Legelata Law firm

Introduction: The startup ecosystem thrives on innovative financing mechanisms that balance the needs of investors and entrepreneurs. One such instrument that has gained significant traction is the Simple Agreement for Future Equity (SAFE). Originating in the United States, SAFEs have revolutionized early-stage financing by offering a streamlined and flexible alternative to traditional equity investments and convertible notes. This article examines the introduction of SAFE agreements in Armenian legislation, comparing it with the established practices in the United States. Understanding SAFE Agreements: A SAFE is an agreement between an investor and a company that provides rights to the investor for future equity in the company, similar to a warrant. The key feature of a SAFE is that it converts into equity upon the occurrence of a specific event, usually a future financing round. Unlike convertible notes, SAFEs do not accrue interest or have a maturity date, making them simpler and more entrepreneur-friendly. Current situation The Armenian startup ecosystem has been growing steadily, with increasing interest from both local and international investors. However, Armenian start-ups are frequently forced to relocate their business ideas to other legislations, which provide more flexible and investor friendly environment. The investors are regularly interested in making investment in start-ups using SAFE, which introduces three major features: Conversion Trigger: SAFEs convert into equity upon the occurrence of a specific event, typically a subsequent priced equity financing round; Valuation Cap and Discount: These terms provide a mechanism to set the price at which the SAFE converts into equity, protecting the investor from excessive dilution; No Interest or Maturity Date: Unlike convertible notes, SAFEs do not accrue interest or have a maturity date, reducing the financial burden on the startup. Introduction of SAFEs in Armenia: In June 2024 SAFEs were introduced in the legislation of the Republic of Armenia, more specifically in the law on Joint Stock Companies. A major point of the regulation is that SAFE agreements are considered as securities as per legislation of the Republic of Armenia, which consequently shall result in the unified custody of SAFEs. Account operators of the companies shall be deemed to make the record of SAFEs which will ensure that the investors may receive participation in the companies as the result of occurrence of certain events. In addition pre-emptive rights of shareholders do not apply to SAFEs. The advantage of this option will ensure that new investors shall be required the waiver of pre-emptive rights prior to subscription of the newly issued shares of the companies, where they have invested. Moreover, SAFEs provide additional attractiveness for the companies, as in general SAFEs are subscribed as interest-free, which does not incur additional expenses in the way of payment of interest for companies, which may be crucial for startups and newly developed companies. Author: Aleksandr Egibyan (Mr.) Junior Partner, Legelata Legal And Tax DISCLAIMER: This material is produced for Legelata LLC. The information contained in this piece is provided for general informational purposes only and does not contain a comprehensive analysis of each item described. Prior to undertaking (or not to undertaking) any actions, the reader is advised to seek professional advice tailored to their specific situation. Legelata or the author accepts and holds no liability for acts or omissions taken in reliance upon the contents of the contained information in this material.

A. Adoption of Basel III and Regulations. The implementation of Basel III, the new regulation developed by the Basel Committee on Banking Supervision in response to the 2007–2009 financial crisis, was a lengthy process in Armenia, concluding only in 2022. Basel III introduced new rules for the structure of banks' capital and assets, aiming to enhance the stability of the banking system by increasing both the quantity and quality of liquid assets. This regulation found its local and adapted reflection in "Regulation 2" on the "Regulation of Banks' Activity, Main Economic Normatives of Banking Activity," issued by the Board of the Central Bank of Armenia (CBA) and periodically amended. B. Subordinated Loans as a Capital Element for Banks. Regulation 2 provides banks the opportunity to attract subordinated loans under specific rules for capital replenishment. Subordinated loans can supplement banks' Tier 2 capital if they meet the specific requirements outlined in the regulation. For example, such loans must have a minimum term of five years, and early repayment requires CBA approval. In the event of financial distress, these loans may be converted into equity, transferring business risk to the lenders and acting as financial buffers for struggling banks. C. Opportunities for Issuing Subordinated Bonds. A review of international experience reveals that the market for subordinated bonds is currently experiencing significant growth, driven by the expansion of the private credit market and investors' search for higher returns. This presents a new opportunity for Armenia to attract foreign (and domestic) direct investments through the issuance of subordinated bonds by banks. To realize this potential, the current regulations should be adapted to accommodate the issuance of such bonds, which are particularly suited to these conditions. Additionally, it is worth considering the issuance of bonds without principal repayment, whose terms could align with those of shares and serve as primary capital (core or additional) for banks. D. Simulation of Subordinated Bond Issuance. Simulations conducted by our company indicate that uncertainties surrounding the timing, terms, and conversion process of subordinated bonds may deter banks from making decisions to issue subordinated debt. Furthermore, the publicity associated with such bonds could be seen as an unnecessary burden for banks in managing their financial condition. Lastly, the CBA’s broad discretionary powers in prohibiting early repayment may be viewed as a significant disincentive, particularly for smaller investors. E. Conclusion. The issuance of subordinated bonds offers a new opportunity to activate Armenia's capital market, including the attraction of foreign investments. To make these debt instruments appealing to foreign (and local) investors, it will be necessary to adapt the regulations governing subordinated loans and limit the regulator's broad discretion over repayment terms. Author: Got Margaryan (Mr)