved matters the investor can veto, and any board seat.
- Information rights, pre-emption, drag-along and tag-along.
Rights given to investors in a later round must fit with those already given in earlier rounds, so keep every round's documents in view when negotiating the next.
This article is general information on Singapore law and is not legal advice. Rules and agency policies change, and every situation is different. For advice on your own circumstances, speak with one of our lawyers.
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