introduction

Whilst your seed investment round may have been done quickly with a convertible note or short form equity financing documentation, closing a follow-on or series A funding round will be a bigger task. It usually involves an equity capital raise with several investors, including one or two lead institutional investors, so the investment documentation inevitably takes longer to agree.

The rapid acceleration of the tech startup funding environment and the type of international investors involved in Southeast Asia means that entrepreneurs have needed to get up to speed on globally accepted venture capital (VC) investment terms – often heavily influenced by Silicon Valley.

This guide for tech startups is based on our experience of advising on many series A and larger follow-on capital raising rounds for companies and investors in Southeast Asia. If you are raising a pre-series A round, check out our guide to raising seed capital in southeast asia.

securities laws

If you are raising money from investors, you are promoting the issue of securities and must comply with the relevant legal requirements in all jurisdictions where the investors are based. For Singapore issuers, under the Securities and Futures Act (Cap. 289), all offers of securities must be accompanied by a prospectus unless the offer is exempted. Fortunately, that Act provides many exceptions for private placements and other share issues. See our guide to raising seed capital in southeast asia for further information on securities law for the issue of shares to investors. Complying with securities law is just as applicable to a series A round as it is when raising seed capital.

getting ready for series A

due diligence

Expect a more structured due diligence process before receiving series A money as compared to seed investments. We suggest setting up a dropbox of documents, ordered with headings and an index (see our template southeast asia due diligence checklist which will help you put together the documents). This will speed up due diligence not only for the current series A deal, but any future financing round.

For businesses operating in more than one Southeast Asia jurisdiction, prepare early for the due diligence process on a series A round. With less publicly available documentation in jurisdictions such as Thailand, Indonesia, Vietnam and the Philippines, investors will want to take local advice and understand the risks. If intellectual property (IP) has been developed by personnel across a group of companies, investors will want to see evidence that the IP has been legally assigned to the parent company. Finally, there may be minimum capital requirements or foreign ownership restrictions to consider at country level depending on local law requirements.

valuation

VCs see a large number of investment propositions in Southeast Asia. A recent presentation from Google and Temasek suggested that Southeast Asia has up to 7,000 startups. As institutional venture capital money flows into the region, valuations have risen. Some exciting tech companies in Southeast Asia have raised money at big valuations, particularly in the mobile and e-commerce space. But Southeast Asia is still a young market compared to the US. A high valuation in early stage rounds can put off investors because it suggests the entrepreneurs involved are unrealistic and will be difficult to deal with in future capital raisings or on exit.

the term sheet

Term sheets record the investment amount, structure and other material terms of an investment deal. The term sheet for a series A deal is normally non-binding and prepared by the lead investor. Term sheets in Southeast Asia tend to fall into two categories: long form term sheets, which set out in detail the key transaction terms; and short form 1-2 pagers which are more high level. The latter seems more appealing on first glance, but the downside is that you will probably end up spending a lot of time later in the negotiations discussing key issues which could have been addressed at the outset.

Term sheets can contain very broad phrases such as customary warranties and indemnities, founder vesting arrangements and standard exit default rights. If you’re unsure what these mean, it’s a good time to chat to an experienced VC lawyer. These concepts can have a big impact on who carries the risk (the company or you personally) and the level of any liability, the time periods for claims, and the remedies for investors. Whilst term sheets are non-binding, it is difficult to renegotiate an issue in the main series A investment documents if it conflicts with the term sheet. So it pays to put the effort in up front in the term sheet where you can.

Most investors will want exclusivity under the term sheet for an agreed period. Ideally, this should not be more than 45 days from the signing of the term sheet, so you can move on quickly if the deal does not close for any reason.

Our template southeast asia series A term sheet is a good example of the terms for a series A investment round in Southeast Asia.

key series A terms

If your priority is getting on with building a funded business, it pays to focus your attention on the critical investment terms and not to sweat the small stuff.

We suggest that you focus on:

• the economic rights (e.g. valuation, liquidation preference, anti-dilution and share vesting)
• the control rights (e.g. board composition and investor veto rights).

Other terms are usually less important and you shouldn’t spend lots of time negotiating terms that have relatively little benefit overall.

With that in mind we set out below a summary of the issues that you will want to focus on.

investment amount and class of shares

The term sheet will set out the total investment amount and a pre-money valuation for a certain percentage on a fully diluted basis. It is essential that you understand, and the term sheet accurately sets out, the company’s valuation, the cap table and the impact of any new or enlarged employment share option plan (e.g. whether the allocation for any employee share option plan (ESOP) is based on a pre or post-money basis). For clarity, you should attach the agreed cap table to the term sheet.

Investors on a series A round in Southeast Asia will expect to be issued preference shares which take priority over the ordinary shares in several respects (e.g. through a liquidation preference and anti-dilution protection) and carry additional control rights.

If possible, avoid the investment funds being paid in tranches against milestones. Early stage companies rarely develop according to plan. Milestones that make sense today are quite likely to become less relevant over time. If an investor insists on milestones, make sure they are realistic and achievable.

board composition

The term sheet will set out the proposed board composition. Investors (jointly or possibly the lead investor alone) typically want board representation. Observer rights (under which investors can attend board meetings in a non-voting capacity) are sometimes offered as a compromise to a director appointment.

Typically, only one investor nominee director is appointed on a series A round.

Occasionally investors want an equal say in board decisions (i.e. half of the board seats so that no decisions can be made at the board level without their consent). This is often accompanied by a requirement to appoint an independent director, to avoid deadlocks. Remember that the board is responsible for managing the company. Given this, founders should be cautious when investors seek equal board representation, since it will see founders effectively give up control of their company:

• when founders and investors sit on a tied board, the founders need the consent of their investors for all decisions concerning the company and its business. This level of negative control gives investors an extraordinary amount of leverage
• when an independent director is the swing voter on a board, founders can find themselves outvoted on major issues concerning the business or the company. Investors will argue that this is reasonable because the independent director will vote in the best interests of the company, rather than in favour of either the investors or founders. However, in our experience there is a tendency for independent directors to align themselves with the views of investors.

Finally, any board appointment or observer rights should remain subject to the appointing investor retaining a shareholding above an agreed percentage (e.g. 10% or 20%). Founders also should retain the express right to appoint either themselves (or a nominee) for as long as they continue to hold shares

veto rights

Investors will want veto rights over certain company actions, e.g. future share issues, related party transactions, the company incurring unusually large expenses or debt obligations, amendments to the constitution, changes to the board, majority ownership changes, or the sale or acquisition of any new business or subsidiary. In practice, this means you would need investor consent for those actions.

