Lots of questions have been continuing to circulate about this instrument, so today we will attempt to answer as many of them as possible and educate you all about the details and nuances of this unique investment method that has recently begun to exist.
What is the CFEA?
A Future Earnings Agreement is an instrument originally invented by Stepex for students to have a more flexible way to pay for a course that they want to take, which stipulates that the amount the student has to pay in a particular month is determinant on how much he/she earns, and if the salary floor is below a certain amount, the student just tells Stepex and he/she doesn’t pay that month.
The CFEA (Convertible Future Earnings Agreement) is two separate instruments that work at different times/circumstances: Stepex’s Future Earnings Agreement (FEA) and a Seedlegals SeedFAST (UK’s version of a SAFE note). This creates a unique investment mechanism that protects the downside of investors while giving them equity upside as well.
How does the CFEA work?
Future Earnings Agreement:
Once the investee takes funding from the Investor, he/she starts repaying his/her Future Earnings Agreement at the rate of minimum 10% if his/her monthly pre-tax founder earnings from either the business (if full time) or full-time job (if part time) is above £2500.
Founder earnings is defined as the money taken from the business bank account to the founder’s personal bank account (or job salary).
The Future Earnings Agreement is considered repaid when the founder has paid back 1.5 times the amount of funding taken from the Investor within 5 years. Example: If the Investor gives a £10,000 CFEA, £15,000 is due in 5 years.
In case this does not happen, the FEA is considered repaid after the founder has paid back 2 times the amount of funding taken from the Investor after 5 years. Example: If the Investor gives a £10,000 CFEA, £20,000 is due after 10 years.
SAFE (convertible equity):
The equity side of the investment supersedes the FEA of the investment once the founder raises a Qualifying Round.
A Qualifying Round is the first qualifying round of equity fundraising that raises at least £700,000.
A founder (or together with a VC) can buy out/pay off the FEA early if the fundraise is going exceptionally well or high profits are coming earlier than expected. But since we have Participation rights, we reserve the right to buy more equity at a 20% discount off the current valuation.
As of the date that shares from the Qualifying Round are issued to the investors, the investee's debt repayment obligations go to £0, however, they do not get back any amount of debt repaid prior to the Qualifying Round.
At the Qualifying Round, the initial investment made into the company less the amount repaid in FEA will convert at a 20% discount to the valuation at that round. The Qualifying Round Valuation is the post-money valuation at that specific Qualifying Round and is calculated by multiplying the price per share by the total number of shares issued by the company. An example of the conversion is if the Company is valued at £1,000,000 and investors put in £30,000, then, investors will have 3% equity in the Company. But if Horizan was to invest £30,000, our equity stake would be 3.75% with the 20% discount applied.
If the Qualifying Round Valuation is greater than £5,000,000, the Horizan will convert at a valuation of no more than £5,000,000, without any discount.
The shares issued to the Investor upon conversion must hold the same rights and be of the same share class as all other investors in the round. Where there are multiple share types, the Investor's shares will convert to the same class of shares that are to be held by the other investors in that round (i.e. the third party investors that contributed the greatest amount of funding to the funding round). Example: If other investors receive Preference B Shares, the Investor will also receive Preference B Shares.
How is income verified?
Income is verified through Stepex, who utilises an application workflow that employs OpenBanking so that previous salary and transactions are transparent. For younger founders, projections are used more than previous work experience, and projections are created by matching skillset/degrees to a future job income level. If this “future job income level” is higher than £30,000, than this founder is considered to have passed the income verification check.
What determines minimum eligibility?
Passing income verification check
UK/EU citizen/permanent resident
Solid startup idea
Is there an interest rate?
No. Future Earnings Agreements do not accrue interest- it’s just the simple 1.5x in 5 years, or 2.0x in 10 years.
Can I pay off early?
Yes, and there is a discount if a founder does (1.5x in 5 years instead of 2.0x in 10 years)
Can payments be deferred?
Yes, a founder just tells Stepex if founder earnings are below £2,500 in any given month
Is the CFEA Founder Friendly? How Does it Compare with Other Forms of Investment?
The CFEA is very founder friendly. Compare the CFEA to other (existing) forms of investment you can get currently:
Pure SEIS/EIS Equity:
Pros- Almost no personal financial responsibility, “status quo”
Cons- Only suits blitzscaling startups (not great economically for those who want to grow slow and steady), generally starts at pre-seed (which is a little bit later than idea stage), extremely competitive
Loans:
Pros- Generally the easiest way to get money for your business (non-CFEA)
Cons- Personal guarantee, generally only funds people with collateral and assets, requires you to pay monthly no matter what, limited ability to defer
Example 1: Barclays Business Loan
7.7-8.9% APR on loans up to £25,000
APR on request for higher than £25,000
Entrepreneur can choose repayment term
Optional 6 month repayment holiday in the beginning
Example 2: Virgin Startup Loan/British Business Bank
Borrow from £500 to £25K per co-founder (Virgin), or up to £25K total (British Business Bank)
Borrow over 1-5 years at a fixed interest rate of 6% p.a.
No set-up fee or early repayment penalties
No minimum trading requirement
Mentorship and Guidance
Grants:
Pros- No equity/repayments
Cons- Grant requirements may not always line up with your vision
Example 1: Co-Op Carbon Innovation Fund
2x board members not married/related
Reduce greenhouse emissions in food/farming
Innovative
Cooperate with other stakeholders
Example 2: Innovate UK Smart Grants
a clear game-changing idea -> new products/services
Realistic potential for global markets
will not fund commercialisation activities
start by 1 October 2022 and end by 30 September 2025 (Innovate UK funding, not project)
If your project’s duration is 6 to 18 months it:
must have total eligible project costs between £100,000 and £500,000
can be single or collaborative
If your project’s duration is 19 to 36 months, it must:
have total eligible project costs between £100,000 and £2 million
be collaborative
Crowdfunding:
Pros- Can be a great way to raise money if your product idea has high demand (in exchange for perks)
Cons- Extremely competitive (less than 10% of projects on Seedrs reach their fundraising targets), visibility can be quite challenging
Example 1: Seedrs
Must be based in UK, EU, EEA (European Economic Area), Switzerland
Target raise should be over £50000
Looks at: website quality, brand identity, founders, terms, traction, product, etc.
Revenue Based Financing:
Pros- No equity, great way to scale e-commerce businesses in a non-dilutive way
Cons- Generally requires earning at least 10k monthly revenue for 6+ months (not great for idea/early stage)
Example 1: Clearcapital (Clearbanc)
10k-10M ticket sizes
Flat 6-12% fee
Primarily e-commerce D2C
Founder community
Example 2: Pipe
25K to 100M GBP ticket sizes (yes, you read that right)
Ticket size based on bid price (based on your recurring revenue/customer contracts)
Trading limit grows as business scales
No fees because $$$ comes directly from institutional investors (more like trading platform)- invisble growth partner
CFEA:
Pros- Flexible repayments, flexibility in terms of what type of company you want to build (blitzscale or slow-growing), economics/downside protection means CFEAs are great for idea stage/friends and family founders
Cons- Personal guarantee for the FEA, some “loan” type mechanics (which pure equity does not have)