Inspired by Y Combinator’s Safe convertibles, utilizing the simplicity and speed of convertible notes but elegantly avoiding the debt trap, I attempted to adapt the U.S. documents to Swedish law a couple of years ago. Many founders asked for a Swedish version of the Safe, and how hard can it be? Just change the jurisdiction to Sweden, right?
After banging my head against the wall for two years, with both lawyers and auditors telling me why it’s impossible, or at least unreliable and risky, under Swedish corporate law, I decided to not adapt the Safe to Swedish law, but to start innovating from scratch.
Today I’m happy to introduce the new Swedish financing instrument WISE (Warrants for Investment in Startup Equity). In practice, it works like the Safe convertibles (where the invested amount is converted to shares later depending on the valuation in next financing round), but it’s based on warrants (teckningsoptioner) which are well-defined in Swedish law and all lawyers and auditors know how they work.
In brief, the benefits are:
- Fast: no lengthy negotiations needed, no shareholders’ agreement.
- Cheap: less legal help needed.
- Flexible: Sign each investor individually as soon as they commit.
The WISE is not supposed to replace priced equity rounds, which are often as good or better, assuming that you have the time and money to pursue the negotiations and paperwork.
If you’re new to startup financing and want an overview of the different options in different stages, I suggest that you first read the startup funding overview.
We’ll get back to how WISE works, but first some background.
Why a new instrument?
Priced rounds (equity investments/share issues, nyemissioner) is the most common financing instrument Swedish startups use when raising money. The company creates new shares that are sold to investors for a fixed price. The startup receives cash (registered as equity in the balance sheet) and the investors become shareholders. You also sign a shareholders’ agreement.
Another option for fundraising is to issue convertible loans. The company then borrows money from the investor. The loan bears interest and has a maturity date when the loan shall be repaid. Typically, if some pre-defined event occurs before the maturity date (e.g. an equity investment), the loan automatically converts into shares on the same terms as in the new share issue, usually with a cap and discount.
Priced rounds vs. convertibles
The commonly mentioned advantage of a convertible over a share issue is simplicity. Using a convertible, you don’t need to agree on exact terms (or valuation) right now but can wait until a later date, i.e. when another investor invests in a priced round and all agreements and valuation are negotiated. Also, since no shareholders’ agreement is needed, you can sign investors continuously as they commit, without everyone signing the same document. Also it tends to be less expensive since less legal negotiations are needed. There is much more written on convertibles vs. priced rounds.
One of the disadvantages with using debt (convertible or not) for financing your company is the debt trap, where the share capital (aktiekapital) is used for covering losses in the business. A Swedish limited company (aktiebolag) should always protect its share capital to avoid exposing the board of directors to personal liability for the company’s liabilities in case of insolvency. If more than 50% of the share capital has been consumed, very strict rules apply for how to avoid liquidation and the directors’ personal liability.
I’m in no way saying that convertibles are always preferable to priced rounds for startups. On the contrary, I would argue that priced rounds are often more appropriate. But, there are certain occasions when a priced round isn’t suitable, e.g. when you raise a small amount just before a planned bigger round, when high speed or low legal costs are of the utmost importance, or when you want to continuously close investors instead of building up to one big investment round.
By creating a standardized financing instrument that is very similar to a convertible loan, but counts as equity in the balance sheet, I hope to open up the world of convertibles to non-profitable companies (even if the WISE documents are not convertibles by definition, but warrants).
How WISE works
Disclaimer: This web site and the documents that can be downloaded from here contain general information, which is not advice, and should not be treated as such. The information is provided “as is” without any representations or warranties, expressed or implied. I’m not a lawyer or a tax advisor and even though I’ve done what I can do minimize any legal, financial or tax risks, I obviously take no responsibility for how you use the documents. Even though I’ve used WISE a handful of times myself already, and know many other investors and startups who have as well, you should always talk to a lawyer and/or tax advisor before implementing.
The WISE utilizes warrants, which are well defined in Swedish law, to mimic a convertible loan that cannot be repaid and therefore counts as equity in the balance sheet.
Assume that an investor wants to invest in a Swedish limited company, with the simplicity of a convertible but without increasing the company’s debt. Using WISE, this is solved by:
- The investor buys warrants from the company for the same amount as they wish to invest.
- The proceeds received by the company counts as equity.
- There is no interest rate (since it’s not a loan).
