Your First Round of Seed Funding
Many first time entrepreneurs struggle with the issue of how to structure their first round of seed funding. Most entrepreneurs we work with are set up as a Delaware corporation or a limited liability company (formed either in Delaware or your home jurisdiction). The principles discussed in this post apply to both types of entities.
Investors tend to prefer investing in priced rounds. If you have a valuation that you and investors can agree on (usually by getting some feedback), use a form of seed preferred stock (or seed units, if you are an LLC). In its most simple form, a seed preferred would give investors a liquidation preference (they get their money back before founders on a sale of the company), plus the right to invest in the next round. The seed preferred typically has an anti-dilution or most-favored-nation clause that gives the investor an adjustment in price if you sell at a lower price in a later round. Check out the form of series seed preferred term sheet here Seed Term Sheet
If you are not sure about your valuation, or you cannot agree with investors, try a convertible promissory note. This works best if you have your next funding round occurring in the reasonable foreseeable future after you hit some milestones that allow you to raise money at an increased valuation (e.g., when you get a patent issued, FDA clearance, customer sales, etc.). The convertible note allows you to push off the valuation question until that next round. In today’s market, typical terms for a convertible note would be a 2-year term, 6% or 7% interest, that converts into equity in the next financing round at a discount of 20% off that round’s price. To protect early investors from a very large spike in price, the note will typically have a ceiling price at which the note converts so you will have to list some value range. A common ceiling value would be about 20% higher than what the entrepreneur thinks the true value is today. Check out a typical form of convertible note here Convertible Promissory Note
Sometimes, the very first investors are amenable to invest using a SAFE (Simple Agreement for Future Equity). The SAFE typically works when the investor already has a relationship with and has been nurturing the company. For example, a SAFE is often used in by small funds that are associated with accelerators and incubators to seed fund their companies. The SAFE is simply a short contract to issue equity to the investor when you do your next round, usually at a 20% discount. The SAFE has no interest and no term. Check out a typical form of SAFE here SAFE Document
We have created document sets to help entrepreneurs inexpensively organize and structure your first round of funding. We help select startups get launched and funded! If you want to connect with us, use the form below and give us your two-sentence elevator pitch.