CARE, along with the rest of the VIMA kit, is aimed at reducing transactional costs and time by allowing parties to focus on a limited number of commercial points.
The Convertible Agreement for Equity (“CARE”) is a convertible instrument which allows an investor to make a cash investment in a company in exchange for receiving cash or shares in a Singapore incorporated private company (company) upon occurrence of certain events.
Unlike the sale or issuance of equity, a company can issue a CARE quickly and efficiently, without the need to enter into multiple documents that may require significant legal and commercial negotiations.
This article focuses on:
(a) why CARE is required;
(b) the key trigger events within CARE; and
(c) other key features of CARE catering to regional preferences.
B. THE NEED FOR CARE
Singapore continues to attract and foster a vibrant start-up community. This has led to a rise in demand for early-stage financing and the need for early-stage financing instruments.
CARE forms part of the suite of the Venture Capital Investment Model Agreements (“VIMA”) standardised documents. The objective is to reduce transactional costs and the time taken to negotiate during early-stage financings, by providing a balanced set of template agreements as a starting point and allowing the parties to focus on a limited set of commercial points. CARE has been drafted with the same objective in mind.
CARE also adopts some of the key principles from the Simplified Agreement for Future Equity (“SAFE”), which has been widely used by investors and start-ups in various jurisdictions. By retaining key concepts of SAFE, CARE affirms the industry standardisation of these concepts and allows investors who are already familiar with SAFE to quickly adopt CARE for their investments in Singapore.
C. KEY TRIGGER EVENTS OF CARE
CARE allows an investor to make a cash investment in a company in exchange for receiving cash or shares in the company on the occurrence of certain events in the future.
The trigger events can be broken into two types of scenarios: the continuity scenario and the end scenario:
(a) A continuity scenario refers to events where the company continues to the next stage of its life cycle, which may be an equity financing or a liquidity event (elaborated upon in the next section). When such an event occurs, the CARE holder will receive cash or shares (or other forms of securities or tokens offered to other investors). The amount of cash or shares the CARE holder will receive in such scenarios will depend on:
(i) the consideration paid by the CARE holder;
(ii) the valuation of the company at the time of such event; and
(iii) the “discount rate” (if any) agreed in CARE.
(b) An end scenario caters for where the company ceases its business activities. In such event, the CARE holder is entitled to receive the cash consideration it paid for CARE.
1. Equity financing
An equity financing event is triggered if, after CARE is issued, the company raises capital by issuing shares. The CARE holder and the company can agree to define the trigger event, with reference to a certain minimum amount that the company is raising (that is, the concept of “Minimum Equity Raise” in CARE). This provides the company with some flexibility to further raise capital using equity, without triggering the automatic conversion of CARE. For example, the company may require emergency funding and find that its only funding option is to issue shares (for example, to existing shareholders or through another family-and-friends round).
In the event of an equity financing, CARE automatically converts the initial consideration paid by the CARE holder into shares of the company. The number of shares issued is determined by applying the “discount rate” to the subscription price per share for the shares being issued by the company to the investors who are participating in the equity financing. The “discount rate” feature rewards the CARE holder by giving a discounted subscription price per share (that is, giving the CARE holder more shares for the same cash investment) compared to the subscription price offered to the investors in the equity financing.
2. Liquidity event
A liquidity event is one which could result in a change of control of the company, an initial public offering or an initial coin offering by the company:
(a) A change of control occurs if a transaction or series of transactions results in either a person holding more than 50% of the voting rights of the company, or a sale of all or substantially all of the assets of the company.
(b) An initial public offering occurs if the company lists its shares on the Singapore Exchange Securities Trading Limited or other recognised securities exchange.
(c) An initial coin offering is any sale or issuance of digital tokens or instruments convertible into digital tokens by the company.
In a liquidity event, the CARE holder is entitled to receive cash. The amount depends on whether the “Multiple” feature in CARE is activated. If activated, the CARE holder will receive the greater of:
(a) the cash consideration paid by the CARE holder multiplied by the “Multiple” (the cash-out amount); or
(b) the amount equivalent of the number of shares the CARE holder would be entitled to receive in such a liquidity event (the conversion amount).
If the “Multiple” feature is not activated, the CARE holder will receive the amount equivalent to the number of shares the CARE holder would be entitled to receive in such liquidity event.
In a liquidity event, the CARE holder also has the option to receive shares or other form of consideration that is being received by other shareholders of the company instead of cash.
