UK Founder Series: Top Tips on Raising Bridge Financing

Convertible securities such as simple agreements for future equity (SAFEs), advance subscription agreements (ASAs) and conventional convertible loan notes (CLNs) are increasingly used as agile and flexible funding instruments, as they can provide companies with short-term, quick-access capital that only converts into equity based on future events and/or valuations. Our Deal Flow 5.0 data shows that in 2024, ASAs and SAFEs accounted for 63% of all convertible deals, outpacing debt-based instruments. The proportion of convertible financings increased to 33% of all rounds, reflecting ongoing market uncertainty and the desire to delay setting a fixed valuation.

In the tenth instalment of Orrick's Founder Series, our Technology Companies Group offer key guidance for UK founders looking to this alternative financing option while they set up for their next equity round and explore some of the key terms found in these instruments.

1. When conversion happens. The right to convert convertible securities is usually triggered on certain future events, such as a future financing round where at least a certain threshold of further funding is provided, an exit event, an initial public offering or on a set longstop / maturity date.

Conversion can either be automatic (i.e. immediately prior to one of the trigger events listed above), or at the election of the investor (i.e. where a financing has taken place, but where it does not meet the threshold specified for it to be an automatic conversion).

Automatic conversion can provide the company, existing investors and incoming investors with certainty that the company will be going into its next financing round or exit debt-free and removes any unnecessary friction from the conversion process.

Recent market practice has seen a continued focus on clear conversion mechanics, especially as the time between priced rounds has increased. Our Deal Flow 5.0 report notes that the size of convertible rounds has increased tenfold since 2021, as founders seek to extend runway in a challenging fundraising environment.

2. What the instrument converts into. The trigger event would normally influence the class of share the investment amount converts into.

As part of the incentivisation rubric of convertible instruments, it is usual for the investment amount to convert into the most senior class of shares issued on the company’s next financing round (usually at a discount as a sweetener, see below). The "most senior class" typically refers to the class of shares with the highest priority for dividends and liquidation proceeds, often preferred shares. This can affect founder control and dilution, as these shares may carry additional rights or protections. It is worth noting that if you have Enterprise Investment Scheme (EIS) investors and are using an ASA (as EIS is not compatible with convertible debt), additional drafting will need to be added to ensure that the longstop date is no more than 6 months from the date of investment and that the investment amount converts into an ordinary class without certain preferences; so that the conversion shares can be EIS-eligible.

On the longstop date, an exit event, an initial public offering or an insolvency, the investment amount would normally convert into either the most senior class of share currently in issue, or into ordinary shares. Where conversion results in an investor acquiring a significant equity interest (25% or more of the issued share capital) or certain control rights, companies should consider whether the conversion or exit event could trigger a notification under the National Security and Investment Act 2021 (NSIA), particularly in sensitive sectors such as AI, advanced robotics and data infrastructure. While this is unlikely to be relevant in most instances, early legal advice and appropriate drafting can help manage compliance and avoid delays or complications at the point of conversion. For more information on staying compliant under the National Security and Investment Act (NSIA), you can read our previous instalment here.

3. Conversion price. There are a number of mechanisms which play into the price per share on a conversion event and which you can use to incentivise your investors to provide the bridge financing required to get your company to its next equity funding round, most commonly:

• Discount: as early-stage convertible investors will be investing in the company at a pivotal and riskier stage in its lifecycle without immediately receiving any of the benefits and investor protections enjoyed by investors on an equity financing round, one way to incentivise investors to invest is to offer them the ability to convert at a discount on the conversion price associated with certain trigger events. Our Deal Flow 5.0 report indicates that, throughout 2024, we continued to see big discounts being given on convertible financings. Discounts ranged between 20%-40%, with the upper end being a noticeable uplift from the upper end in 2021 (which was closer to 20%) and even higher than the heights of 2023 (at 33%).
• Valuation cap: the valuation cap is designed to provide a ceiling on the conversion price. Where the next round valuation is higher than the valuation cap, the investment amount will convert at the cap, resulting in the investor receiving an increased number of shares to that which they would have otherwise received. This provides the investor with a significant benefit for taking the additional risk and investing early.

