This post was originally part of my “Ask the Attorney” series which I am writing for VentureBeat (one of my favorite websites for entrepreneurs). Below is a longer, more comprehensive version. Please shoot me any questions you may have in the comments section – or feel free to call me directly at 415-979-9998. Many thanks, Scott
We’ve gotten commitments for a seed investment of $600,000, and the lead investor advised us that to save time and money on legal fees we should use the Series Seed documents, which he said are just fill-in-the-blank forms, with no negotiations. Have you heard of the Series Seed documents and, if so, do you think this makes sense?
The so-called Series Seed documents are a stripped-down set of preferred stock financing documents, which were designed for seed investments by Silicon Valley lawyer Ted Wang (with an assist from venture capital firm Andreessen Horowitz). The goal, as Ted notes on his site, was to “[create] a simple set of documents for early stage investment.”
The problem Ted was attempting to address was how to get shares of preferred stock into the hands of investors in a seed investment without having to draft and negotiate a full-blown set of Series A documents, with all the bells and whistles (and associated legal fees of $50,000+). In short, Ted has solved this problem – and for that I tip my hat off to him. Moreover, a number of investors have been quite vocal in their support of the Series Seed documents and have begun utilizing them, particularly in Silicon Valley.
But the issue, of course, is whether the documents are fair from the entrepreneur’s perspective. Indeed, if entrepreneurs are going to be required to simply sign form financing documents with no negotiations, they obviously must be comfortable with what they are signing. So let’s examine the terms of the Series Seed documents.
The Good News. The good news for entrepreneurs is that, first, the number of documents (and pages) for a preferred stock financing have been reduced dramatically, including the removal, among other things, of anti-dilution provisions, registration rights and a legal opinion. Preferred Stock financings are thus much quicker and cheaper.
Second, the liquidation preference is 1X non-participating, which is very pro-entrepreneur; and third, the company’s obligation to reimburse the investors’ lawyers is a flat fee of $10,000.
The Bad News. The bad news is that, unlike in connection with the issuance of convertible notes, the founders must give-up certain control rights to the investors, including a Board seat and veto rights with respect to certain corporate actions pursuant to protective provisions. For a $600,000 seed investment, this may not make sense and is the fundamental problem with using fill-in-the-blank forms. Other issues include the four-year vesting requirement and the 30-day no-shop provision (which some VC’s, like Fred Wilson, do not require).
The bottom line is that if you are a “hot” startup with strong negotiating leverage, you’re better off issuing convertible notes to avoid the foregoing issues and to kick the valuation issue down the road to the Series A round. Needless to say, the pendulum has recently swung dramatically in the entrepreneurs favor (particularly in Silicon Valley), and most of the hot startups are issuing convertible notes in seed rounds, not equity.
For example, in January of this year, Yuri Milner and SV Angel announced that their Start Fund would offer all Y Combinator companies $150K in convertible notes; and last August, Paul Graham tweeted that: “Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”
In conclusion, the Series Seed documents may be a good starting point in certain situations; however, agreeing to close on a set of form documents without negotiation may not be in your best interest — particularly if you have a hot startup.