Understanding Financing Options for Start-ups: Equity vs. Debt (SAFE/CARE)

As a start-up in Singapore, navigating the complex world of financing can often feel overwhelming. When you're looking to fundraise, understanding the nuances between equity and debt financing is crucial. In this article, we'll break down these concepts, focusing on popular instruments like convertible notes, SAFE (Simple Agreement for Future Equity), and CARE (Convertible Agreement Regarding Equity), to help you make informed decisions for your business's growth.

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Equity Financing: The Basics

Equity financing involves selling shares of your company to investors. This method is often seen in Series A rounds and beyond, where a valuation of the company is established, and new shares are issued to investors. While equity financing can bring substantial capital to your business, it's important to note that it is generally more complex, costly, and time-consuming than debt financing options. This complexity arises from the need to set a company valuation and negotiate share issuance, which can dilute the ownership stakes of existing shareholders.

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Debt Financing: A Simpler Alternative

For early-stage companies, raising a seed round through convertible debt, such as a SAFE or CARE, is a popular choice. This approach is favoured for its simplicity, cost-effectiveness, and speed. Convertible debt allows businesses to raise funds without immediately diluting ownership, as these instruments convert into equity at a later date, typically during a future equity financing round.

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Convertible Note

A convertible note is an unsecured debt that converts into equity under certain conditions, such as during the next round of equity financing. It includes a principal amount, an interest rate, and a maturity date. However, the principal often converts to equity at a discounted price, subject to a valuation cap, providing an incentive for early investors.

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SAFE/CARE

SAFE and CARE agreements are specific types of convertible notes that convert upon future equity financing or an exit event. Unlike traditional convertible debt, they do not have a maturity date, do not accrue interest, and do not require repayment. These characteristics make SAFE and CARE particularly attractive for very early-stage startups, offering a simpler, more founder-friendly approach to raising capital.

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Equity vs. Convertible Debt: Making the Choice

Choosing between issuing convertible debt or equity depends on several factors. Convertible debt can be appealing if you anticipate your company's equity to increase in value, allowing you to minimise dilution by converting debt into equity later. It also involves lower transaction costs and simpler negotiations. However, it's essential to manage convertible notes carefully across multiple fundraising rounds to avoid future ownership and dilution complexities.

For investors, convertible notes offer a way to invest without setting a company valuation upfront, deferring this decision to later-stage investors. While debt instruments provide some security in liquidation scenarios, their seniority over equity is less significant in early-stage companies, where liquidation values are typically low.

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Navigating Legal and Tax Considerations

When considering debt instruments like convertible notes, it's crucial to assess legal, finance, and tax implications, especially in Southeast Asia, where foreign investment restrictions may apply. Instruments like SAFE and CARE can offer a way to navigate these restrictions, but a thorough assessment is necessary to ensure alignment between shareholders and note holders and to minimise potential tax liabilities.

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Conclusion

Choosing the right financing option for your small business is a critical decision that can significantly impact your company's future. By understanding the differences between equity and debt financing, and the specific instruments available, you can make informed choices that align with your business goals and growth strategy.

If you're a start-up founder wearing many hats, and you need help getting your accounting in order, please don't hesitate to reach out to us at Harvest Accounting.