Even with a majority of directors on the board, veto rights and the inevitable investor interference can significantly reduce your control and distract you from the day job. We suggest that you approach this issue in two ways:

• consider streamlining the consent procedure so that only one or two lead investors (or alternatively a majority of the investors) are required to give consent. Ideally, this consent would be given by the investor nominee director at board level. Consent should not be required of all investors as this will stymie the company’s decision making
• limit the items that require investor consent. It is good practice to review the veto rights carefully so that they are fit for your company.

Resist items which might impede the company’s ability to:

• raise the next round of funding. It is critical that your board has the power to issue shares to raise further capital when required without any party having a veto
• change the annual budget, business plan or strategy (unless that change is material). And, for material changes, because these documents affect all shareholders, we think an investor should be required to act reasonably in respect of that decision
• hire and incentivise key people. The ability to hire key personnel and teams is fundamental and should not be unnecessarily restricted (e.g. by investor approval being required for the allocation of options under an ESOP). Any consent right on the appointment or removal of the CEO, CFO or similar key employee are key operational decisions for your company and the investor should be required to act reasonably
• set up in other territories. This is often a key business strategy that Southeast Asian tech startups present to their investors, yet the ability to do so remains restricted by investor veto. The investment documents need to align with the plans you have presented to investors.

In short, investors always expect some control over board actions at series A stage. However, investors understand the burden that seeking consent can impose on founders and are normally very open to negotiating the scope of veto rights.

liquidation preference

A liquidation preference provides investors with some downside protection if your company is either wound up or sold (a liquidity event). The preference provides that, on a liquidity event, investors will receive a specified amount of the proceeds in priority to the ordinary shareholders. This preferential amount could be equal to the investment amount or possibly a multiple of it (often 1x or 2x). The remaining proceeds are then shared amongst either the preference and ordinary shareholders on a pro-rata basis (called a participating preference) or amongst just the ordinary shareholders (called a non-participating preference).

In terms of a quick analysis of liquidation preferences:

• a participating preference can significantly reduce the amount of proceeds that ordinary shareholders will receive on a liquidity event. As a result, sometimes the amount received by the preference shareholders is capped. The cap is typically set as a multiple (e.g. 2x or 3x) of the original investment. Once preference shareholders receive the fixed amount, they cease participating in further distributions with the ordinary shareholders
• under a non-participating preference, once preference shareholders have received their preferential amount, ordinary shareholders receive the balance of the proceeds. This means that if the proceeds of the liquidity event would return to preference shareholders at least their preference amount, their shares will convert into ordinary shares. In doing so, investors then participate alongside ordinary shareholders on an equal basis
• a 1x non-participating liquidation preference is therefore the best position for founders. This ensures that, on a liquidity event, investors participate on a pro-rata basis alongside ordinary shareholders as long as they receive back their investment amount
• multiple or participating liquidation preferences (or combinations of both) can have a significant negative impact on returns to founders.

As a general rule, most investors in Southeast Asia tend to accept 1x non-participating liquidation preferences on series A rounds.

conversion rights

Investors holding preference shares may convert these shares to ordinary shares. This a general right but there also will be certain events which cause automatic conversion (e.g. IPO or where a majority of the preference shareholders agree). Practically speaking, conversion normally occurs on an exit event.

Preference shares convert into ordinary shares at an initial conversion ratio of 1:1. This conversion ratio will be adjusted in accordance with anti-dilution rights (see below) with the result that investors may receive additional shares on conversion.

anti-dilution

Anti-dilution rights protect investors when new shares are issued at a price which is lower than the price at which they invested (a down round). This protection operates to compensate investors for the dilutive impact caused by the issue of shares at the lower valuation. A formula is applied which determines a number of new shares which investors should receive on conversion. Alternatively, the mechanism can require the company to immediately issue shares for a nominal sum as a bonus issue. In Southeast Asia, the anti-dilution mechanism is typically dealt with by adjustment to the conversion ratio.

Anti-dilution protection comes in different forms, each providing investors with different levels of protection. E.g.:

• full ratchet: this re-prices investors’ shares to the lowest price of any later share issue, regardless of the number of shares issued and the reasons for the lower pricing. This is a blunt instrument, potentially providing investors with a windfall, so is generally considered unfair to founders
• weighted average: this amends the price of the investors’ shares to the average price at which the company has issued its shares (including the issue of shares in the down round). This is much more company friendly than the full ratchet
• the weighted average mechanism comes in two forms – narrow based and broad based. The distinction is that a broad-based weighted average provision includes both the company’s shares on issue (including all ordinary shares to be issued upon conversion of the preference shares) as well as shares which could be issued by converting all other options, rights, and securities, including employee share options. A narrow-based mechanism does not include these other convertible securities and limits the calculation to shares currently on issue
• using a broad-based weighted average results in a higher conversion price for the holders of the preference shares. This is favourable to founders because, on conversion, fewer ordinary shares will be issued to investors, causing less dilution.

Our experience is that a broad based weighted average is the standard accepted by nearly all series A investors in Southeast Asia deals.

pre-emptive rights on new share issues

Where a company issues new shares, investors typically want the right to maintain at least their percentage equity stake on the same terms. The term sheet will set out the rights-of-first-refusal that investors and other shareholders will have if the company wants to issue new shares after the series A financing has closed.

If you need to raise capital quickly, pre-emptive rights can be problematic, since a waiver of the rights will be needed from each shareholder with pre-emptive rights.

Despite this issue, series A investors usually insist on pre-emptive rights. However, they may agree to:

• allow a majorityof investors to waive the pre-emptive rights, avoiding the need to get a waiver from every investor no matter how small their shareholding
• limit pre-emptive rights to major investors holding shares above a certain percentage of the total equity
• very rarely, limit the application of pre-emptive rights only to down rounds.

In all cases, share issues under an approved ESOP should be exempted from the pre-emptive rights provisions. We sometime see a further carve-out for shares issued as consideration to sellers on future acquisitions by the company.

Often, the other non-investor shareholders also want the right to participate pro-rata to their existing holdings on future share issues. Be cautious before agreeing to this as this can give an individual shareholder a right of veto on future equity financings.

