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Venture Capital Structures in Bulgarian Start-Ups

Venture Capital Structures in Bulgarian Start-Ups

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Venture capital investments in Bulgarian start-ups are on the rise, and modern legal structures such as share option plans and convertible notes can, if local law peculiarities are taken into account, be applied in the country.

Share Option Plans

Share option plans are designed to incentivize founders and key employees of the company to devote their time and efforts to the company’s interests. A share option plans involves the grant of an option to an employee to acquire shares over a certain period of time at a discounted value and upon certain conditions. The company and the employees are free to agree on the terms of the plan, and the corporate instruments to implement it are usually the issue of new shares and/or the transfer of existing shares.

Issue of New Shares

The issue of shares, as a rule, requires a shareholders’ resolution. This can be a drawback in a start-up company, which typically has a large investor base. In a joint stock company (AD), however, the board may be empowered by the general meeting to issue shares up to a certain amount and for period of up to five years. This empowerment should also restrict any pre-emption rights shareholders may have by law. In a limited liability company (ODD), the issue of new shares always rests with the general meeting of shareholders acting unanimously, which turns the share option plan into a more lengthy process. 

Transfer of Shares

An alternative to the issue of shares is the transfer of shares (from majority shareholders to employees). In all cases, the transfers are made pursuant to the targets set out in the share option plan. This grant of shares does not involve a capital increase, and the transfer occurs by a quick and simple procedure. In an OOD, the transfer of shares from a shareholder to an employee could be set out in a preliminary agreement between the company, the shareholder, and the employee. The execution of the final agreement will be subject to the conditions set out in the share option plan. The advantage of this approach is that the option holder can enforce, via a court order, the preliminary agreement if the company and the shareholders do not cooperate.

Convertible Notes

Early stage investments are often structured as convertible notes: securities incorporating a loan granted to a company which could be converted into shares at a subsequent investment round or upon the occurrence of a specific event (e.g. a change of control or an IPO). This is the preferred method of swift financing for both start-up companies and investors because it avoids the need to value the company at the time of the financing. Instead, the valuation is made upon the occurrence of a future event which provides a valuation benchmark (i.e., a subsequent investment round, a change of control, or an IPO). A convertible note set outs at a minimum the principal, interest rate, maturity date, and conversion price, together with conversion discounts and/or valuation cap and conversion events.

For a Bulgarian start-up, a convertible note translates into: (i) a convertible bond (applicable in an AD only); or (ii) a loan which can be converted into shares by in-kind contribution. 

Convertible Bond

A convertible bond is the same as the convertible note described above. In a start-up context, it is not a financial instrument and its trading may be restricted. The conversion occurs at the discretion of the investor in a capital increase procedure initiated by the company with a resolution of the general meeting. Once a convertible bond is issued, the general meeting may not veto the conversion, which is a key advantage.

Convertible Loan

A convertible loan involves an agreement between the company and the investor whereby the loan converts into shares by capital increase, on certain conditions and at the discretion of the investor. The capital increase is effected via in-kind contribution of the investor’s loan receivables (principal and interest), which requires a general meeting resolution and an expert valuation of the receivable. Hence, a main disadvantage of this structure is that the investor needs the cooperation of the shareholders (who may veto the capital increase) and the company. A possible way out is to bind the shareholders and the company in the loan agreement to do the capital increase on the agreed-upon conversion terms.

By Ilko Stoyanov, Partner, and Katerina Kaloyanova, Attorney at Law, Schoenherr Bulgaria 

This Article was originally published in Issue 4.12 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

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