Seed Round with Convertible Loans: What you need to know

 

Post written by Michael Baier andMichael Tschudin.

The granting of convertible loans (“CLs”) has become increasingly popular for seed round financings of start-ups. In fact, many business angels prefer to invest in this structure. The reasons for this are manifold: compared with equity rounds, it is relatively fast, the agreements are shorter and simpler and the overall transactions costs can be lower.

Convertible loans are just that: loans. The loans will convert into equity (usually preferred shares) at such time as the next financing round is raised. Despite this simplicity, there are certain issues, which must be kept in mind when issuing convertible loans.


Economics: Valuation Caps & Floors / Discounts

Convertible loans are considered easier than equity financing because no valuation of the start-up is set and you get to avoid this part of the negotiation. However, investors and start-ups/founders will still have to think about economic implications:

Investors want to ensure that their price per share at the conversion event is not too high and therefore will ask for a discount (10% to 20% being the most common) and a cap (= max. valuation of the start-up at the conversion event). This might not work for the start-up, as a low valuation cap for the seed round can cause future investors to shy away (since investors might feel they could overpay if valuation has increased significantly). Also, future investors might focus on the cap set for their own valuation of the start-up. This leads to a scenario where the start-up underpriced itself by setting a low valuation cap in the preceding seed round. To mitigate this risk, the start-up should try to not disclose the seed round terms until a price has been set with the new investors. Lastly, from an entrepreneur’s perspective, CLs should have a valuation floor (= min. valuation), instead of a cap, so that the CL investors do not get shares too cheap.


Conversion Mechanics & Governance Matters

When a start-up plans to issue CLs it needs to comply with a few statutory provisions: First, it generally needs to grant (pro-rata) preferential rights to all existing shareholders to subscribe for the CLs to be issued. Second, the board of directors of the start-up has to ensure that in the event of the conversion, the required number of shares is available, without having to consult the shareholders first.

Upon a conversion event, the CL investors automatically become shareholders. It is therefore crucial that they undertake, in the CL agreement to adhere to the then existing shareholders’ agreement (of the start-up).


Taxes & 10/20 rule

The CL investor will want to have a minimum upside from his investment in the form of an interest rate for the loan granted. Interest rates cannot be agreed at the discretion of the parties; the Federal Tax Authority (FTA) publishes annual ‘safe harbour’ tax rates for (shareholder) loans. If the interest rate deviates from these safe harbour rates, the portion that is too high is considered to be a hidden dividend distribution and the portion that is too low is considered to be a hidden capital contribution.

If a start-up grants more than 10 loans with identical terms, or more than 20 loans with different terms, with a total principal amount of at least CHF 500,000, interest payments are subject to a 35 % withholding tax. Depending on where the CL investors are located, such withholding tax may not be reclaimed in full or at all. In any case, the start-up needs to avoid taking on CLs from any more than 20 investors, as otherwise it will qualify as a bank (with the need for a license!).

 

Convertible loans are a real and viable alternative to equity rounds, in particular for seed financings. They are in fact simpler and faster to handle. However, the foregoing has made it clear that careful drafting is key as it saves the start-up, the founders and the investors from legal and tax problems.

Feel free to reach out – we are happy to answer follow-up questions and to support you in your seed financing round!

After ten RedBoxes and four BlueBoxes, Zürcher Kantonalbank announces two GoldBoxes in the Kickbox Program with Bluelion Incubator

After one year of Bluelion Kickbox, Zürcher Kantonalbank has recently announced two projects in the GoldBox stage. Since last year ten RedBoxes and four BlueBoxes have been awarded at Zürcher Kantonalbank.

We asked Chris Renfer, Head of Trend- and Innovation Management at Zürcher Kantonalbank, and Gabriele Frossard from the team of the GoldBox project BeMySponsor, to tell us a bit on how the bank is pushing innovation through the Bluelion Kickbox Program.

 

Chris, what’s the story of Kickbox at Zürcher Kantonalbank?