If all shareholders have pre-emptive rights, we sometimes see smaller holders agree to sign up to limited powers of attorney at series A stage in favour of the board. This at least helps you execute a future capital raise without minor shareholders frustrating the transaction.

restrictions on share transfers

lock-in

Series A investment documents often prevent founders from selling any shares for a set period of time. Try to negotiate that a small percentage of your shares fall outside of this restriction, (e.g. 10-15%) to enable some liquidity, noting that you will, in any event, be bound by a right-of-first-refusal (ROFR) on share transfers.

right-of-first-refusal (ROFR)

These rights require a shareholder wishing to sell shares, to first offer them to the shareholders who have that right on a pro-rata basis. You will need to consider who should benefit from the ROFR (e.g. only investors, or other shareholders too). It is common for founders to receive a pro-rata right alongside their investors. Alternatively, founders may have a secondary right to purchase shares offered for sale which investors do not take up.

The ROFR is usually subject to standard exceptions, including the right of individuals to transfer shares to relatives or for tax or trust administration purposes, or the right of corporates to transfer shares to affiliated companies within their group.

right-of-first-offer (ROFO)

Many institutional investors will refuse to be bound by a ROFR. This is not ideal for a founder as a major equity share of the company could be sold to a non-strategic third party without the founder having a chance to purchase those shares. In those circumstances, a compromise right-of-first-offer (ROFO) can be agreed. This right carries considerably less weight than a ROFR. With this right, the investor is only required to notify the applicable shareholders that it is looking to sell its shares. This, in turn, presents an opportunity for the other shareholders to make an offer for the shares that is acceptable to the investor. However, the investor is not compelled to sell so ROFO is in effect no more than a right of negotiation.

co-sale right (tag-along)

If a shareholder wishes to sell shares that are the subject of a co-sale or tag-along right, the other shareholders who benefit from this right can require that the purchaser buy an equivalent percentage of their shares on the same terms and conditions. On Southeast Asian series A deals, investors expect to receive the right to participate pro rata in any sale of shares by founders to a third party. If founders wish to sell shares which would leave them with less than a certain percentage of the total number of shares (e.g. 20% in aggregate), co-sale rights typically allow investors to sell their entire stake in the company. As a result, these rights make it hard for founders to sell their shares. This is the intention of investors who have invested in your company on the basis of the management team leading the business. You might wish to seek an exception to this so that you can freely sell some of your shares (e.g. 10-15% of your total holding).

Co-sale rights are generally subject to pre-emptive and/or drag-along rights (see below).

drag-along rights

A drag-along right requires all shareholders to sell their shares to a potential purchaser if shareholders holding a certain percentage of the shares agree to sell to that purchaser. These rights are important where a potential purchaser is seeking to buy 100% of the shares of the company. The trigger percentage for drag-along is often 75% but could be higher or lower. Sometimes, the exercise of the drag-along right is limited to a third party offer above a certain valuation.

Drag-along rights are not often seen in series A term sheets in Southeast Asia. Most investors do not seek such rights on the basis that they don’t want to be dragged themselves. Otherwise they could lose control over their future exit.

Separately, the board may want to require smaller shareholders to sell if an offer is received which the major investors have also approved. This will help administratively on the future sale of the company. In the absence of a drag-along right, you could ask smaller shareholders to execute powers of attorney in favour of the board covering future sales.

vesting

Share vesting provisions can have a big impact on founders. As investors are investing partly on the strength of the founder team, they often require a mechanism to claw back unvested shares from founders if they leave the business. Investors often require that 50%-75% of your existing shares be subject to vesting. Of those vested shares, 25% often vest after 12 months (the cliff) with the balance vesting in the following 2 or 3 years.

Vesting can affect your relationship with investors, but also with your other founders. Make sure that you are comfortable with how it works, including the length of the vesting period, the implications of a founder leaving, the circumstances of that departure, the price to be paid for vested or unvested shares if you depart, and how a change of control affects vesting (e.g. acceleration of vesting). In particular, if you are forced out of the company for alleged poor performance, you may be a bad leaver. This may result in you losing all of your shares for no value.

If a founder leaves, you might want to consider whether the remaining founders should be able to issue new shares up to such amount that has been repurchased by the company from leavers, outside of ROFR, e.g., through an increased ESOP allocation or by issue to the remaining founders.

Series A vesting arrangements in Southeast Asia typically involve the buy-back by the company of shares of a leaver. For Singapore registered companies, under the Singapore Companies Act, there are certain restrictions on company share repurchases. E.g.:

• the constitution must expressly permit repurchases
• a buy-back agreement must be approved in advance and the directors must be satisfied that, at the date of that agreement, the company is solvent
• no more than 20% of the total issued share capital can be repurchased in any 12 month period.

representations and warranties

Investors will want a full set of corporate and business warranties for the company and any subsidiary, to be set out in the subscription agreement. We suggest that you avoid:

• broad warranties which require you to confirm the accuracy and completeness of allinformation that you have provided
• forward looking representations and warranties, e.g. don’t warrant the accuracy of a business plan or an information memorandum which you have presented to investors.

Generally the subscription agreement will include an indemnity covering breaches of the representations and warranties and other obligations. Indemnities are fundamentally different from warranties. To bring a claim for a breach of warranty, investors would need to show that their shares were now worth less because of that breach. That is not required for an indemnity claim. This makes it easier for investors to recover from the company for breaches of indemnities so consider their scope carefully.

Most series A investment deals involve founders taking on some personal liability for claims. If liability is stated to be joint and several as between the company and the founders, investors can pick and choose who they take action against. E.g. if the company doesn’t have the resources, the investors can recover the full amount of the claim against any individual founder. As a protection, we suggest that investors be required to bring claims against the company first. Also, claims should ideally be brought only with the consent of the lead investor, to avoid one disgruntled small investor from creating trouble.

Investors may also seek remedies against founders personally if the company materially defaults. Get advice on this – it is important that you understand the risks of this and that you negotiate sensible limitations.

Investors tend to be open to including limitations on liability (including for breaches of indemnities and warranties). These limits might cover:

• monetary caps for both the company and the founders individually. We think a cap is especially reasonable for a founder as this is personal risk
• time periods to bring claims. In theory, investors should have discovered any claim after the first financial audit of the business, so try and limit the claims periods to 18 months
• representations and warranties being subject to disclosure.

disclosure

Warranties are usually qualified by information that is fully and fairly disclosed in a schedule to the subscription agreement or a separate disclosure letter. This is a great protection for founders but is a key element of the transaction which is often forgotten about until just before closing. Our advice is to get on top of this as soon as you can.

