Seed Investing: Understanding the Landscape - Part II
- Peter Buckland
In this second post of our three-part blog series on the different types of seed instruments we will explore Series Seed.
Series Seed documents were introduced by lawyer Ted Wang and venture capital firm Andreessen Horowitz as a standard for priced seed . They intended to reduce the cost and time of seed investments, while at the same time providing fair and reasonable terms for both the investor and the founders.
Before the introduction of Series Seed, companies used full-blown Series A documents for issued in a priced round. In a Series A financing, the investors, as preferred , typically get preferential treatment over common with respect to payment of , amounts distributed in case of , voting rights, anti- protections and/or .
Series Seed documents introduced a trimmed-down version of the Series A terms and imposed fewer restrictions on the day-to-day operations of the company. Unlike Series A documents, Series Seed documents do not include preferential , rights, anti- protections (although some investors for them to be included) and . Series Seed documents also have more lightweight protective provisions, information rights, and than Series A documents. Since the investors come in at a valuation (unlike in a convertible note), a company using Series Seed documents has to make sure that the pool is set up, since the pre-money valuation will also take into account an pool.
Pros of Series Seed
and cost reduction. Series Seed documents have cut the cost of
financing by reducing the number of documents involved. The standard terms
serve as a fill-in-the-blank, which limits the need to negotiate and makes
the process quicker. Series Seed also introduced a standard legal cost—$10,000—so
no surprises with the legal bill at the end of the round.
terms. The Series Seed documents come with a standard 1X
non-participating preference, which is the most founder
friendly of the preferences. They also did away with terms
like anti- that are not relevant at the early seed-stage funding.
valuation and aligned interest. Since a Series Seed financing is a
priced round, investors and founders have to agree upon a valuation. This agreement
provides certainty as far as stockholding, in future and
One of the often discussed “pros” of convertible notes is that they do not require any valuation discussions but with “caps” on convertible notes becoming more and more common, notes are also effectively setting a “maximum valuation for noteholders. While the Series Seed priced round sets a specific valuation, capped notes don’t downside protection for founders.
In the case of uncapped notes, the interests of the founders and noteholders are not always aligned—it is in the founder’s interest to maximize the valuation of the company at the time of the next financing in order to minimize the resulting . Noteholders, on the other hand, seek to minimize the valuation of the company so that the principal and interest under the notes convert into as many shares of as possible. If the company gets a very high valuation, noteholders could wind up owning a much lower percentage of the company than they originally anticipated.
- Long-term . From the investor perspective, a priced Series Seed means that the long-term tax clock starts ticking from the time of issuance of the , If the founders issue convertible notes, on the other hand, the clock starts when the debt converts to shares.
Cons of Series Seed
use. Since its introduction, Series Seed documents have been used in
several investments, usually when both the valuations and investment amounts
are low. Beyond a certain threshold (usually, a $1 million investment and a valuation
of $3-$4 million), the investors are more interested in the bells and whistles
that come with a Series A investment.
control rights. Investors usually get a board seat and veto rights for
certain corporate actions in Series Seed documents. Founders should consider
whether this is a right that they want to give up for financing below a certain
threshold. That said, investors may be willing to negotiate these rights, but
the negotiations will add time and money to the financing.
creep. Just as products suffer from “feature creep,” Series Seed documents
have created a trend toward “term creep”—parties want to start with Series Seed,
but change the terms in the . The resulting “hybrid Series Seed”
documents are growing to resemble Series A documents more and more, which means
that the advantages of using standard documents apply less and less.
The most favored nation (MFN) clause is often one of the changes made to the standard documents. With the MFN clause, Series Seed investors get the same rights as investors in the next round of financing, with a few adjustments for economic terms. Although this clause may reduce negotiation and keep documents trimmer at the seed stage, it also means that the entrepreneur is not only giving up equity at a lower valuation but is also not getting the founder-friendly terms.
costs down the road. Although a company will likely save by using Series
Seed documents at the seed stage, its legal bills for the Series A financing
will be much higher because the Series A Certification of Incorporation will
need to be amended and restated. The provisions missing from Series Seed (e.g.,
) that are standard in Series A will also have to be added
to the . Lawyers will have to spend time (and the
company’s money) comparing documents and adding all the rights from the Series
Seed to the Series A, which will take even longer if the Series Seed terms
aren’t completely standard.
Of course, this extra cost only becomes a concern when a company goes on to raise a Series A round. Some companies might decide to save at the seed stage and pay more later when they have more money in the bank.
In case you missed it, read Part I on . Stay tuned for Part III next week.