Early stage investment rounds in Dutch startups are structured more and more via convertible loans instead of equity nowadays. The main reasons to opt for a convertible instead of equity are that convertibles tend to be faster and cheaper than equity deals and that discussions on the valuation can be postponed (which is usually mainly favorable to the founders since they appreciate not yet having to negotiate on the valuation of the company with an often still far from complete team, an unfinished product and hardly enviable levels of traction). The investment will initially be structured as a regular loan and will only convert into shares at a future qualified investment, against the then applicable valuation (with a discount for the converting investor and usually a conversion cap to protect the converting investor).
Given the popularity of convertibles, several alternative investment instruments have been introduced in the US as alternatives to convertibles, like Y Combinator’s SAFE (Simple Agreement for Future Equity) and 500 Startups KISS (Keep It Simple Security). These instruments should provide for even faster and easier deal making and – after initially being received with some hesitation – are picking up in popularity in and outside Silicon Valley. These documents are certainly worth looking at, but they are written for US deals not for Dutch deals and are governed by US law (and no you cannot simply replace the “governed by US law” clause by Dutch law).
Since it always takes a fair bit of time for new initiatives like these to be adopted by us conservative Dutchies, similar instruments have been lacking in the Netherlands to date. Enter the EPOS (the Easy Prepayment On Shares), an investment agreement on little over 2 pages of legal wording (which is so short it defies the very nature of us lawyers).
The EPOS is effectively an agreement pursuant to which the investor provides funding in return for the right to be issued shares at a qualified investment in the future, against the then applicable price per share (minus a discount and with a cap). This is very similar to the convertible, but unlike the convertible the EPOS is not a debt instrument (although the tax authorities could try to challenge this) and consecutively has no maturity date, nor accruing interest.
The intention of the EPOS is that the investor will be issued shares at a later investment round. Until that happens, the investor has hardly any control over the company, but is provided some protection by way of an obligation of the company to pay the investor back a multiple (standard 2 times) of the prepayment amount in the event of occurrence of a Liquidity Event (transfer of the majority of the shares or other events which lead to a change of control, like a merger or de-merger, as well as a dissolution or winding up of the company ) or an Event of Default (a material breach of contract, payment of dividends, transfer of a material part of the assets of the company). This effectively gives the investor a 2x liquidation preference and the EPOS will terminate after such payment is received.
In the event that the envisaged qualified financing occurs, the EPOS prescribes that the investor will then receive the most senior class of shares outstanding or issued and that a participation and shareholders agreement will be concluded which at least contains the rights for the investor as are contained in the Capital Waters Participation and Shareholders Agreement, Extended Version, so the parties agree to a minimum and market practice level of influence by the investor following his becoming a shareholder.
The EPOS hence provides for an even easier way of investing than by way of a convertible, with nearly the same characteristics as a convertible but with the added advantage for the company that it does not include the risk that the company is faced with insolvency or liquidity problems as a result of a repayment obligation to the investor at maturity.
With the EPOS, the investor will however have to be willing to take a slightly more founder friendly approach than with a typical convertible, given the lack of control on the company and on the moment of being issued shares due to the absence of the maturity date. The investor should hence have confidence in the company being able to secure subsequent financing. Also, the investor should bear in mind that more often than not if a convertible is used and the conversion or repayment is triggered due to the maturity date being reached (and hence no qualified investment has taken place), the company is probably not doing so well which means repayment will be difficult and conversion will likely result in the investor being issued relatively worthless shares.
I hope the EPOS will be used as an easy alternative to a convertible and I would highly appreciate to hear your feedback on and experiences with it.
And then some lawyer stuff to end with. Neither the EPOS nor this blogpost is intended to constitute legal advice. Each situation is highly specific and requires legal and tax advice of an attorney-at-law specialized in this field of law.
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