CLA & SAFE
⚡TL;DR
- A CLA is a middle ground between equity financing and a traditional loan.
- It's a quick and efficient way to raise money if you don't have a valuation yet or are between financing rounds.
- Beware of the 10/20 rule.
- Use discounts and interest to your advantage when negotiating with investors.
A Convertible Loan Agreement (CLA) is a flexible option that falls between equity financing and traditional loans. It offers several advantages, including:
- Quick and Cost-Effective: Easier and faster to set up than equity financing.
- No Repayment Required: No need to repay the loan or interest.
- Future Conversion: Converts at a later valuation, providing a fair link between investment amount and ownership stake.
CLAs are also known as Simple Agreement for Future Equity (SAFEs).
You should consider a CLA if:
- Valuation Uncertainty: You can’t set a valuation yet. A CLA allows you to postpone this discussion and access funds immediately.
- Need for Speed: A CLA can be established quickly, making it ideal for getting funding quickly.
- Bridging Funding Rounds: You're between your Seed and Series A rounds and need more time to boost your valuation (e.g., 3x) before looking at your Series A. A CLA can help bridge this gap.
Under Swiss tax law, interest paid on bonds and similar debt instruments of Swiss companies is subject to a 35% federal withholding tax. Under certain circumstances, CLAs may be considered bonds for tax purposes and trigger the withholding tax.
A CLA may be considered a bond for tax purposes and trigger taxes if cumulatively:
- The company enters into loan agreements with more than 10 ‘non-banks’ or institutional investors sharing substantially identical commercial terms; or with more than 20 ‘non-banks’ or institutional investors, regardless of the terms (even if some have no discount while others do); and
- The total amount invested exceeds CHF 500'000.
Example
Let's say Startup X-Force issues 15 CLAs to private angel investors and raises CHF 1,000,000. All CLAs have the same terms, including an interest rate of 5%.
After one year, the total loan amount grows to CHF 1,050,000 due to interest. The loan, including interest, is converted into shares at a specified conversion rate.
Since X-Force has issued more than 10 loans with identical terms and conditions, exceeding the total investment limit of CHF 500,000, these loans qualify as "bonds" for Swiss withholding tax purposes.
When the CHF 1,050,000 loan is converted into shares, the Swiss tax authorities will treat the CHF 50,000 interest as only 65% of the total interest amount. This means that they will demand an additional CHF 27,000 from X-Force. Normally, X-Force will not be able to recover this amount from the investors.
Best practices
10/20 rule: If the total amount invested through CLAs exceeds CHF 500,000, no more than 10 CLAs with substantially identical commercial terms or no more than 20 CLAs regardless of commercial terms may be concluded.
- Investment Amount: This is the total amount of money you’ll receive from the investor.
- Trigger Events: These are the events that trigger the conversion (or transfer of shares to the investor). Standard trigger events are:
- Qualified Equity Financing: The company raises significant funds in the next funding round, resulting in new shares being issued immediately to new investors.
- Liquidity Event: The company is sold through an M&A process or goes public with an IPO.
- Maturity Date: A predetermined date on which the CLA automatically converts if no other trigger event has occurred.
- Valuations and discounts: The number of shares that the investor receives for their investment is based on the company's valuation. The appropriate valuation depends on the event triggering the conversion:
- In the case of a Qualified Equity Financing round or Liquidity Event, the parties typically use the same valuation for new investors and CLA investors. However:
- the risk taken by the CLA investors (who invested earlier) is compensated by a discount rate, typically ranging between 10 and 25% (i.e., the investor receives a lower share price, meaning they get more shares for the money);
- a valuation cap is often negotiated to ensure that CLA investors receive a pre-defined minimum percentage of equity in the company.
- A specific maturity valuation is usually set for conversion at the Maturity Date.
- Interest: Since the CLA is a type of loan, it may accrue interest, which is usually converted into equity. This can be used to incentivize investors to accept a lower conversion rate.
- Discount: A discount works like an interest rate by giving investors more shares at conversion than those who invest later. Essentially, it's an interest rate based on equity rather than cash. Psychologically, the discount plays a critical role in motivating investors to commit early through a CLA.
- Cash redemption option: The company might keep the option to reimburse the loaned amount in cash instead of with shares.
Best practices
Discount: The discount, if granted, is between 10% and 20%.
Interests:
Loan interest is either 0% or between 1-3%.
If the loan is granted by a related party (e.g. a shareholder), the interest rate will not exceed 3-5% in order to avoid tax complications.
Cap table: The cap table is up to date, includes the CLAs entered into and shows the future impact of the CLA on the cap table (in particular the dilution).
Y Combinator SAFE template
We strongly discourage the use of the YCombinator SAFE template or any other template found online. In fact, the Y Combinator template (and, in general, most similar agreements) is not tailored to Swiss law.
While it may feel like an additional investment, drafting a Swiss-based agreement will ultimately prove to be more cost and time efficient.