Kickbox within Zürcher Kantonalbank was launched after a hackathon in September 2017: In order to further strengthen the innovation culture and cross-divisional cooperation from the inside, we  organized the “Hackathon & Innovation Challenge” for our  employees. More than 20 ideas were processed and the three best together with one chosen by the public received the award and were then evaluated by a jury of experts reporting directly to management. In the Bluelion Kickbox, Zürcher Kantonalbank saw a suitable program to optimally support the winners to continue working on their idea after the hackathon. The four winner-teams were therefore invited to test the Bluelion Kickbox Program while still in pilot mode.

 

Why Bluelion Kickbox?

The Bluelion Kickbox Program strengthens the internal entrepreneurial spirit and promotes a culture of innovation, which perfectly complements the bank’s cultural environment named Performance & Entwicklung. Employees can thus independently drive forward new product and service developments as well as innovative ideas and business cases.

 

BeMySponsor – GoldBox  Team (Dennis Gehrig, Michael Schlüter, Susanna Neyen, Gabriele Frossard)

 

 Gabriele, tell us shortly what your startup idea is and how you got there

Our idea is dedicated to the field of “Sponsored Runs” and the resulting contacts.  Zürcher Kantonalbank is already active today in sponsoring various projects of this kind.

Our journey began at the Hackathon. A colleague introduced me to the topic shortly before the event: I have a little FC player at home and many FC teams run sponsorship, so, as a mum, I am also personally affected by it. My whole team was immediately impressed by the idea – and, I dare to say, not only the team, since at the end of the Hackathon the audience decided to give us the ticket to our “Kickbox-Journey”.

 

What differentiates you from a “normal” startup?

 In a normal startup, the motivation, joy and drive are probably very similar to what we experience! What is different from a “normal” startup, however, is that the interests of our employer are very much in focus and the final goal is creating something that Zürcher Kantonalbank will benefit from.

 

How do you manage to bring your startup and your everyday job under one roof?

Reconcile our daily work and our project does not come without challenges. We are all fully committed to our jobs and the team consists mostly of part-time employees. This means that finding enough time and suitable days can be hard sometimes. But we really have a good team spirit, believe in our idea and enjoy working on it – extra miles don’t scare us!

 

You have been working on your idea for about a year now as part of the Bluelion Kickbox Program. What have you already achieved during this time?

We know what the challenges of sponsorship are and we were able to develop a solution for it. Our idea is now getting sympathy and attention from inside and outside of our company and we are ready for the implementation of our minimal viable product (MVP).

 

Keyword Kickbox: is there need for a colourful shoe box to propel an idea?

Of course there’s the need for a colourful shoe box! That was the highlight for us after every successful pitch! It was the emotional element, making it a huge fun to open the individual boxes to discover many gifts and tools for us to use and enjoy.

 

What advice would you give aspiring “Kickboxers”?

Go for your idea! Pack your heart, creativity and passion. Try things out without pretension or search for perfection…and be ready to overcome some obstacles.

 

What do you think about the introduction of the Kickbox Program within the Zürcher Kantonalbank? 

I think it’s great how entrepreneurship and innovation culture are developed and strengthened this way. Accompanied by Bluelion, I think  Zürcher Kantonalbank has initiated a very profitable cooperation for this program.

 

How does the program fit into the future challenges in banking?

Whether banking or not, the program really helps to develop innovative ideas with a proper method and to test their feasibility. Zürcher Kantonalbank has a large number of employees who have great ideas and are in the position to independently promote new developments in products and services. Participating in the Kickbox Program helps to advance these ideas and, thus, our bank.

 

 

We couldn’t be happier of how our intrapreneurship program is going. We get to work with amazing companies and their employees on some very cool ideas – ready for a roaring 2019 full of innovation!

 

 

 

 

Bluelion has a new website!

Hi everybody,

We are extremely happy to announce that Bluelion now has a new website…which is the one you are in right now!

We launched it today with the priceless help of our friends what.digital. Make sure you keep on checking the page regularly, as some of the content will be updated on the run. Especially this section, the blog: we will post articles and blog posts regarding our projects, our work and all things about our Bluelion Family.

For now, enjoy the new design and the new content of our brand new website…I hope you like it as much as we do 🙂