The Emergence of Seed Financing Documents

Better, faster, cheaper. That is the mantra for most Internet and software start-ups these days as entrepreneurs utilize open source, cloud services and outsourcing to drive down their start-up costs and accelerate their time to market. At the same time, an emerging class of seed investors and super angels are stepping up to finance these new companies. With this expansion of the seed and angel marketplace, the terms and documentation for these financings are becoming more mainstream and standardized and entrepreneurs need to know what to expect.

Several years ago, the National Venture Capital Association NVCA began a project to standardize institutional venture capital financing documents.  The NVCA model document project has been a huge success and those model documents have reduced the costs and cycle times associated with venture financings. More recently, however, some commentators have noted that those documents are overkill for seed and angel financings while others have suggested that those documents are too investor-friendly. As a result, there have been a few efforts to create a set of seed round financing documents that would do for seed and angel financings what the NVCA Model Documents have done for venture financings. One such set of form documents is known as the “Series Seed” Preferred Stock financing documents.   Other sets of model seed financing documents have been developed by TechStars and Y Combinator.  Investors such as Brad Feld and Jason Mendelson have complained about the proliferation of competing model covenants while recognizing it is unlikely that one set will emerge as the presumptive standard.

At the same time, other commentators, such as Paul Graham of Y Combinator, are suggesting that convertible debt financings are even cheaper and simpler than Series Seed equity financings and that all angel/seed rounds should be done as convertible debt financings. Others, including Seth Levine of the Foundry Group and Josh Kopelman of First Round Capital, are less sure about the benefits of convertible debt financings. What is clear is that the market is looking for standardization, and even if there is no one size fits all set of documents, there will be a small set of preferred, streamlined structures.  One under-reported aspect of the recent AngelGate eruption was the desire by angel investors to have more standardized and transparent forms. Presumably, this would also benefit entrepreneurs who would no longer have to compare apple-to-orange term sheets to determine which one represented a better deal.

As we develop the Founder’s Workbench, we anticipate devoting more attention and materials to financing strategies and alternatives, from bootstrapping and angels to strategics and traditional VCs. In the meantime, entrepreneurs should do their homework and understand the different alternatives and their implications. For instance, while convertible debt might confer some pricing advantages, it is still a liability on the balance sheet and having a series of unrelated promissory notes outstanding can result in an entrepreneur having to get the consent of 100% of the company’s investors for any change in loan terms or to enter into a new financing.

This post on Seed Financing, Venture Capital and Company Financings was authored by John Egan.


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