Seed financings enable a startup to put together its initial team, build a working prototype, and begin to test the market. Often these investments are made via convertible debt or SAFEs. Veteran Silicon Valley startup and corporate attorney Jason Putnam Gordon will cover the following topics: 1. Required corporate structure 2. Legal considerations when pitching investors for seed financing 3. Differences between using convertible debt and SAFEs 4. Key terms and considerations when raising seed funding 5. Common mistakes and pitfalls that companies make when raising seed funding via convertible debt and SAFEs 6. How to close your seed financing 7. Important post-closing tasks 8. And much, much more

1. © Copyright 2021 by K&L Gates LLP. All rights reserved.
Jason Putnam Gordon, K&L Gates LLP
How to Raise Seed Funding
for Your Startup: Convertible
Notes and SAFEs
Idea to IPO

2. IMPORTANT CAVEATS
 Today’s Discussion is General Information – Not Legal
Advice
 We will be discussing rules and exceptions. Those rules,
exceptions, and exceptions to the exceptions may not be
applicable to your situation.
 You need to retain competent legal counsel to review all
facts and circumstances before weighing in with advice.
 Off-the-cuff answers to your questions are not, and
should not be taken, as legal advice.
klgates.com 2

3. OVERVIEW
 My Background
 Structural Considerations
 Considerations When Pitching Investors
 Financing Options
 Key Terms and Considerations for Convertible Securities
 Overview of Valuation and Dilution
 Common Pitfalls
 Q&A
klgates.com 3

4. Background
 Venture Capital and Emerging
Growth Company attorney-
practicing law since 2005.
 My office is in San Francisco,
but I work with companies
throughout the US and the
world.
 I love working with
entrepreneurs on financings, as
outside counsel, and on exits.
klgates.com 4
Jason P. Gordon
Partner
+1.415.882.8124
Jason.Gordon@klgates.com

5. Review of Audience Survey
klgates.com 5

6. Structural Considerations
 Typically a
Delaware C-Corp.
klgates.com 6

7. CONSIDERATIONS WHEN PITCHING
INVESTORS
 Know your audience different investors have
different objectives
 Compliance with securities laws.
klgates.com 7

8. FINANCING OPTIONS
 Convertible Debt/Equity
 Also known as bridge notes
 Convertible debt is the parent of convertible equity,
which can also be known as a SAFE Instruments
 Y Combinator developed the SAFE
 Venture Rounds (different presentation)
 Series Seed and Series A
klgates.com 8

9. CONVERTIBLE SECURITIES
 Convert to future equity securities at a
negotiated discount to a future qualified equity
financing
 This avoids valuing the company
 Far less expensive than a venture round like a Series
Seed or Series A round
klgates.com 9

10. CONVERTIBLE SECURITIES (CONT.)
 Maturity*
 Interest Rate*
 Conversion Terms
 Amendment Terms, e.g., majority in interest
 Remaining Terms
 It’s not that common to negotiate these
 (*For Convertible Notes, not SAFEs)
klgates.com 10

11. MATURITY*
 Generally up to 18-24 months
 Should be trying to time this with some cushion when
you’ll have a venture round.
 Pay attention to California Financing Law, which
applies to persons “engaged in the business of a
finance lender or broker.”
 Make sure the financing fits into an exemption.
klgates.com 11

12. INTEREST RATE*
 Can be as low as AFR.
 Otherwise, imputed interest issues.
 Can be as high as 10% in CA
 Double check the usury laws.
klgates.com 12

13. CONVERSION TERMS
 Mandatory conversion at a discount of price paid
in Next Qualified Financing
 Series Seed/A needs to meet the definition of a
“Qualified Financing”
 Equity financing
 Minimum size, e.g., “$2,000,000”
 Discount has to be reasonable or later investors will
not go for it. 20-25% is typically reasonable.
klgates.com 13

14. CONVERSION TERMS CONT.
 Conversion Price Cap
 Conversion upon a change of control/sale
 Optional Conversion upon maturity or something
less than a qualified financing
klgates.com 14

15. STRUCTURE
 Convertible Notes – Generally one or two
documents (in addition to corporate
authorization and/or side letters)
 Purchase Agreement and a Convertible Security
 SAFEs – Generally one agreement (in addition
to corporate authorization and/or side letters)
klgates.com 15

16. CHOOSING THE PATH FOR YOUR COMPANY
 Convertible Securities
 Upsides:
 Most common; cheaper, simpler;
 No valuation of the company, nearly impossible at this early
stage, and helps maintain a low FMV for stock
options/restricted stock
 Downsides (At least for Convertible Notes)
 This is debt and may be required to be paid at some point
 Extra liquidation preference above all other equity, unless
otherwise handled
klgates.com 16

17. FOUNDATIONAL BASICS – VALUATION
AND DILUTION
 Pre-money valuation – the value of the company
before the next round of investment.
 Post-money valuation – the value of the
company after the round of investment.
 Fully-diluted basis – all common stock issued
and outstanding, plus all securities that can be
converted to common, plus (typically) the shares
reserved for equity compensation.
klgates.com 17

18. FOUNDATIONAL BASICS – VALUATION
AND DILUTION
 Very Simple Example (not factoring in the option pool or
any other equity)
 Pre-money $10,000,000
 10,000,000 shares split among three equal founders
 Founder A = 3,333,333 shares or 33%
klgates.com 18

19. FOUNDATIONAL BASICS – EXAMPLE
CONTINUED
 Basic Example without Convertible Securities
 Investment $3,000,000 at $1.00/share ($10,000,000 pre-
money/10,000,000 outstanding shares) (Post-money is
$13,000,000)
 Founder A = 3,333,333 of ~25% with a paper value of
$3,333,333
klgates.com 19

20. FOUNDATIONAL BASICS – EXAMPLE
CONTINUED
 Basic Examples with Convertible Securities
 If there had been $450,000 convertible security with 25%
discount only, holder would have received 600,000 shadow
shares. $450,000/((1-.25)*$1.00)
 This example ignores the circular math: in determining the price the new
money will pay and on which the discount will be applied, the investor will
include the shadow shares in the fully diluted basis.
 If there had been a $450,000 convertible security with
$5MM cap only, holder would have received 900,000
shares. $450,000/(5,000,000/10,000,000)
 This example also ignores that the investor will include the shadow
shares in the fully diluted basis, which will change the price per
share the investor pays.
klgates.com 20

21. COMMON PITFALLS
 Non-Compliance with Securities Laws
 Finders
 Thinking that there are “standard” terms
 Finders
 Side Letters
 Failure to obtain proper corporate authorization
klgates.com 21

22. Questions/Comments