During due diligence, you will provide piles of documents to investors. Don’t assume that this means all of those documents are deemed to be disclosed. Make sure the disclosure letter or schedule formally records disclosure of these documents and provide carve outs to the warranties.

Disclosures are either general, (e.g. referring to accounts, publicly available searches, or the contents of your datasite) or they are specific, (i.e. individual items that, if not disclosed, would breach a warranty). An example of a specific disclosure is a pending claim or if you know a key customer is about to terminate its contract. All founders and key management staff should review each warranty carefully and consider whether they are aware of specific issues to disclose.

default rights

The term sheet may provide for investor rights if the company or founders default, e.g. drag-along rights, forced share repurchase, and/or investor control imposed over the board. Default provisions are onerous so only agree to them if the term sheet is clear on scope.

Sometimes the company and even the founders are obliged to buy-back shares from investors in the event of default. This is not realistic for most founders and, if such a right is agreed, it should be limited to material breaches of pre-agreed key terms.

exit rights

Series A investors often want founders and companies to agree to achieve an exit within a stated period of time. Term sheets often include rights if any exit is not achieved before that time. These rights can be adverse to founders and include drag-along rights, compulsory share repurchases, and/or investor control imposed on the board. If investors insist on exit rights, then confirm what remedies they will have if an exit is not achieved, and don’t agree to an unrealistic exit date (the period should not be earlier than 7 years from closing of the series A round).

legal costs

Often term sheets require the company to reimburse investors’ legal and professional costs relating to the investment. If you agree to this, cap the costs to a reasonable amount (US$20,000 -$30,000 is common for series A deals in Southeast Asia), payable only if the investment is completed.

next up

Be sure to read part 2 of raising series A capital in Southeast Asia where we discuss closing the deal, follow-on and venture debt financing.

introduction

In an earlier guide on raising series A capital in Southeast Asia, we discussed the key series A terms.

In this second guide, we talk about closing the deal and follow-on financings. We also look at the option of venture debt financing.

main transaction documents

Once you have agreed and signed your term sheet, the next step is to prepare the more detailed and legally binding investment documents. In a perfect world, where you have a well drafted term sheet covering all of the material terms of your deal, this would be a largely mechanical exercise for the lawyers to prepare the full investment documents. In reality, there is often additional negotiation at this stage to address gaps and the finer details of the deal.

Southeast Asian series A transaction documents are fairly standard – particularly if your company is domiciled in Singapore. The documents will usually include:

• a subscription agreement which sets out the mechanics and terms of the investment, the conditions to be satisfied before closing, and any representation, warranty and indemnity to be given to the investors by the company or founders (or both)
• a shareholders’ agreement which contains rights and obligations relating to the governance of your company (e.g. information rights, such as receipt of financial statements and quarterly updates) and investor protections going forward
• an updated constitution which, amongst other matters, sets out the terms attaching to the preference shares and mirrors certain parts of the shareholders’ agreement
• a disclosure letter in which you list out all general and specific disclosures against the representations and warranties set out in the subscription agreement.

signing the documents

Often negotiations on a series A investment round are led by one or two of the larger investors. But, remember that all series A investors will also need to sign the documentation, along with all existing non-founder shareholders and any noteholders (whose convertible notes will most likely convert on closing). While most seed investors see the upside from the new funding round and will happily sign the documents, it pays to bring them up to speed at term-sheet stage and provide them with plenty of time to review final documents. This avoids surprises and helps manage expectations.

conditions precedent

Conditions precedent is a term used to describe all of the actions that need to happen after the signing of your investment documents but before the deal completes and the funds are received. These conditions are usually included in the term sheet and (in more detail) the subscription agreement. Aside from the corporate authorities discussed below, they often include actions to tidy up issues found in due diligence. So the cleaner your company, the fewer conditions precedent you are likely to see, and the shorter the time to close and receive funding.

Most subscription agreements will include a long stop date by which the conditions precedent must be completed. The person who benefits from the conditions (usually the investor) can choose to waive any condition which is still to be performed, extend the long stop date (if one is stated), or cancel the investment. A typical long stop date is 30 days following the date of the subscription agreement unless more complex conditions are included (e.g. regulatory approvals in jurisdictions such as Indonesia can take several months).

corporate authorities

A series A investment transaction in Southeast Asia will require a variety of corporate authorisations or approvals. As with a seed funding round, directors’ and shareholders’ resolutions will be required to approve all of the transaction documents.

Assuming your company is domiciled in Singapore, this usually needs to cover:

• approval and execution of the subscription and shareholders’ agreements and the disclosure letter
• issue of the subscription shares to the investors
• appointment of the investor director(s) to the board
• approval and execution of service agreements if founders are to become executive directors of the company
• appointment of corporate representatives to execute on behalf of any corporate shareholders
• adoption of an employee share plan, or allocation of the share or option pool.

Normally, you will need to obtain waivers of any pre-emptive rights from existing shareholders to enable the series A deal to proceed.

completion

In most cases the completion date for an investment is on or around the date that the conditions precedent are satisfied or waived.

The subscription agreement will set out the actions to be taken by each party on the completion date. A typical list of completion requirements includes:

company

• delivery to the investor of the signed corporate authorities
• the new shareholders’ agreement, signed by the company and all existing shareholders
• a certified (i.e. signed by a director) copy of your company’s share register recording the investors as shareholders in your company
• any other deal specific deliverable document.

investors

Payment of the investment funds into the nominated company account, and delivery to the company of:

• the new shareholders’ agreement, signed by the investors
• the written consent of the investor (or the investor’s nominee) to act as a director of your company.

Post-completion, you will need to update your company registers and your records at the relevant regulatory body (e.g. in the case of Singapore, the Accounting and Regulatory Authority) to reflect the issue of the new shares to the investors, the appointment of any investor nominated director, the adoption of the new constitution of your company, and any other matter required by that body.

employee share incentives

At series A stage, if not already in place, most companies implement an employee share option scheme (ESOP). This pool is for founders and employees, and options under the scheme will be granted by the board. The ESOP pool is often set at 10-15% of the fully diluted share capital.