- The money can never be repaid (since it’s not a loan).
- Each warrant gives the right to purchase at least one share for quota value (kvotvärde) immediately before the next financing round.
- The exact number of shares per warrant depends on the valuation in the financing round. The formula takes into account a valuation cap and a discount. More on this later, but in short:
- If the valuation cap is reached, one warrant corresponds to exactly one share.
- If the valuation (after discount) is less than the cap, the investor can buy more than one share per warrant. For example, if the valuation is half of the cap, each warrant corresponds to two shares.
- If the investor decides not to purchase the shares at that time, the warrant is void.
- For examples and a model on how to calculate the conversion, see this WISE conversion spreadsheet.
- The exact number of shares per warrant depends on the valuation in the financing round. The formula takes into account a valuation cap and a discount. More on this later, but in short:
- If no qualified financing round has occurred within four years, each warrant gives the investor the right to purchase at least one share (typically two shares) for quota value anyway.
- This corresponds to a fallback conversion for a convertible loan (if you’re familiar with that).
All in all, the result is:
- The investor pays the full investment amount up front, and only the negligible quota value of the shares later.
- The investor can never have their money back.
- The company receives all proceeds up front, registered as equity (no debt).
- There should be no tax consequence for the company or the investor.
- There is no need to negotiate a shareholders’ agreement or even a term sheet. The only thing you negotiate is the discount and the cap.
- Using standardized documents, the process should be rather quick.
As you know, I’m not a lawyer or a tax advisor of any kind, but since the instrument is based on common warrants, I don’t think you will experience any problem. Also, Bolagsverket has approved the setup in several real cases where Swedish startups have used these documents. Skatteverket can’t give a binding statement for how they will see things in the future but their legal team confirms in writing that, in general, “payment for warrants issued for financing a company is no different from a tax perspective than a financing done via a new share issue, which is normally tax free” (my translation and interpretation). I have also already several times invested using the WISE documents myself. But, as always, make sure to ask for professional advice before implementing.
You’ve probably heard before that tax rules relating to employee warrants can be tricky, but the most common pitfalls only apply if you issue warrants to employees or others who receive warrants as compensation for work. That kind of warrants should generally be taxed as income. But these WISE warrants are not compensation for work, and the investor pays a negotiated market price for the warrants, so no one should be able to claim that someone received something for free (or below market value). This is also why you don’t have to care about Black-Scholes formula which is common for warrant-based stock option programs for employees.
Getting started with WISE
Download the documents. In the Word documents, there are some variables you need to fill in yourself. We’ll discuss the most common questions below.
WISE Terms FAQ
The WISE Terms document is valid for all warrants issued at the same time. It has official status and will be registered with Bolagsverket (i.e. it’s public!). This is also the reason why it has to be in Swedish (with English translation). The other document (the WISE Agreement) is a private agreement between the company and the investor and must be signed with every investor.
How to set a Discount and Cap (§ 1)?
As discussed above regarding convertible notes in general, there is usually a cap and sometimes a discount. This is what you’ll negotiate. Think of it this way: The investor’s money (which was used to buy the WISE) will “convert” to shares on a valuation that equals the valuation in the text round minus the discount, however not more than the cap.
Entrepreneurs want the cap to be high and the discount to be low, which would in practice lead to the investors buying shares on basically the same valuation as the future investor. Naturally, early investors want a lower valuation since they’re taking more risk than later investors. How to balance this is both art and science and I won’t try to give you a full answer.
Based on personal experience (100 anecdotes or so) there are two main cases:
- If you are about to close a bigger round but need some bridge financing to cover only a few months before the money is in the bank account, typically there is a high cap and a small discount of perhaps 15-20% (to compensate for the risk).
- If you don’t know that a big round is soon closed, you have a moderate discount (20-30%) and a fair cap (around or slightly above what would be a fair valuation today).
It also happens that startups raise long-term money without a cap or a very high cap, but investors don’t like that. Assume that you raise seed funding that should take you 12-18 months ahead, what is a fair discount? Ask yourself this question: How much more risk are the seed investors taking compared to series A investors? It seems like about 10-50% of serious U.S. seed funded startups reach series A, so investors take perhaps 50-90% more risk than series A investors. Looking at valuations, seed valuations in U.S. seem to be about 40% of those in A rounds, which would indicate at least 60% discount. As you can tell, this isn’t easy. Probably it’s just better to go with #2 above with both discount and cap, or to do an equity round.
