Wednesday, November 10, 2010

Seed Round of Raising Capital: What Terms are Customary?

I am certain that any business owner looking to raise capital by issuing equity securities to investors wants to have a good idea of what terms/privileges would the investors be looking for in exchange for investing in the company. How can a business owner who has never accessed capital markets before know what is reasonable and expected and whether there is room to negotiate? The answer is: the Internet, where much has been written about private placements.  Another answer is, of course, consult a knowledgeable securities lawyer.

In particular, I would like to bring to your attention several sets of investment documents suitable for seed rounds I found on the internet. The seed round is usually $750,000 or less, so the terms are somewhat simplified (as compared to the later rounds when venture capital firms get involved). Typically, one would see the following legal documents as part of the transaction (apart from the disclosure documents): (a) a term sheet summarizing the key investment terms (not binding); (b) restated articles of incorporation or charter, revised to include the terms of the new securities, this document gets filed with the state of incorporation; (c) a shareholders agreement, revised to include the new investors; (d) bylaws that may or may not change; and (e) a subscription or stock purchase agreement, a contract between the company and each of the new investors containing customary representations and warranties by both parties.

The first set of documents was developed by Cooley Godward LLP and can be found here: The second set of documents was developed by Y Incubator and Wilson Sonsini Goodrich & Rosati, and can be found here: The third set of documents was developed by attorneys at Fenwick & West and is found here:

The three models offer some variations but the key terms are as follows. Investors get voting preferred stock that can be converted into common stock at any time at agreed upon conversion rate, subject to adjustment. Upon liquidation, investors get to receive their money first, before the common stock owners. Once investors are paid back, the rest of the money is distributed among the common stock holders. Investors get to vote separately as a class on the main decisions by the company, such as its sale. Investors get rights of first offer in future rounds of financings and if any future financings offer better rights, investors get them too. Investors receive annual and quarterly financial statements of the company. And last but not least, investors get a board seat.

These models are good tools for business owners to get a better idea of what to expect from a seed round of equity financing. All documents have to be reviewed by counsel and negotiated. These are simplified forms generally suitable for early rounds of financing, so some provisions are missing. Again, please consult an experienced securities attorney before engaging in raising capital.

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