Reinoud van Ginkel

In the dynamic world of startups and innovative companies, venture capital (VC) plays a crucial role in funding growth potential. But what exactly is venture capital, how do Venture Capitalists work and what is their role in the investment ecosystem? In this article, I take a closer look at the definitions, processes and strategies behind venture capital, as well as the role VC plays in the Dutch startup economy. This article is the first in our series about venture capital. Definition of Venture Capital Venture capital is a form of financing that focuses on (innovative) start-ups and small companies with high growth potential. These target companies are in their development phase, are generally not yet profitable and depend on external money for their further growth and development ambitions. VC investors invest in these companies to further support their initial development or rapid growth. It is important to note that venture capital usually focuses on companies that have already achieved some degree of validation. This means they would have a working product, an initial customer base, or have demonstrated clear market potential. Venture capitalists rarely invest in completely untested ideas, which sets them apart from earlier funding sources such as angel investors or the 3Fs (family, friends and fools). How Does Venture Capital Work? Investors and Sources of Capital Venture capitalists are professional investors who put their capital into companies with high growth potential but also inherent risk. These investors obtain their capital from various sources, including external investors called Limited Partners (LPs) and sometimes from their own funds. LPs can be pension funds, university endowments, family offices or high net worth individuals. VC parties also often act jointly and, in the Netherlands, regularly with government-funded parties such as Regional Development Companies (Regionale Ontwikkel Maatschappijen). The consortium of collaborating investors then takes a joint position within a start-up. Phases of Investment The process of venture capital investment involves several stages: Investors use their personal networks, recommendations and online platforms to identify interesting young companies (deal sourcing). In the deal screening phase, startups are assessed based on criteria such as market potential, team expertise and innovation. A thorough due diligence is conducted to assess the feasibility and risks of the investment. This process includes a comprehensive audit of the startup to evaluate finances, operations, legal aspects, market position and more. At the investment committee stage, the final investment decision is made (FID) by a group of experts and partners. After due diligence, the venture capital firm generally prepares a term sheet and other relevant documents and structures the deal. Once the necessary documents are signed, funding is provided through capital contributions to the company (capital deployment). In practice, the actual capital investments often take in several rounds/phases, each with specific goals and conditions. The first formal investment round, also known as the seed round, focuses on product development and market validation. The subsequent series A round focuses on refining the business model and accelerating growth. All rounds (series B and beyond) after that focus on scale-up and expansion. Each round typically entails more capital and higher valuations, but often also contains more stringent requirements on the company’s performance. Conditions and Risks In return for their financial investment, venture capitalists receive partial ownership of the company and, often, a say in its operations. This then usually takes the form of a seat in the board, supervisory board or otherwise. Investors may also make other demands, such as the right to future investments, the right to get their investment back on a priority basis or the possibility to sell the company at a profit after a certain period of time. Venture capital is a risky type of investment because the companies are still in the early stages, have little or no revenue and have not yet proven that they will actually be successful. The exit strategy, or how the investor can sell its shares, may therefore be uncertain or unclear. It is crucial to understand that most venture capital investments are not successful. VC firms expect to earn their returns from a small percentage of their investments – often only 10-20% of their portfolio. These ‘winners’ must generate sufficient returns to offset losses on the other investments to still generate an attractive total return. This showcases the high risk-return ratio in the venture capital sector. Exit Strategies The main goal of investors is to earn a return on the money invested. This is usually done by selling the shares after a certain period, on average between 3-7 years, through an initial public offering, merger or acquisition by another company or investor. Although initial public offerings and acquisitions are the most common exit strategies, they depend heavily on market conditions and the performance of the startup. Not every company will achieve such a successful exit though. Venture capitalists consider different scenarios and then adjust