In the document, the cap is defined as the maximum non-diluted company valuation. Often you think of valuations as fully diluted, including the value of all options etc. However, this can be very hard to calculate, so to keep things simple the cap is based on the non-diluted number of shares in the company.
Example: If you have 1M shares in the company and 100k options, and a new investor agrees that you have a pre-money fully diluted valuation of 11 MSEK, the value per share is 11M / (1M+100k) = 10 SEK. However, the non-diluted (counting only real shares) valuation is 1M*10 SEK = 10 MSEK.
What is the Floor (§ 1)?
While the cap is the maximum, the floor is the lowest possible company valuation that the investor’s warrant can “convert” on.
So, the complete formula (defined in § 5.3) for determining the valuation at which the warrants “convert” is: valuation_in_next_round × (1 – discount), but not lower than the floor and not higher than the cap. N.B.: Technically, the warrants don’t “convert” at a “valuation”, but the investor has the right to exercise the warrants to purchase shares, where the number of shares per warrant is determined by the formula described above.
The floor is a technicality required by Swedish law. A warrant needs a maturity date (§ 4) when the investor has the right to purchase shares at a fixed valuation (the floor), if no qualified financing round has occurred before that date.
You should set the floor to a low number, since if no new financing has taken place, the company is probably not doing very well. The counter-argument is that perhaps you don’t need more investments because you’re doing great, and therefore the fallback valuation should be high. On the other hand, you can always choose to raise a financing round even if you don’t really have to.
As you can tell, there is no clear answer to how to set the fallback valuation to deal with all scenarios, but if you set it to something that both you and the investors can agree is not higher than today’s fair valuation, you should be fine. The most common fallback valuation I’ve seen is 50% of the cap which is also default in the template.
What’s the right price per warrant (§ 2)
The price per warrant can be calculated as soon as you have agreed on the cap. The formula is the cap divided by fully diluted shares. “Fully diluted shares” means the total number of both issued and non-issued (but decided) shares, options, warrants, convertible loans etc., excluding the WISE issued now.
To understand the formula you can think like this: The cap divided by the number of fully diluted shares corresponds to the value per share if the cap is reached. Since one warrant corresponds to one share if the cap is reached, and the share later is purchased for practically nothing, this would be the right price per warrant if we knew that the cap would be reached.
But we can’t be sure that the cap will be reached. This is why the investor in some cases can buy more than one share per warrant.
How many shares can the investor buy per warrant (§ 3)?
As already hinted in the previous section, each warrant corresponds to one share or slightly more. If the cap is reached in the next funding round the investor can buy exactly one share, but if the valuation (after discount) is e.g. half of the cap, then the investor can instead purchase two shares per warrant.
In § 3 you enter the maximum number of shares that can be purchased per warrant. This will become a reality if the valuation (after discount) in the next round isn’t higher than the floor (see above), or if there is no share issue at all for four years. This is why the formula to calculate the number of shares per warrant is the cap divided by the floor.
If there is a financing round within four years, the number of shares per warrant is recalculated (see § 5.3 below) to a number ranging somewhere between the number in § 3 and 1.
The advanced subscription (§ 5) sounds complicated.
It’s not. All the wording about “bona fide” and “principal purpose of raising capital” is just to ensure that only a real financing round triggers the “conversion”. If you issue shares cheaply to a new co-founder (beware of tax risks!) this should not trigger conversion so that investors can buy shares very cheaply. And the company cannot issue a few shares at a ridiculous price to a “fake” investor in order to try to trigger the conversion at a high valuation.
How does the recalculation formula in § 5.3 work?
In the default case, if there is no financing round before the maturity date (after four years, see § 4), each investor can buy (typically) two shares per warrant. Hopefully you will raise money before then, at a valuation that’s close to the cap or higher. In that case, the investor can buy less than two shares (but not less than one) per warrant, namely the cap / V shares, where V is the valuation in the financing round (taking floor, cap and discount into consideration).
Then multiply this number by the number of warrants that the investor owns and round it downwards, to get the total number of shares that the investor can purchase. Also, if there have been any stock splits or similar, § 9 (see below) will make some final adjustments.
Example: The investor owns 10k warrants, which have a discount of 25%, a cap of 10 MSEK and the floor is 5 MSEK. In the financing round, the valuation is 12M, so V is 12M × (1-25%) = 9M (this is between the floor and the cap, so those limitations don’t apply). In this example, each warrant would give the investor the right to buy 10 MSEK / 9 MSEK = 1.111… shares. With 10k warrants, the investor can buy in total 11,111 shares.