Options are a great way to incentivise employees but the ESOP terms can vary. Aside from when the shares vest, think about:

• whether the ESOP should include good/bad leaver provisions or KPIs
• how the vesting period may accelerate on a liquidity event. Generally, to exercise the options, the option holder must sign a deed confirming that he or she will be bound by the current shareholders’ agreement. If that agreement doesn’t include a drag-along right, this is often added to the ESOP documentation.

We suggest holding off putting an ESOP in place until after the series A has closed (and often it is a requirement to implement within 90 days). This means the handling the ESOP won’t distract from closing the investment round.

To implement an ESOP, the shareholder’s agreement and constitution will need to authorise the granting of ESOP options and issue the associated shares on exercise, outside of any restriction on issuing new shares. Also, investors may want to approve the terms of the scheme before its implementation. This is fine, but the allocation of the options should remain at the sole discretion of the board (who are the best persons to determine who is worthy of participating).

An ESOP is not the only way employees can be incentivised, e.g. employee share ownership (ESOW) plans allow employees to directly own or purchase shares in the company.

taxation

For companies which are incorporated in Singapore, if an employee is granted share options under an ESOP by an employer, he or she will be taxed on any gain or profit arising from the exercise of the share option. However, an employee who is granted shares under an ESOW is subject to tax on any gain or profit only when the ESOW plan vests on the employee.

There is a lot of publicly available information on ESOPs, certainly for Singapore domiciled companies, e.g. the Singapore Ministry of Finance has provided information on Stock Options and Awards and, on the Inland Revenue of Singapore (IRS) website, there is a guide to work our your taxes.

follow-on rounds

Successful companies may be supported further by existing and new investors. Each time additional funding is raised, the follow-on shareholders usually expect to be issued a new class (or series) of shares carrying preferential rights to the highest class of shares on issue. So you may need to issue series B or series C preference shares in the future. These follow-on rounds can take businesses beyond development to the next level and can end up being large investments at high valuations.

The terms of series B and follow-on investments are similar to those on a series A round. Often, these investments are led by the same VC funds as the previous round. However, one key difference can be the bargaining power. Your series A investment round may have been negotiated by a lead investor who retained much of the control in its sole capacity. On subsequent rounds, there may be several major investors who will end up holding similar percentages of the total equity. The result is that investor veto rights are often flattened out so that approval is given by a specified majority of all preference shareholders. This is good for the company as no one investor can then block key decisions as the company approaches the key stage of its growth.

With your business now established, there are good grounds for founders to ask that their personal liability (if any) under the investment documentation fall away. Often, representations and warranties at series B are given by the company only. This means that founders can focus on growing the business without concerns about ongoing personal risk.

In Southeast Asia, new VC funds are emerging that specialise in this later stage investing – see Techcrunch’s article on Eduardo’s Saverin’s new fund. If you get to series C and beyond, investment banks, hedge funds, large corporates or private equity firms may also accompany the more typical VC investors. The terms on these deals may be more like a private equity deal with a clear focus exit.

venture debt

Venture debt is another form of follow-on financing which is becoming increasingly popular in Southeast Asia. Some financial institutions in the region have set up schemes to finance startups, including Singapore’s DBS and OCBC. Temasek’s Innoven Capital and the Singapore government agency Spring Singapore have looked at similar schemes. Venture debt typically supplements an equity round by providing additional capital – but with the upside of limited further dilution for companies. It is senior debt so it takes priority over any other debt that your business may have and includes the issue of warrants (a right to subscribe for shares in the future at a fixed price).

Venture debt is different to convertible instruments which were discussed in our guide to raising seed capital in southeast asia – structure and terms, i.e. unsecured debt which converts into equity on the next financing round. Venture debt doesn’t convert but will typically be secured against the assets of the company. e27’s blog post on venture debt has a good analysis of venture debt transactions.

introduction

In the last 5 years, there has been a lot of seed and institutional venture capital (VC) money flowing into the Southeast Asian technology space. With a total population of 600m, and with a young and tech savvy consumer market, investors have spotted the potential for the rapid growth of disruptive tech companies in the region.

In this guide, we discuss the things Southeast Asian tech startups need to think about before they raise seed investment from sources such as seed focussed VC funds, 500 startups, high net worth individuals, government matching investment schemes and startup accelerators.

If you are looking to raise series A or other follow-on financing, check out our guide to raising series A capital in southeast asia.

(Note: Already have your startup registered in Singapore? Great, you can head over to Part 2 where we cover structure and terms of your seed round.)

where to domicile your company

When starting a new tech business in Southeast Asia, one of the first things you need to think about is where to incorporate.

Whilst the VC market is increasingly global, investors prefer a safe place to invest their money. In Southeast Asia, that generally means Singapore – currently the regional leader in terms of infrastructure, respect for intellectual property and legal protections. For this reason, most Southeast Asian tech startups raising professional capital domicile (or redomicile – discussed below) out of Singapore (either to attract investment or as a requirement of their investors).

We suggest that Southeast Asian startups incorporate their holding company in Singapore from the outset, irrespective of the key market of the business.

administrative support

Many startups want to focus on building their business and look to outsource supporting roles, such as company secretarial services. Appointing an ongoing company secretarial provider is a simple process, but don’t simply choose a provider on price. Because startups in Southeast Asia often grow rapidly, you could raise capital two or three times in the first 24 months. This is likely to require the company to issue different classes of shares to multiple international investors.

You may also want to issue convertible debt or adopt an employee share option plan (ESOP). As a result, a large amount of company secretarial paperwork may be required, some of which can be quite complex. Therefore, look to work with a provider with a track record of working with tech and venture backed companies.

Most startups will also need to engage an accountant to assist with their annual accounts and ongoing tax compliance and book-keeping.

redomiciling (flipping) your company

It’s not always possible to incorporate in Singapore from the outset, e.g. if you have received Government seed grants which require the recipient company to remain incorporated in the local jurisdiction for the period of the grant.

But, when the time comes to raise capital for your startup, you will probably need to redomicile your company to Singapore to meet the requirements of investors (and this discussion assumes this is the case). This is commonly referred to as flipping your company.

Flipping to a new jurisdiction can be done by either a transfer of shares (see diagram 1) or a transfer of assets (see diagram 2).