their strategies as the company evolves. In some cases, a secondary sale of shares or a recapitalisation can provide an alternative to the usual exit routes. Role in the Startup Economy Venture capital is an essential source of funding for start-ups and innovative companies, especially when traditional bank loans are too difficult to obtain. It helps in the rapid growth and development of these companies and can lead to exponential growth across the startup ecosystem. Networking and relationships play a crucial role in deal flow. VCs often invest in startups with founders they know or through recommendations from trusted sources. A strong network can significantly improve access to high-quality investment opportunities. Networks not only play a crucial role in deal flow, but also influence the quality of due diligence and strategic decisions. Strong networks enable VCs to gather in-depth, reliable information on potential investments. They also facilitate access to industry experts, potential customers and partners, which significantly increases the value a VC can add to a startup. Moreover, good networks can help find suitable executives or board members for portfolio companies. VC firms based in thriving entrepreneurial regions, such as Silicon Valley, New York, Berlin, Stockholm or Tel Aviv and closer to home ‘Brainport Eindhoven’, BioScience Park in Leiden, the Amsterdam region or metropolitan region of The Hague-Rotterdam, generally have better access to deal flow than firms in less active areas. Said regions offer a rich ecosystem of startups, talent and resources. VC firms that specialise in specific sectors or industries are more likely to get a better deal flow as they have deeper understanding of the market and are better able to identify promising startups. Specialisation can also help make due diligence more efficient and make better investment decisions . The main sectors currently attracting VC investment are information technology, healthcare/biotechnology, fintech and consumer products and services. Conclusion To summarise, venture capital is a complex but essential part of the startup economy. By understanding the phases of deal flow, the key players in the VC ecosystem, and the factors that influence deal flow, both entrepreneurs and investors can develop strategies to be more successful. Mitigating challenges such as a limited deal flow, investor competition, time constraints and risk management is crucial to achieving success in the world of venture capital. By using technology, building strong networks, and implementing efficient processes, VC firms and entrepreneurs can effectively navigate the dynamics of deal flow and increase their chances of success. With the right strategies and mitigation measures, both entrepreneurs and investors can benefit from the potentially high returns that venture capital has to offer. Contact Do you have questions about bad leaver or good leaver clauses or want to exchange views? If so, please contact Mathijs Arts, Reinoud van Ginkel or one of our other Mergers and Acquisition (M&A) specialists.  

Today, innovation is the norm. Business models are constantly evolving, and financial instruments play a crucial role in shaping the business future. This article looks at three emerging models that impact the business and financial landscapes: the widely used convertible loan, the Simple Agreement for Future Equity (SAFE), and the Agreement for Subscription against Advance Payment (ASAP). In this contribution, we delve deeper into these models, examine their impact on companies and investors, and shed light on the legal considerations inherent in these financial approaches. Converible loan A convertible loan is a financing instrument widely known and extensively used by especially young companies to attract capital. It combines features of both debt and equity, making it attractive to both investors and entrepreneurs. In practice, a convertible loan is a loan that can be converted into shares of the issuing company at a later date. In exchange for providing capital, the investor receives interest payments during the loan period. At a predetermined moment, often under specific conditions in the agreement, the investor and/or the company itself have the option to convert the loan into shares of the company. When entering into a convertible loan, investors should carefully study the conversion terms. This includes determining the conversion moment, the conversion price, and any adjustments that may occur in certain events, such as a new financing round or even bankruptcy. The ranking relative to other creditors/shareholders is crucial in case of bankruptcy or liquidation of the company. Finally, investors must be aware of their rights during the loan period, such as protection clauses or input in significant decisions. Clear communication is crucial when drafting the convertible loan. Transparency can prevent future disputes, and it is advisable to document all agreements in advance in a legally binding document. The issuing company should therefore specify how the provided capital will be used and be accountable to the investor. In addition to agreements on the loan and its conversion, parties should also consider the situation after conversion and the agreements regarding