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Part of Convertible notes in the UK: how they work for seed rounds
Convertible notes in the UK: how they work for seed rounds
Convertible notes in the UK seed round: how they work, why advance subscription agreements are more common, and what SEIS and EIS rules mean for founders.
What to take away
- A convertible note is debt that converts to equity on a later funding round, often with a discount or valuation cap.
- UK seed rounds more often use an advance subscription agreement (ASA), a contract for future shares.
- US-style SAFEs do not map cleanly onto UK company law or tax rules, so do not copy a US template.
- SEIS and EIS relief depends on the share issue meeting the statutory conditions and time limits.
- Put the conversion mechanics, long-stop date and tax position in writing before any money moves.
How a convertible instrument works
A convertible note starts as a loan. The investor pays cash now, and the debt converts into shares when a qualifying funding round closes.
Convertible note conversion path
- Investor pays cash now
- Note starts as loan
- Qualifying funding round closes
- Debt converts into shares
- Discount or cap sets price
- Long-stop date: convert or repay
Conversion usually uses a discount or a valuation cap, and both change the price the investor pays. A discount reduces the next round price. A cap sets a maximum valuation for conversion.
Some notes combine a discount with a cap. The investor converts at whichever price is lower. That sounds simple, but the two terms interact and can produce a very different outcome from the headline cap.
Worked example: an investor puts in £100,000 on a 20 per cent discount and a £4m pre-money cap. If the next round prices the company at £6m pre-money, the discount price is £4.8m and the cap price is £4m, so the cap wins. If the next round prices at £3m, the discount gives £2.4m and the discount wins.
The note also has a maturity or long-stop date. If no qualifying round happens by then, the note may convert at a set price or become repayable. That date changes the risk for both sides.
Why UK seed rounds often use an ASA
An advance subscription agreement is a contract for shares, not a loan. The investor pays now, and the company issues shares later, usually when a priced round or a set milestone occurs.
ASA vs US SAFE
Advance subscription agreement
- Legal form
- Contract for shares
- UK company law
- Fits articles
- Tax fit
- Can fit SEIS/EIS
- Long-stop date
- Usually included
US SAFE
- Legal form
- US contract
- UK company law
- No direct equivalent
- Tax fit
- May not qualify
- Long-stop date
- Not standard
UK company law does not have a direct equivalent of the US simple agreement for future equity. Founders who copy a SAFE may create a document that does not work with the company's articles of association or the share authority under the Companies Act 2006.
Directors need authority to allot shares, and the articles may need amendment or a shareholder resolution before conversion.
An ASA usually has a long-stop date too. If the qualifying event does not happen, the parties must decide whether to extend, convert or refund the advance.
An ASA can also fit the SEIS and EIS timetable because the shares are issued as shares, not debt. Founders who want to check the eligibility conditions and time limits can read this SEIS and EIS comparison before drafting the instrument.
The tax relief point most founders miss
SEIS and EIS reliefs apply to qualifying shares, not to loans. A convertible note is debt, so it normally falls outside both schemes. That is the main reason UK seed investors ask for an ASA or direct equity.
SEIS/EIS eligibility check
Is the instrument debt or shares?
Debt -> normally outside SEIS/EIS
Shares -> may qualify if issued in time
HMRC's guidance on the Enterprise Investment Scheme sets out the share and timing conditions. A company can apply for advance assurance before a raise. The EIS application guidance explains the process.
SEIS has its own limits and investor rules. It is aimed at earlier, riskier companies. The Seed Enterprise Investment Scheme entry summarises the main conditions, but always check the current HMRC guidance.
Timing matters. Shares must be issued within the scheme's time limits, and the company must meet the trading and independence tests.
SEIS shares usually must be issued within 3 years of first commercial sale. EIS shares usually must be issued within 7 years, or 10 years for knowledge-intensive companies. The money must be spent within 3 years for SEIS and 2 years for EIS.
Terms to check in a convertible note or ASA
A term sheet can look simple while hiding the points that decide who takes the risk. The table below compares the two instruments on the features that matter most in a UK seed round.
Terms to check
Convertible note
- Legal form
- Debt
- Conversion trigger
- Qualifying funding round
- Interest
- Usually applies
- SEIS or EIS treatment
- Usually not available for the note
- Typical UK use
- Less common at seed
Advance subscription agreement
- Legal form
- Contract for future shares
- Conversion trigger
- Qualifying round or agreed milestone
- Interest
- None
- SEIS or EIS treatment
- Possible if the ASA leads to qualifying shares
- Typical UK use
- Common in UK seed rounds
Typical UK seed ranges are a discount of 10 to 25 per cent and a valuation cap of £2m to £6m pre-money. Convertible notes often carry interest of 5 to 8 per cent, while ASAs usually have none. Long-stop dates commonly run 12 to 24 months.
Terms to check
- Check the conversion trigger and the long-stop date.
- Model the discount and any valuation cap before you sign.
- Confirm whether the instrument is debt or a share subscription.
- Ask a tax adviser to confirm SEIS or EIS eligibility.
An ASA template should cover the share class, conversion trigger, discount, cap, long-stop date, interest, share authority, articles amendment and tax conditions. Clause-level detail matters because the conversion mechanics and the share issue must line up with the company's articles and the scheme rules.
A valuation cap is not the same as a company valuation. It only sets the maximum price for conversion. Founders can test the difference with these startup valuation methods before agreeing a cap.
Common questions
Are convertible notes legal in the UK?
Yes, but they are debt and are less common in early-stage UK rounds. UK company law and tax relief rules tend to favour share subscriptions or ASAs.
What is an advance subscription agreement?
An ASA is a contract under which an investor pays now for shares to be issued later, usually on a qualifying funding round.
Do convertible notes qualify for SEIS or EIS?
Usually no. The test is whether the company issues qualifying shares within the scheme's time limits. An ASA can meet that test if the share issue is structured correctly.
What terms matter most in a seed round?
Conversion discount, valuation cap, long-stop date and interest are the core terms. Also confirm the share issue mechanics and the tax conditions.