Diagram 1 – flip by way of share transfer

Diagram 2 – flip by way of asset transfer

A share transfer is the simplest and most common approach. It involves a transfer of all of the shares in the existing company (ExistingCo) to a new holding company (NewCo). NewCo then immediately issues shares in NewCo to mirror the holdings that had been held in ExistingCo. These are separate corporate transactions in two different jurisdictions. As a result, it’s a good idea to get legal and tax advice on both of them. E.g., the share transfer may be a liquidity event in certain jurisdictions triggering a tax charge on the deemed capital gain. Separately, you will need to attribute a value to the ExistingCo shares being transferred for the purposes of appropriately recording the share issue at the Accounting and Regulatory Authority (ACRA).

A company flip involves an issue of shares for non-cash consideration. Section 63B of the Singapore Companies Act, (Cap.50) (Companies Act), requires an agreement to be filed with ACRA setting out the terms of the non-cash consideration. This agreement (commonly called a share exchange agreement) also gives ExistingCo shareholders comfort that they will receive the equivalent number of shares in NewCo once the transfer of shares in ExistingCo is completed. This is important as, in certain jurisdictions in Southeast Asia, share transfers are subject to regulatory approvals and can take some time to complete.

Our share exchange agreement is a great template to use to flip your company from a jurisdiction in Southeast Asia into Singapore by way of a share transfer and issue of new shares in a NewCo. You will need to have the agreement reviewed for local compliance by a lawyer in the jurisdiction of ExistingCo.

Flipping your company by way of an asset transfer is usually more complex and time consuming because it requires the sale of individual assets from ExistingCo to NewCo. Given this, asset transfer is usually only used if there is a significant legal, tax or commercial impediment to a share transfer.

An asset transfer involves the assignment or transfer of intellectual property, other key assets, contracts and employees. These assignments and transfers may require the consent of third parties. This process usually leaves ExistingCo without any assets other than either shares in NewCo or a debt from NewCo (the consideration for the asset transfer). However, if your company has a material liability (e.g. a customer threatening to sue ExistingCo), investors may require the liability and associated contract to remain with ExistingCo. In this case, it’s a good idea to chat to a lawyer about how to best structure the split.

You will need to carry out some due diligence on your own company before flipping it. Aside from local legal and taxation matters, check whether existing contracts and other arrangements will be impacted by the redomicile, e.g. a shareholders’ agreement will need to be mirrored and restated under the laws of NewCo’s jurisdiction.

For further information and tips on redomiciling your company in Southeast Asia, see e27’s blog post on flipping.

founder arrangements

If, as a startup, you are planning to raise capital in the near future, we suggest holding off entering into a shareholders’ agreement. Most incoming investors will want the company to adopt a new shareholders’ agreement to protect their interests, so work on an earlier shareholders’ agreement may be wasted time and cost.

However, founder vesting arrangements may be needed from an early stage. These arrangements protect the company if a founder moves on before you complete a capital raise (and, in any case, founder vesting arrangements sometimes remain in place post-investment), because investors don’t like departing founders retaining a large percentage of the equity.

Under a vesting arrangement, a founder who leaves the company within a set period (typically 2 or 3 years) forfeits a portion of his or her shares back to the company. These are increasingly common in Southeast Asian tech startups and generally follow the Silicon Valley model.

We have two examples of founder agreements on our website:

• in our short form co-founder agreement some or all of a founder’s shares vest progressively over a set period, either with or without an initial cliff. The company’s right to purchase unvested shares for a nominal sum applies where the co-founder ceases to work for the company. This is by far the most common arrangement
• our long form founder agreement takes a similar approach to the short form one, but the company also has the right to purchase unvested shares for a nominal sum if the company considers the founders has failed to make the required contribution to the business. This is useful if the founder doesn’t have an employment agreement or similar document setting out what is expected in terms of contribution to the business.

Where the vesting arrangement involves the buy-back of a leaver’s shares by the company (which is usual), the local jurisdiction of the company may restrict share repurchases. E.g. for Singapore companies, the Companies Act requires:

• the company’s articles of association or constitution (as applicable) to expressly permit share repurchases
• a buy-back agreement to be approved in advance, with the directors being satisfied that the company was solvent at the date of this agreement
• no more than 20% of the total issued share capital to be bought back in a 12 month period.

For these reasons, vesting agreements may provide that leavers transfer shares to other founders.

group restructuring

Many investments in Southeast Asia are made into a Singapore holding company, but you may have group companies in other countries in the region (e.g. where the business actually operates). Due to foreign ownership regulations, founders may still personally own shares in subsidiaries at the time of starting discussions on a proposed investment. Investors will want to see a clear group structure in terms of ownership and evidence of any local capital requirements having been satisfied. The more companies and jurisdictions involved in the group, the more extensive due diligence and pre-closing conditions you can expect.

Investment is often conditional on a group company in another jurisdiction completing a particular corporate action. E.g. foreign businesses operating in Indonesia may need to set up a PT PMA company (a foreign investment limited liability company) which can take up to 6 months to complete (of course, this is often worthwhile when you consider Indonesia’s vast and young population and rising consumption – it is an exciting country for entrepreneurs and investors, with a significant amount of capital being invested there).

Some markets or sectors may be closed to foreign investment too, e.g. Indonesia has a negative list administered by the local investment coordinating board (BKPM), and similar restrictions may apply in other Southeast Asia jurisdictions. Check with local counsel on what is required and understand the timing to execute, as it may add significantly to the deal timetable. It may be that certain actions need to be completed after the closing as it is simply impractical for them to be completed before funding occurs. Ensure you take advice on how long these actions may take and understand the investors’ remedies if you fail to complete them in time.

Be sure to read our next guide in this series where we discuss how to structure seed investment deals, the key terms and documentation to consider, and how to go about finding investors.

introduction

In a previous guide on raising seed capital in Southeast Asia, we discussed getting investor ready, including where Southeast Asian startups should incorporate their company, founder arrangements, and group structure.

In this guide, we talk about how to structure seed investments, the key terms and documentation, and how to go about finding investors.

convertible notes

Many seed investment rounds in Southeast Asia complete using convertible note instruments like the 500 Startups Keep-It-Simple-Security (KISS).  These are unsecured debt instruments that convert to equity when a company completes its next equity raising.

The KISS is the most common type of convertible note used in Southeast Asia.  If you are contemplating a seed round, we suggest you upskill on this document by downloading a version of the KISS adapted for Southeast Asia from our website.