It is increasingly standard for instruments to include both a discount and a valuation cap, with the lower price applying in the event of conversion. For example, if the next equity round is at a £10 million valuation, the cap is £5 million, and the discount is 20%, the investor will convert at the lower of the two prices, maximising their equity. This means, if the discounted price is £0.80/share and the capped price is £0.50/share, the investor gets the benefit of the lower price (£0.50/share).

Founders should be aware that these mechanisms can increase dilution, especially if the company’s valuation rises sharply before the next round. However, the combination of these mechanisms can also create a fair balance between founders and investors as the discount provides a baseline reward for investors' early risk, while the cap can be set at a level that founders are comfortable with, ensuring that they are not unduly diluted in the event of a successful financing.

4. Does the instrument carry interest? As a debt instrument, CLNs will usually accrue interest from the date that the funds are advanced until conversion or repayment. The applicable interest rate is a commercially negotiated term and will often be dictated by the circumstances of the bridge financing and the perceived level of risk being taken by the investors. Our Deal Flow 5.0 report highlights that interest rates throughout 2024 have increased, with 65% of the convertible rounds where interest is applied having an interest rate of 8% or higher, reflecting the higher cost of capital in the current market.

Unlike CLNs, SAFEs and ASAs are equity instruments and so do not typically accrue interest. Further, accruing interest rate would prohibit an ASA or SAFE from being EIS / SEIS eligible.

Notably, in the case of a CLN, accrued interest is rarely paid in cash whilst the instrument is outstanding, and more often gets “rolled up” and added to the principal amount to be repaid or converted on the applicable trigger event as if it was part of the original capital.

5. Redemption. Unlike ASAs (and most SAFEs), which do not usually provide for redemption of the investment amounts, CLNs will often include a redemption provision. This allows the investor to demand repayment under certain circumstances (for example on an event of default, such as an order being made for the winding-up, liquidation, administration or dissolution of the company), or the company (sometimes with the prior approval of the investor or a majority of the investors) to seek to repay the debt prior to conversion on a trigger event.

Redemption can sometimes carry a premium to balance a high-risk profile of an investment. In such circumstances, the company is required to pay back the principal amount of the debt along with a redemption premium (most commonly 200% of the principal amount) as well as any accrued interest.

From the company’s perspective, although not unusual, this can result in the debt being expensive and should be resisted. We often see redemption premiums form a more important part of negotiations in distressed financing scenarios, where there is a risk that the company may not be able to deliver on its business plan, is under-performing, or is in danger of triggering an insolvency event.

6. Security. Taking security is not market standard and is generally not viewed as appropriate in the context of convertible financing rounds of early-stage startups.

The limited occasions where you may see investors requesting security over the company’s assets are in distressed financing scenarios where investors invest money as a way to rescue the company from potential insolvency and therefore require the additional comfort given by obtaining security against the company’s assets.

7. Tax considerations. One of the benefits of ASAs is that (if drafted appropriately) individual investors who are subject to tax in the UK may be able to benefit from certain tax reliefs in respect of the shares issued pursuant to ASAs, specifically the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).

Although we won’t go into detail here about the EIS and SEIS regimes, one of the key requirements is that EIS / SEIS investors invest their money in exchange for equity in higher risk, early-stage companies, therefore the investment cannot resemble debt or carry investor protections that could otherwise protect that investor’s return.

Unlike CLNs, the features of which reflect a debt-like position (e.g. the ability / obligation to repay in certain circumstances, the duration of the loan, and the inclusion of interest), ASAs convert into equity in all circumstances and do not include these debt-like terms. As a result, ASAs are more likely to be eligible for EIS / SEIS relief. 

This is a highly technical area requiring specific tax advice, so you should always seek specialist advice to ensure that the proposed investment would qualify for EIS / SEIS and your investors should seek their own tax advice regarding their personal tax position and eligibility for EIS / SEIS.

8. What if you have US investors? If you have US investors coming in as part of your convertible round, they are likely to be most familiar with the form of SAFEs (rather than ASAs or CLNs), which were popularised and standardised by the US start-up accelerator, Y Combinator.

