Convertible loan notes and SAFEs in the UK: how early-stage founders raise before a priced round
SAFEs are a US-born instrument that generally do not suit UK fundraising, so most early-stage UK companies raising before a priced round use a convertible loan note or, more often, an advance subscription agreement instead.
A convertible instrument lets a founder take investment now and defer agreeing a company valuation until a later, priced round, and in the UK this is usually done through a convertible loan note or an advance subscription agreement rather than the SAFE (Simple Agreement for Future Equity) that dominates early-stage fundraising in the US. The underlying idea, cash in now, shares later, at a price set by a future round, is the same across all three instruments, but the legal structure and the tax consequences for the investor differ in ways that matter a great deal to a UK seed-stage company.
Why doesn’t the US-style SAFE work well in the UK?
The core problem is tax relief. A SAFE is not a share and not a loan, it is a contractual promise of future shares, and that structure means it generally does not qualify for SEIS or EIS relief, the income tax reliefs that make early-stage UK investment materially more attractive to individual investors. Because a large proportion of UK angel investment is contingent on SEIS or EIS eligibility, an instrument that cannot offer it is a real handicap when trying to close a round, which is the main reason SAFEs, while not illegal to use in England and Wales, have not become the market standard here the way they have in the US.
What is an advance subscription agreement, and how is it different?
An advance subscription agreement (ASA) is the UK market’s closest equivalent to a SAFE: an investor pays money now in exchange for a contractual right to receive shares at a future date or triggering event, typically the next qualifying funding round, usually at a discount to that round’s price. Unlike a SAFE, an ASA can be structured to qualify for SEIS and EIS relief, which is the main reason it has become the more commonly used “SAFE-like” instrument for early UK rounds. Because HMRC’s rules for SEIS and EIS require that relief-qualifying shares are issued reasonably promptly, an ASA intended to qualify must generally convert into shares within a defined period, commonly six months, of being signed, and it must not carry a right to interest or a right to be repaid in cash, since either of those features can push it closer to being treated as a loan rather than pre-payment for shares. It is worth having an ASA drafted, or at least checked, by a solicitor familiar with SEIS and EIS qualifying conditions, since getting the structure wrong can mean investors lose the relief they were expecting.
What is a convertible loan note, and when might a company use one instead?
A convertible loan note (CLN) is structured as debt rather than a future promise of shares: the company borrows the money, the loan usually accrues interest, and it converts into equity, or in some cases can be repaid in cash, when a defined trigger occurs, most often the next priced funding round. Because a CLN is a genuine loan until it converts, it does not qualify for SEIS or EIS relief in the way a correctly structured ASA can, which is one reason ASAs are often preferred for the smallest, earliest rounds where investors are specifically seeking that relief. A CLN can still be the right instrument in situations where SEIS/EIS eligibility is not the deciding factor, for example a bridge round between two priced rounds, where existing shareholders or new investors are less focused on income tax relief and more focused on downside protection, since a loan-based instrument generally gives an investor a stronger claim if the company is wound up than an equity-based one does.
SAFEs, ASAs and convertible loan notes compared
| SAFE | Advance Subscription Agreement (ASA) | Convertible Loan Note (CLN) | |
|---|---|---|---|
| Legal structure | Contractual right to future shares | Contractual right to future shares (prepayment for shares) | Debt instrument |
| Accrues interest | No | No | Usually, yes |
| SEIS/EIS eligible | Generally no | Can be, if correctly structured | Generally no, while still debt |
| Typical UK usage | Rare | Common, especially pre-seed and seed | Common, especially bridge rounds |
| Conversion trigger | Next priced round (or defined date) | Next qualifying round, or a backstop date (often within 6 months for SEIS/EIS purposes) | Next priced round, maturity date, or other agreed trigger |
What terms typically appear in these agreements?
Most convertible instruments in the UK, whether ASA or CLN, include a discount rate, a percentage reduction applied to the price per share of the triggering round to reward early investors for taking risk before a valuation was agreed, and often a valuation cap, a maximum company valuation at which the instrument converts, which protects the investor if the company’s value rises sharply before the next round. Some also include a “most favoured nation” clause, giving the investor the right to adopt more favourable terms if the company issues another convertible instrument on better terms before this one converts. As with a term sheet for a priced round, none of these terms are unusual in themselves, but the specific discount, cap and backstop date agreed can materially change how much of the company an early investor ends up owning once conversion happens.
What should a founder weigh up before choosing an instrument?
The choice generally comes down to how important SEIS/EIS eligibility is to the investors being targeted, and how much certainty the company needs about not being asked to repay cash. For a first outside round aimed largely at UK angel investors, an ASA structured to qualify for SEIS and EIS is usually the more useful instrument, since the tax relief is often a genuine factor in an angel’s decision to invest and in how much they are prepared to put in. For a bridge between two priced rounds, often involving existing investors who are less focused on new tax relief and more focused on protecting their position, a convertible loan note is a common and reasonable choice.
A word on independent advice
Getting a convertible instrument’s SEIS or EIS qualification wrong, for example by allowing it to accrue interest, or by leaving the conversion trigger open-ended for longer than HMRC’s guidance allows, can mean investors lose relief they were expecting and, in some cases, can complicate a company’s ability to raise the following round cleanly. Because the qualifying conditions are detailed and change from time to time, it is worth checking a company’s intended structure against the live GOV.UK SEIS and EIS guidance and taking advice from a solicitor or accountant experienced in early-stage UK fundraising before using any convertible instrument, rather than relying on a general explainer such as this one.