Raising money before you agree a valuation: what an investor expects from an ASA

There is a specific moment that catches early-stage founders out. Someone wants to put money in. You want to take it. But nobody can honestly say what the company is worth yet, and spending three months and several thousand pounds in legal fees arguing about a valuation you will both regret is a poor use of a runway measured in months.

The standard answer is to take the money now and set the price later, at the next proper funding round, when there is a real negotiation with a lead investor to anchor it. Two instruments do that in the UK, they look superficially similar, and choosing the wrong one can cost your investor their tax relief — which in practice means costing you the investment.

The convertible loan note

A convertible loan note is a loan. It carries interest, it has a repayment date, and it converts into shares on a defined trigger, usually the next qualifying funding round. If that round never happens, the investor can normally ask for their money back.

That repayability is the whole appeal from the investor's side. It is also the problem. Because it is debt, it sits on your balance sheet as a liability, the interest accrues whether you can afford it or not, and if a round does not materialise you have a creditor rather than a shareholder — a distinction that matters enormously at the exact moment you can least handle it.

The advance subscription agreement

An advance subscription agreement is not a loan. The investor pays now for shares to be issued later, and the money cannot be returned. There is no interest, no repayment right, and no security. In exchange, the investor gets the shares at whatever price the next round sets, usually with a discount.

That sounds worse for the investor, and on paper it is. The reason ASAs dominate UK early-stage rounds anyway comes down to one thing: tax.

The tax point that decides it

SEIS and EIS relief is not available on shares issued on conversion of a loan. If an investor puts money in through a convertible loan note, the shares that eventually arrive do not qualify. For an angel investor in the UK, where SEIS offers substantial income tax relief on qualifying investments, that is not a technicality. It is most of the reason they were investing in an early-stage company at all.

An ASA, structured correctly, can qualify. HMRC has been clear about what correctly means, and the conditions are strict. The agreement must not allow the subscription money to be refunded under any circumstances. It cannot carry interest. It cannot be varied, cancelled or assigned. It must not give the investor the kind of protections a lender would expect. And it needs a longstop date — the backstop on which shares are issued if no funding round has happened — which HMRC expects to be no more than about six months from the date of the agreement.

Every clause that makes an ASA feel safer for the investor is a clause that makes it look more like a loan. Look enough like a loan and the relief disappears, which makes the investor worse off than the protection was worth.

That six-month longstop is the one founders most often try to negotiate away, and it is the least negotiable. A twelve-month ASA may be perfectly valid commercially and simply not qualify for relief. Investors relying on SEIS or EIS should be checking it, and the ones who have done this before will. The wider context for why they ask is set out in EIS and SEIS explained.

Discounts, caps and the dilution nobody models

The investor taking early risk expects to pay less per share than the people arriving at the priced round. Two mechanisms do that.

A discount gives them a percentage off the next round's price — commonly in the range of 10% to 30%. A valuation cap sets a maximum company valuation at which their money converts, however high the next round prices. Some agreements use both, converting at whichever is better for the investor.

Work an illustrative example. You raise £150,000 on an ASA with a 20% discount. Nine months later you close a priced round at £1.50 a share. The ASA investor converts at £1.20, receiving 125,000 shares rather than the 100,000 their money would have bought at the round price. Those extra 25,000 shares come out of the existing shareholders — you — not out of the new investor.

Now add a cap. If the ASA carried a £2 million cap and the round prices the company at £4 million, the investor converts as though the company were worth £2 million: their effective price halves and the share count roughly doubles again. Founders routinely agree caps without modelling this, then discover at the round that their own holding is several percentage points smaller than they had assumed, and that the new lead investor has repriced their offer accordingly.

Build the cap table for the conversion before you sign, not after. It takes an hour in a spreadsheet and it is the single most useful hour in the entire process.

When neither is the right answer

Both instruments assume a priced round is coming. If it is not — if you are a profitable trading business rather than a venture-track one — then converting future equity is solving a problem you do not have, and you are giving away permanent ownership to smooth a temporary cash gap. Debt, invoice finance or simply growing more slowly are usually better answers, and the honest case for that is made in bootstrapping isn't a virtue.

And if a round is genuinely close, consider just pricing it. Deferral has a cost: an uncapped ASA in a company that performs well is expensive for the investor, and a capped one in a company that performs very well is expensive for you. Nobody has ever regretted a straightforward priced round with clean documents.

The practical order of events

Agree the discount and cap in a short term sheet before any lawyer opens a document. Confirm with your investor whether they are relying on SEIS or EIS relief, because that answer alone rules out the convertible loan note. Apply for advance assurance from HMRC if the relief matters to them. Use a recognised ASA template rather than an adapted loan agreement — the clauses that make a loan safe are precisely the ones that break the relief. Model the conversion under two or three scenarios. And put the longstop date in your diary, because it arrives whether or not the round did, and shares get issued on that date regardless.

Common questions

What is an advance subscription agreement?

An ASA is an agreement where an investor pays for shares now and receives them later, at a price set by a future funding round or on a longstop date if no round happens. It is not a loan: the money cannot be refunded, there is no interest and there is no repayment right. In return the investor normally gets a discount to the next round's share price, and sometimes a valuation cap as well. UK early-stage rounds favour ASAs over convertible loan notes chiefly because a correctly drafted ASA can preserve SEIS and EIS relief for the investor, which conversion of a loan cannot.

Why can't investors claim SEIS or EIS on a convertible loan note?

The legislation does not allow relief on shares issued on the conversion of a loan. A convertible loan note is debt until it converts: it can typically be repaid in cash, it usually carries interest, and it gives the holder creditor rights. Because the shares arrive by converting that debt, they fall outside the qualifying conditions, and the investor gets no income tax relief and no capital gains treatment. For a UK angel investor this often removes the main reason for investing at that stage. It is the single most common and most expensive drafting mistake in early-stage rounds.

What is a valuation cap and should I agree to one?

A cap sets the maximum company valuation at which the early investor's money converts, regardless of how high the next round prices. It protects the investor from being penalised for the company doing well between the two events. Whether to agree one depends on how confident you are about the next round: if the priced round comes in far above the cap, the early investor converts at a much lower effective price and your own holding dilutes more than the headline discount suggests. Always model the conversion at two or three plausible round valuations before agreeing a cap, not afterwards.

How long can an advance subscription agreement run for?

Commercially you can agree any longstop date you like, but if the investor is relying on SEIS or EIS relief the practical answer is no more than about six months, which is what HMRC expects to see. A longer period makes the arrangement look more like a loan than an advance payment for shares, and puts the relief at risk. On the longstop date the shares are issued at whatever the agreement specifies, typically a pre-agreed fallback valuation, whether or not a funding round has taken place. Diarise the date when you sign, because it does not wait for your round.