the mutual legal relationship as shareholders. Simple Agreement for Future Equity (SAFE) A Simple Agreement for Future Equity is a financing agreement between an investor and a company, often a startup (commonly early seed), wherein it is agreed that the investor has the right to a certain number of shares in the company on a future date, typically during a future financing round. Unlike convertible loans, a SAFE does not include interest payments or a fixed term. SAFEs are known for their simple structure, speeding up the negotiation process significantly and reducing costs. This makes it an attractive option for investors and entrepreneurs who want to act quickly in the dynamic startup world. Another advantage is that the classic risks of debt are much less present in SAFE agreements since they do not involve interest payments or repayment obligations. However, parties can decide otherwise and structure the SAFE as equity instead of debt. In the Netherlands, the ASAP is increasingly used for equity qualification. This allows startups to grow and invest more easily, and it gives SAFE investors a greater chance to benefit from the valuation growth of a startup. In a SAFE, the investor does not commit to a specific valuation at the time of the investment but rather chooses a valuation method. This also simplifies negotiations. Due to the straightforward nature of SAFE agreements, startups can raise capital more quickly compared to more traditional forms of financing. Administrative burdens are consequently much lower. The company does not need to have a (concrete) valuation, reducing legal costs and complexity. Unlike convertible loans, SAFE agreements do not carry interest expenses, allowing startups to focus on growth instead of generating immediate cash flow. Despite all these advantages of SAFE agreements, it is crucial that the terms regarding conversion, valuation mechanisms, and investor rights are clearly defined. Despite their name, SAFE agreements still bring some legal complexities and risks. It remains essential that both parties are well-informed and seek legal advice to ensure a solid agreement. Understanding the characteristics and legal implications of SAFE agreements is one of the keys to a successful and mutually beneficial financing round. Agreement of Subscription against Advance Payment (ASAP) Lastly, there is the Agreement of Subscription against Advance Payment, or the ASAP agreement. The ASAP is a variant of the SAFE and grants an investor the right to acquire shares in the company’s capital against immediate payment of the issuance price. The paid amount is, unlike the SAFE, booked as equity under reserves instead of as debt. ASAP shares can be issued in various scenarios, such as the closure of a financing round, transfer of more than 50% of the shares, or the occurrence of an event like a bankruptcy application. The remaining amount of the investment after the issuance of ASAP shares is booked as additional paid-in capital. The procedure for issuing ASAP shares includes prior notification to the investor, providing details about the number of shares to be issued, the issuance date, and, in financing rounds or termination, information about new investors and agreed-upon prices. Since the issuance of shares requires cooperation from the startup, the interests of the ASAP investor are protected through an irrevocable power of attorney to issue the ASAP shares before or at the latest by the closing of the new financing round. Additionally, a discount may be applied to the calculated issuance price as an additional safety measure. When the company then makes a profit and the general meeting decides on a profit distribution, the investor has a dividend right. This generally does not apply to interim dividends, allowing the ASAP investment to continue as equity instead of debt. Conclusion This contribution on convertible loans, Simple Agreements for Future Equity (SAFE), and Agreement of Subscription against Advance Payment (ASAP) makes it clear that the business world is in a time of remarkable transformation. These agreements have not only changed the way capital is acquired and managed but have also revised the dynamics between investors and entrepreneurs. Convertible loans, with their unique blend of debt and equity, offer startups a flexible financing route, while SAFE agreements bring speed and simplicity to the venture capital world. On the other hand, the ASAP model illustrates that investments can also be made gradually over a longer period. Within these innovative approaches, a common thread is found: the importance of clear legal frameworks. Whether establishing convertible loan terms, defining SAFE clauses, or formulating transparent subscriptions, legal precision is essential to ensure success and minimize disputes. Understanding these dynamics and embracing legally sound strategies will remain crucial for companies aiming for growth and sustainability in a constantly evolving world. This contribution was written by Reinoud van Ginkel in collaboration with Mathijs Arts. If you have questions about the convertible loan, SAFE, or ASAP, or if you would like to discuss further, please contact Mathijs Arts, Reinoud van Ginkel, or one of our other Mergers and Acquisitions (M&A) specialists.