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:
Required corporate structure
Legal considerations when pitching investors for seed financing
Differences between using convertible debt and SAFEs
Key terms and considerations when raising seed funding
Common mistakes and pitfalls that companies make when raising seed funding via convertible debt and SAFEs
How to close your seed financing
Important post-closing tasks
And much, much more
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.
Do not provide me with any information you desire to be
confidential.
Jason.Gordon@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
Jason.Gordon@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.
Jason.Gordon@klgates.com 4
Jason P. Gordon
Partner
+1.415.882.8124
Jason.Gordon@klgates.com
7. CONSIDERATIONS WHEN PITCHING
INVESTORS
Know your audience different investors have
different objectives
Compliance with securities laws.
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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
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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
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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)
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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.
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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.
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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.
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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
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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)
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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
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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.
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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%
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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
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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.
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21. COMMON PITFALLS
Non-Compliance with Securities Laws
Finders
Thinking that there are “standard” terms
Side Letters
Failure to obtain proper corporate authorization
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