3. Dissolution event
CARE also caters for the end scenario which is a dissolution event. This provides for a scenario where the company may have hit a road block and the business or idea is not viable anymore. A dissolution event occurs if there is a voluntary termination of operations of the company, a general assignment for the benefit of the company’s creditors or any other liquidation or winding-up event. In a dissolution event, the CARE holder is automatically entitled to receive the consideration it paid for CARE.
4. Liquidation preference
It is important to know where a CARE holder will stand vis-à-vis other CARE holders, creditors and shareholders under the scenario where amounts are due to the CARE holder. CARE sets out the liquidation preference rights of the holder where the CARE holder is entitled to cash proceeds from the company. Where the holder stands in line vis-à-vis others depends on the event triggering the cash payment.
Where the holder is entitled to receive cash-out amount in a liquidity event or the initial consideration made by the holder in a dissolution event, the holder’s claim is:
(a) junior to other debt and creditors’ claims (that is, is paid after other debt and creditors’ claims);
(b) on par with payments to be made to other CARE holders and preference shareholders whose CARE is converted to preference share (that is, paid paripassu); and
(c) senior to ordinary shareholders (that is, is paid before the ordinary shareholders).
Where the holder is entitled to receive a conversion amount in a liquidity event, the holder’s claim is:
(a) junior to other debt and creditors’ claims;
(b) junior to any cash-out amounts payable by the company; and
(c) on par with payments to be made to other ordinary share, preference share and/or CARE holders entitled to receive payments from such event.
D. REGIONAL INVESTOR PREFERENCES
After consulting various investors in early-stage companies in the region, there was a preference for:
(a) some form of “finality” with a convertible instrument, and
(b) more “transparency” from the company regarding how the proceeds from the financing are used and how the company carries on its operations during the term of the instrument.
Typically for early-stage convertible instruments available in the market (such as SAFE), there is no automatic termination or end date in the event that the company does not raise further equity or the company is not wound-up. This means that, at least technically, the convertible instrument can continue to exist.
Early-stage investors and start-ups in the region indicated a preference for some form of “ending” to the instrument. To cater to this regional preference, CARE contains a “Maturity” feature.
If this feature is activated, it effectively gives the CARE holder an option, after a set date (the “Maturity Date”), to require the company to convert CARE into shares in the capital of the company at a set valuation (the “Maturity Cap”). The parties can agree on the Maturity Date and Maturity Cap upfront. This feature caters for the scenario where the company does not proceed to a liquidity event or dissolution event, in which case the CARE holder has the option to become a shareholder in the company. This option can provide a CARE holder with some finality in case the company is not proceeding to a liquidity event or dissolution event.
CARE also gives the CARE holder information rights in relation to the business and financial condition of the company, providing some level of transparency regarding the company and its potential prospects. CARE includes an undertaking from the company that the proceeds from CARE will be used in accordance with the business plan and/or budget shared with the CARE holder at the time of issuance of CARE. The information rights and the undertaking regarding “use of proceeds” seek to provide transparency and some level of assurance to holders of CARE.
CARE, along with the rest of the VIMA kit, is aimed at reducing transactional costs and time by allowing parties to focus on a limited number of commercial points. CARE draws heavily from its predecessors, but also caters to regional preferences, to assist the users in adopting the instrument in an efficient and effective manner.
Satbir Walia is a Partner in the M&A team in Singapore. She has worked on a broad range of cross-border M&A transactions globally having worked in our Singapore, Hong Kong and New York offices. Satbir joined Clifford Chance in 2008 and has since advised a wide range of clients on strategic mergers and acquisitions and joint ventures in the financial institutions, technology, private equity and consumer goods sectors. She has a particular focus on financial institution groups and tech sector. Satbir received her BA (with distinctions) in Economics and Finance in 2003 from Wilfrid Laurier University and her LLB in 2006 from Osgoode Hall Law School in Ontario, Canada.
Michael Ng is an Associate in the M&A team in Singapore. He has worked in our London and Singapore offices and specialises in advising on infrastructure and private equity transactions as well as strategic mergers and acquisitions and joint ventures in a range of sectors.
Disclaimer: This article is intended for your general information only. It is not intended to be nor should it be regarded as or relied upon as legal advice. You should consult a qualified legal professional before taking any action or omitting to take action in relation to matters discussed herein. This article does not create an attorney-client relationship and is not attorney advertising.
Published 29 May 2020