What about that boring recalculation clause (§ 9)?
Clause 9 deals with special cases like share splits, IPOs and mergers, which can take place before the warrants are exercised and would affect the subscription price, or the number of warrants the investor can buy.
Example: If a warrant gives the right to buy one share, but before that happens, there is a share split, dividing every share into 50 new shares. In that case, the investor should have the right to buy 50 new shares instead. Without § 9, the warrant would lose 98% of its value.
Where do I sign?
You don’t sign the WISE terms. You sign the WISE agreement (see below), to which the terms are attached as an appendix.
WISE Agreement FAQ
The WISE agreement is much simpler than the terms. The company will sign one agreement per investor and append the WISE terms to the agreement. Most variables in the agreement are the same as in the terms. Only a few things should be pointed out.
What is the right of first refusal (§ 3)?
Just like in most shareholders’ agreements, the existing shareholders have the right to purchase any equity instruments (shares, warrants etc.) before any third party may buy them. If the investor gets an offer to sell the warrants, they must first be offered pro rata to the existing shareholders.
Can the investor really be forced to sell the warrants (§ 4)?
Yes, in case of an exit where a third party wants to acquire the majority of the company, the company can demand the investor to sell the warrants to the acquirer. Also, even if the company doesn’t make such a request, the investor has the right to sell in this situation. This is similar to a tag along and drag along in the shareholders’ agreement. The price per warrant will be calculated similarly to the advanced subscription clause (§ 5) in the warrant terms, with the same discount and the same cap.
What about the shareholders’ agreement (§ 6)?
The investor is not a shareholder and is therefore not a party to the shareholders’ agreement. However, when exercising the warrants and subscribing for shares, the existing shareholders’ agreement must be signed.
Assuming that you have prepared the WISE documents and are ready for signing, you need to follow all the usual corporate formalities when issuing warrants. You will have to summon both a board meeting and a general meeting, and you need to submit documents to Bolagsverket. Follow the link to read more about the process with Bolagsverket. I’ll summarize it below. In the downloadable document package you will also find templates for the necessary meeting minutes.
- Hold a board meeting. First, the board must make a suggestion to the shareholders to issue the WISE warrants, see Board Meeting Minutes (Proposal to GM) and Board Meeting Minutes (Proposal to GM) Appendix 1. Appendix 1 also refers to the WISE Terms. All the mentioned documents can be downloaded below.
- Hold the GM. Next, a general meeting (annual or extraordinary) has to vote for issuing the WISE warrants, see General Meeting Minutes. Please note that it refers to the board proposal in Appendix 1 so make sure to attach it.
Instead of making the decision of who gets how many warrants directly on the GM (which is most straightforward), you can instead let the GM authorize the board the mandate to sign new investors continuously during the coming months. If you choose that path there will be some more paperwork and you need to make some changes in the GM and board minutes, see Bolagsverket. The mandate has to be registered with Bolagsverket immediately, see latest registration document version at Bolagsverket (document no. 824). Don’t forget to pay the registration fee.
- Sign subscription list. When the GM has decided to issue warrants to the investor, they have to subscribe for the warrants (i.e. confirm the purchase of the warrants) by signing the subscription list Warrant Subscription List. If more than one investor are subscribing, they can sign the same subscription list or separate lists.
Nowadays, subscriptions list are not legally required but are included in the StartupTools templates since it’s still common and might make the process more straightforward.
- Pay for warrants. After subscription, the investor has to pay the price of the warrants, according to instructions from the company.
- Confirm subscription. The board confirms the subscriptions. Use Board Meeting Minutes (Confirmation).
- Notify Bolagsverket. You must inform Bolagsverket of the issue, see Bolagsverket’s web site for form 826, and pay the registration fee. They need to know that you have issued warrants but they don’t care to whom.
In the form, they ask for “Tid för aktieteckning” (“Period for subscription of shares”). The fallback case is that this happens in between four years and four years plus three months, and this is what Bolagsverket usually wants to see in the form. However, since there is a (high) possibility that there is a priced round before then, I suggest that you add “Tiden för aktieteckning kan tidigareläggas enligt §5 i optionsvillkoren” as a comment under item 5 (“Övrigt”).