There are other forms of note in use in Southeast Asia, including US style documents.  With these documents, US specific provisions need to be amended, e.g. removing US securities law and taxation language which shouldn’t be relevant for a non-US issuer.

Convertible notes anticipate that the investment amount is drawn down either in a lump sum on one date or, more likely, over a period of time.  The investment amount typically automatically converts to equity on the date of a qualifying capital raise at a discounted price to the next round price, but subject to an overall valuation cap.

If not already converted, the debt may be repayable (potentially at a multiple of the outstanding amount) or convertible at the noteholder’s discretion:

• on the occurrence of a liquidity event, i.e. the sale of your company
• at the maturity date for the note. This is often at least 18 months from the initial drawdown.

Convertible notes have been successful in Southeast Asia partly due to the availability of series A money.  This gives noteholders comfort that you are likely to raise follow-on capital quite quickly, which triggers conversion of the note into equity.

key features of convertible notes

Investment Amount	The amount to be invested by the investor (noteholders)
Series	Notes of a particular series are issued on the same terms. Typically, you may have a period of time to issue further notes on the same terms without seeking the consent of existing noteholders. The total investment amount is sometimes drawn down in a lump sum on one date or over a period of time with multiple closings
Interest	This is the annual rate at which interest accrues on the note whilst it is outstanding. In Southeast Asia, the rate varies, but usually is a low amount, e.g., 1% or 2%
Maturity Date	This is the date on which the debt is due for repayment. This should be a reasonable period of time from the date of the note, so that the company can achieve the qualifying capital raise (see below) to trigger conversion.  In Southeast Asia, periods to maturity are generally set at 18 months and can be longer.  Usually, if the company is unable to raise money before maturity, the majority of noteholders can elect for the debt to convert to shares rather than demanding repayment
Qualifying Amount	The investment amount of the notes will automatically convert into shares at the time of the company’s next capital raise.  There is normally a minimum amount that must be raised to trigger conversion (called a qualifying capital raise), which is set to ensure that the raise is a legitimate company financing, not a device to trigger conversion
Discount	Assuming the company’s next financing round is a qualifying financing, the notes will automatically convert into shares often at a discount to the share price paid in that financing.  The discount is intended to compensate investors for the risk they take on by investing at an early stage.  In Southeast Asia, this discount is typically 15-25%.  This follows Silicon Valley norms
Valuation Cap	This addresses an initial concern that investors had with the KISS style and other convertible notes – that the company’s valuation could increase significantly and they would only have the protection of the discount to the price of the next funding round.  The valuation cap effectively caps the price at which investors pay for their shares when the note converts.  If your company raises a financing round at a $5 million pre-financing valuation but the convertible notes have a $2 million valuation cap, your note holders will effectively receive a 60% discount to the price that the new investors are paying.  So consider a valuation cap carefully as it can have a significant dilutive effect on the next round of financing if set too low
Majority-in-Interest	This term simply means those noteholders holding a majority of the total investment amount of the series.  It is useful to incorporate this concept into the document so that key decisions are taken, or rights waived, not by individual investors but on a majority rules basis

convertible notes vs equity

There has been a lot written on this topic.  For a founder’s take on the debate, have a look at the blog Seedinvest: Pros and Cons of Convertible Notes or 500startups KISS blog post.  For an investor point of view, Jason Lemkin’s SaaStr blog post An insiders’ guide to convertible debt vs equity is good read.

From a founder’s perspective, the biggest benefit of convertible notes over an equity financing is speed.  The note is generally a single document with simpler terms to negotiate, and without lots of conditions, representations and warranties.  In addition, the KISS and other most convertible notes are designed to be executed by individual investors, so it is possible to receive funds without closing with all investors simultaneously.

Other benefits of convertible notes include:

• postpones the difficult discussion about the company’s valuation. It is hard to value startups early on.  Deferring the valuation until a larger equity round is raised is one way to address this.  Also, if a third party is prepared to invest at a particular point in time and valuation, it provides some level of market evidence of the valuation for the notes.
• lower cost to execute. Convertible notes are simple and flexible.  It involves a single document, whereas even small equity investments can involve a subscription agreement, shareholders’ agreement and a new constitution
• fewer representations and warranties. Subscription agreements often include multiple representations and warranties which are inappropriate for an early stage startup.  A convertible note generally includes only a handful of very focused warranties, avoiding protracted negotiations and unnecessary time spent on disclosure by the company
• concedes much less control. Noteholders typically receive little (if any) control over the company, e.g. no veto or director appointment rights.  This works well with the need for startups to pivot and to raise the next round of funding without investor interference.  Because notes provide this flexibility, there has been good success rate of note financed companies raising a series A follow-on round
• less administrative burden. The fewer shareholders you have, the less shareholder notices and other company secretarial formalities you have to deal with.

However, there are some downsides to convertible notes from a founder’s point of view:

• convertible notes are debt. The clock starts running towards repayment on the maturity date.  If you have not completed a qualifying capital raise by that date, the debt needs to be repaid.  While it is uncommon for investors to enforce that right and force the winding up the company if the debt cannot be repaid, you may have to renegotiate some form of refinancing with note holders
• preference shares generally issued on conversion. Most convertible notes convert into the class of shares issued to the investors on the next round of financing.  In Southeast Asia, this means preference shares.  As a result, convertible note investors have the double protection of both a price discount on conversion plus the liquidation preference negotiated by the lead follow-on investors
• disenfranchised investors. Convertible notes have valuation caps and often don’t include information or participation rights in later financings.  This means convertible note investors are not as involved in the business as they might be by owning equity.  But, startups need all the help they can get, so make sure that your note holders are real supporters of the business and can potentially help bring in the next round of funding
• additional protections. Finally, convertible notes can sometimes include additional protections for noteholders, such as participation rights, additional reporting from the company, and a most-favoured-nation provision (which gives noteholders comfort that they will receive a replacement convertible note if one is subsequently issued on better terms).  Avoid these if possible, but if investors insist on them, ensure that they can be waived by a majority of the note holders.

Notes carry some uncertainty, particularly if follow-on money is unavailable,  But in Southeast Asia, they remain a very effective tool, predominantly due to how quickly deals are closed – we have seen convertible note financing rounds closed in Southeast Asia in a few days.  For startups looking to raise money fast and get on with growing the business, this remains a key factor.

seed equity financings

Convertible notes are not always an option since some investors prefer the certainty of equity even on seed rounds.