Although the Y Combinator SAFE is governed by Delaware law and is drafted specifically for investments into Delaware corporations, at Orrick we have created a SAFE template based on the Y Combinator SAFE, but which is subject to English law and includes amended terms appropriate for investments into companies incorporated in England and Wales. This gives US investors the comfort they require by investing on familiar terms, while also being appropriate from the company’s perspective.

9.  Warranties. More common in the context of a CLN rather than an ASA or SAFE, investors will sometimes seek additional protection through the inclusion of warranties provided by the company. Warranties are statements of fact given at the time of the agreement about the state of the company’s business, its assets, any potential liabilities etc., which give investors additional comfort around the value investment they are making.

We would not expect to see a full suite of warranties (in the same way as an equity investment round) in the context of a convertible financing, but certain title and capacity warranties, as well as very limited business warranties can sometimes be included.

To the extent the CLN includes warranties, you should consider whether your CLN investors should then also benefit from the warranties given at the time of an equity financing.

10. Other terms. Convertible instruments are intended to be a quick and easy way to raise capital. In contrast to traditional equity rounds, convertible fundraising involves short-form documents and fewer terms to negotiate, as the investor is not actually receiving equity (to which many of these rights attach) at the time of the investment.

Some investors, however, want to secure their position in respect of certain key investor rights on conversion of their convertible instruments, and we do sometimes see more investor-friendly positions being negotiated in convertible financings, mostly in the form of side letters.

Some of the more common terms we see requested are:

• Information rights to allow investors to monitor their investment and comply with their own reporting duties to LPs. Information rights were included in 49% of the convertible debt financings we saw in 2024, a 26% increase from 2023, reflecting investor demand for transparency.
• Consent rights for investors on key decisions relating to the company. Our Deal Flow 5.0 report highlights that only 15% of the convertible debt financings we advised on in 2024 included consent rights for investors (a significant reduction from 42% in 2023), reflecting a return to more company-friendly terms, where convertible debt investors have traditionally not obtained consent rights on their convertible investment, as they are not equity shareholders at the time of the investment.
• Pro rata entitlement to participate in the company’s next equity financing, with 42% of the convertible debt financings we saw in 2024 including pre-emption rights for convertible investors, as investors sought out some of the protections / rights they would have received as shareholders in a priced round, given the increased use by founders of this form of financing.
• Director or observer appointment rights on the next equity financing, with 19% of the convertible debt financings we saw in 2024 including this right for investors; a continued indication that being able to accurately track and influence portfolio company performance and decisions remains at the forefront of investors’ minds during choppier economic times.
• Most Favoured Nation provisions in essence allow investors to cherry pick “superior” terms from subsequent convertibles and absorb such terms within their own convertible. To the extent you do not intend to issue any more convertibles (on different terms e.g. with a bigger discount) ahead of your next equity round on which such convertibles will convert, this should not be a controversial request to accept. However, where you are likely to have additional convertible investors come in on more advantageous terms, you might want to consider pushing back on this request.

Our London TCG practice reflects London’s role as one of the world’s leading financial markets and a centre for international commerce. Nothing inspires us more than helping tech companies develop novel strategies and push boundaries. Through our extensive client portfolio, deal volume, and relationships in the tech ecosystem, we provide commercial and legal insight to each company’s strategy. We work with tech companies on all aspects of their business plans, financing strategies, protecting intellectual assets, retaining talent, securing and monetising data, and advocating for innovation-friendly public policy.

If you would like more details on any of the issues above, please contact Jamie Moore.

About the Series

Orrick's UK Founder Series offers monthly tips for startups on key considerations at each stage of their lifecycle, from incorporating a company through possible exit strategies. The Series is written by members of our market-leading London Technology Companies Group (TCG), with contributions from other practice members. Our Band 1-ranked London TCG team successfully completed over 350 financings and tech M&A transactions in 2023 & 2024 totalling $5B+ and has dominated the European venture capital tech market for over nine years (Pitchbook).
View all series instalments here