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Seed Round Financing
As you start and grow your business, you likely will need to bring in investment money to launch your company and advance your business plan. And you will need to bring it into your company quickly and cost effectively – one way to do this is through a seed round financing.
We outline below some of the key considerations that you should know when planning your seed round financing:
WHAT:
A Seed Round financing is an early-stage financing transaction where your company sells securities to investors in exchange for money invested in your company. This type of financing typically involves either equity or debt securities, such as Common Stock, Preferred Stock, simple promissory notes or convertible promissory notes. If done right, your seed round financing will get done quickly and without complications and extra costs, so that your company receives its investment money quickly without too much expense.
A Seed Round financing tends to be less complicated than other later-stage financings, with a focus on valuation issues (especially for equity securities) and certain investor protections (such as representation on the Board of Directors, access to company information and the opportunity to invest in future financings).
In an equity deal, your company will need to be a C-corporation if Preferred Stock is used for the Seed Round financing or if there are non-individual or foreign investors. A limited liability company (or LLC) can issue preferred equity, but it usually is more complicated and expensive to amend an LLC’s operating agreement than it is to amend a corporation’s certificate of incorporation.
In a debt deal, convertible promissory notes typically are used to bring in Seed Round investment. The convertible promissory notes often convert, at a price discount, into the equity securities of the next qualified financing round (i.e., a specified minimum amount of investment in the next equity financing round, such as $1 million).
WHY:
Early-stage investment may be critical to get your company off the ground or to advance your business plan and reach important milestones that may help attract additional investment into your company.
WHEN:
As its name implies, a Seed Round financing occurs during the initial stages of your company. A Seed Round financing may include Friends and Family investors, Angel Investors and small Venture Capital funds that focus on early-stage companies. Some companies and investors use “Seed Round” to refer to very early-stage financings as well as somewhat later stage financings involving Series A Preferred Stock.
Because the Seed Round is an early stage financing, investors usually conduct less business and legal due diligence for your company, which helps lower the costs of raising the investment money. Also, this type of financing should be completed more quickly and with lower transaction costs (including lower legal fees) than other more complex financing transactions such as a traditional venture capital financing round.
WHERE:
Your company can conduct a Seed Round financing anywhere, but you will need to comply with the applicable securities laws in the state where your company conducts its business, in the states where the investors are located and in accordance with the U.S. securities laws and sometimes foreign laws.
HOW:
As a first step, you should determine how much investment money your company will need and whether a debt or equity financing is best for your company.
Once you have settled on the type of security, then you should prepare a financing term sheet with the key financing terms, as well as the financing materials that you will present to investors, such as an executive summary, financial projections (with the projected use of cash), an investor presentation and, in some cases, a more complete business plan.
As you negotiate with investors, remember to keep the financing terms simple and straightforward; otherwise, you will not get the intended benefits of the Seed Round financing — a shorter time period to receive the investment money and lower transaction costs for the financing.
Your Turn:
Share with us your experiences in bringing in seed investment money. We would love to hear your feedback.