If the amount being raised is not significant then it is in everyone’s interests to keep the documentation simple and get the round closed quickly.  Try to avoid “Series A” terms and documentation as this is likely to be overkill and is likely to limit your flexibility both in terms of how you grow your business and how you raise further capital.

Small seed investments can be completed using our southeast asia seed investment term sheet, subscription agreement and shareholders’ agreement.

Keep the following tips in mind:

• issue ordinary shares – as soon as companies start issuing preference shares, the deal becomes more complex with discussions on liquidation preferences, conversion mechanics, and anti-dilution rights
• aim to keep the subscription agreement (which sets outs the mechanics and terms of the investment) simple. Ideally, include only a limited set of representations and warranties covering items such as compliance with reporting obligations, IP ownership, and confirmation of no claims
• put in place only a simple shareholders’ agreement which contains fundamental rights and obligations for the governance of your company (e.g., information rights, pro-rata participation rights in future financings, and non-competes). Avoid any investor consent rights so that investors do not need to be consulted except for significant capital expenditure or a material change in the direction of the company
• avoid amending the company’s articles of association or constitution (as applicable) – this should be possible as long as you avoid issuing preference shares
• aim to have the company’s lawyer prepare the documents as this usually ensures reasonable first drafts can be presented.

corporate authorities

All seed capital raising transactions in Southeast Asia require corporate authorisations which your company secretary will need to complete.

E.g., in Singapore, directors’ and/or shareholders’ resolutions will need to cover:

• approval of all the transaction documents, including any convertible note or the subscription and shareholders’ agreements (as applicable)
• adoption of the new constitution or articles of association of the company (if required)
• the issue of the subscription shares to the investors
• the appointment of any investor director(s) to the board of directors
• an obligation on the investors to pay the subscription monies to the company’s bank account
• approval and execution of any service agreement if founders are to become executive directors of the company.

Aside from the transaction documentation, ACRA requires that Singapore based company secretaries carry out stringent know-your-client (KYC) checks on new shareholders.

You should plan for this early in the process to ensure that this investor KYC documentation does not hold up closing the deal.

finding investors

There are now over 25 active venture capital funds based out of Singapore focused on the Southeast Asia region.  Many of these funds have participated in seed investment rounds as well as larger follow-on capital raisings.

Tech-in-Asia have provided a useful directory of VC firms and angel investors with a presence in Singapore that have been investing in startups in the last few years.  Some of these funds were supported by the Singapore government through the National Research Foundations Technology Incubation Scheme (NRF TIS) and the Early Stage Venture Fund (ESVF).  The NRF continues to evolve with the future ESVF initiatives being announced in early 2016.  Further information can be found on the NRF’s website.

In addition, you can meet potential seed investors through various accelerators and incubators in Singapore, e.g. SPH Plug and Play, Joyful Frog Digital Incubator, Muru-d and Startupbootcamp, the latter of which focusses in the area of fintech.  e27 have compiled a more complete list of Singapore accelerators and incubators.

LaunchPad, also known as Block 71, is a startup cluster in Singapore that the government plans to become home to up to 1,000 startups.  Aside from incubators, accelerators, and other startup support services, you may find some potential seed investors as part of that cluster.

Finally, Singapore has a significant density of high net worth individuals (HNWs).  However, many of these HNWs have made their wealth from traditional industries or property, and have never worked in tech.  Working with investors who are new to the tech industry can be difficult, both before and after completing an investment transaction.

securities laws

Companies raising money from investors are promoting the issue of securities and must comply with local securities law in the jurisdictions where the investors are based.  For Singapore issuers, the Securities and Futures Act (Cap. 289) requires that all offers of securities be accompanied by a prospectus unless the offer is subject to an exemption.  Fortunately, the Act provides for many exceptions for private placements and other share issues.

These exemptions include (amongst others):

• small personal offers where the total amount raised from such offers within any 12 month period does not exceed SGD5m or such other amount prescribed by the Monetary Authority of Singapore (MAS)
• an offer to no more than 50 persons within any period of 12 months and under certain conditions
• certain offers of securities of an entity made to existing members or debenture holders of that entity
• an offer to qualifying persons like employees of the corporation or its related corporations under the specified conditions
• an offer to institutional investors
• an offer to specified persons, including accredited investors

Further information can be found at:

• Laws of Singapore, Commercial Law, Ch.17 Corporate Finance and Securities Regulation
• Securities and Futures Act (CHAPTER 289).

The map of the funding terms is a tool to track typical investment terms that our VC lawyers see on fundraising deals at different stages of a company’s life cycle in Southeast Asia. It helps startup founders compare what is typical in the market when reviewing their own term sheets. To use the tool, click on the relevant term and you can review the position at each stage of fundraising.

 

Traditionally, growth stage technology companies in Southeast Asia have raised venture capital via convertible debt or equity rounds. However, venture debt is fast becoming an alternative or complementary path for startups looking to get capital to accelerate their growth. In this guide we cover the basics of venture debt. For more detail, download our latest free e-book, The Startup Guide to Venture Debt in Southeast Asia.

what is venture debt?

Venture debt is a form of debt financing, similar to bank loans but with a few key commercial differences. Venture debt is typically used by VC-backed, fast-growing tech startups that may not have positive cash flow or significant assets to use as collateral. These companies are typically not eligible to receive traditional debt financing from banks or other institutional lenders (or would only be able to borrow at prohibitive interest rates).

is my company a good candidate for venture debt?

The typical profile of a company taking on venture debt is a venture backed, fast-growing startup at series A or later. By the time a company is ready to explore venture debt, it will already have cashflow and an established customer base. Venture debt lenders also prefer venture-backed companies (i.e. those who have received funding from VCs / institutional investors). Institutional investors will have ‘vetted’ the company, and can be a future funding source should the company need help in paying back the venture debt.

why go for venture debt instead of an equity round or convertible debt?

There are a few reasons why a company may use venture debt as an alternative, or supplement, to equity financing:

• less dilution: founders retain more of their shareholding
• board control: venture debt lenders typically do not require a director seat
• transaction time: the process is generally faster than an equity round, since lenders ‘piggy-back’ off the due diligence of the institutional investors.

learn more about venture debt and the process

If you’re looking for more information about types of venture debt, key terms to negotiate in your venture debt term sheet, and details of venture debt providers in Singapore, download our free PDF guide.

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