The Series Seed Documents are a standardized set of documents that can be quickly and easily deployed for a seed investment: to help get a company financed properly, legally, quickly, and intelligently
Up until now, various smart people have talked or blogged about reducing the transaction costs associated with seed stage investment without rallying around a particular attack. Of course both entrepreneurs and investors would rather see their investment dollars used toward developing a new product and bringing it to market than toward what are usually routine transaction costs. The problem has been crafting a set of documents that provide adequate protections without being unduly burdensome. While traditional financing documents give broader rights and protections to investors, for a seed stage investment the benefits of simplification in the Series Seed documents outweigh the value of these additional rights and protections.
I first blogged about the need for Series Seed Documents in 2007. Since that time, a single standard has yet to emerge on the document front despite a number of good efforts in this arena.
The prime obstacle, I suspect, is that done with only the goal of “simple” in mind, a shorter form of documents would actually increase transaction costs in any single transaction. Not only would the practitioner have to invest time drafting the shorter documents, but the investors’ counsel would be forced to spend additional time reviewing and understanding the shorter documents and educating the client about the items missing from the standard forms. Thus, although there is a good deal of consensus among venture capital lawyers on what should be in the short forms, to date what has been lacking are documents that express that consensus. It’s my hope that the Series Seed Documents can fill that role.
It is also important to note that these are not my firm’s form documents. Although many of my colleagues at Fenwick & West have been kind enough to help me with the initial draft, these documents are the result of conversations with a wide range of practitioners and I consider them jointly owned by the entire seed investing community. I describe more about how these documents will be curated in an open source manner below.
Finally, none of the folks involved with this project believe that the documents are the only acceptable way to address a seed financing. There are a number of different approaches and in certain cases a more fulsome approach or another form of financing documents may be a better fit. The Series Seed Documents are meant to be a shorthand way of describing a simple and short set of preferred equity financing documents.
The main purpose of this blog post is to get into a few more technical issues about the Series Seed Documents themselves. This is really targeted at lawyers who work in the venture capital field and those VCs and entrepreneurs who are actually willing spend time on the investment documents themselves (you know who you are!).
In this post I’m going to cover what is (and is not) in the documents and the curation process going forward. One over arching point is that these are seed round documents. All of the provisions from the standard financing documents that have been excluded have some intrinsic value. The relevant question is whether the value of any provision at this stage in the Company’s life is worth the cost of having it included in the financing documents, and therefore written by one lawyer, reviewed by at least one other lawyer and potentially commented on and haggled over. For any particular clause, one could make the argument that either (a) the provision is helpful or (b) the provision alone is fairly standard and not subject to very much negotiation. In the aggregate, however, shorter, simpler documents are going to reduce transaction costs and so the Series Seed Documents included only those provisions that are most important to the economics of the seed financing transaction.
The Series Seed Documents (the “Documents”) consist of four documents, an Amended and Restated Certificate of Incorporation (the “Charter”), a Series Seed Stock Preferred Stock Purchase Agreement (the “Purchase Agreement”) and an Investors’ Rights Agreement (the “Rights Agreement”) and a term sheet summarizing the terms set forth in the other Documents.
On the Charter the basic structure of a standard venture capital charter is mainly intact with a couple of things stripped out. First, preferential dividends are not included as they are largely meaningless for seed stage venture deals. Second, redemption rights are not included as they seemed a bit onerous for a seed round. Third, there is no price based anti-dilution. A seed stage investment is generally designed to prove (or disprove) a basic hypothesis regarding product acceptance. If the product is not accepted by the market, the company is either shut down or sold for a nominal amount. If the product is accepted, a new financing at a higher valuation typically follows. Therefore, at this stage in a company’s life, the odds of a down round are fairly slim. Moreover, this is one of the densest sections of the entire document and so excluding this section makes this document more readable by civilians (i.e. non-lawyers). Finally the carve-outs (i.e. exclusions) to the anti-dilution section are often the subject of negotiation -- which can be costly and time consuming. For all of these reasons it seemed like the value of price-based anti-dilution exceeded its cost.
The remainder of the document is a fairly standard charter. The only notable twist is that the Board is set up as two common directors and one preferred director, but, in the case where the Board is going to be one common seat, one independent (or CEO seat) and one investor seat, a provision in the Rights Agreement is included requiring the common holders to vote their shares for the independent director.
The Purchase Agreement is just a slimmed down version of a standard stock purchase agreement. The number and scope of company representations has been drastically reduced, as the typical laundry list of representations seemed somewhat burdensome for a seed stage investment. I’ve always found it odd that I have to negotiate a representation regarding financial statements for a company that consists of two college grads and their computers. The biggest change from a standard SPA is the elimination of the closing conditions. Virtually every venture deal is done as a simultaneous sign and close and, although it makes for a convenient checklist, the benefit of including a laundry list of closing conditions didn’t seem to outweigh its costs. The more significant point is that this deletion anticipates the elimination of a number of the conditions themselves, namely the Officer’s Certificate, the Secretary’s Certificate and the Legal Opinion. The first two of these items have always seemed vestigial when transactions are simultaneous signing and closing. Though there are theoretical arguments to the contrary, it seems unlikely that these documents will serve any meaningful purpose. With respect to the legal opinion, this is a simple cost benefit analysis. The true value of the legal opinion is not the document itself, which is rarely litigated, but rather the opinion serves as a forcing function to drive company counsel to ensure that the matters covered therein have been adequately diligenced. The problem with this approach for the seed deals is that the cost of generating an opinion for a law firm is far greater than the value of this particular form of assurance. Moreover, the elimination of the legal opinion in seed stage deals has already become largely a market term and accordingly this exclusion should not be too controversial. I would, however, expect a management rights letter to be included as part of the closing documents in order to ensure VCOC compliance. No exemplar has been provided in the Documents because they seem to have some real variation amongst funds.
The Rights Agreement is the most radically redesigned of the documents. First, there are no registration rights (or accompanying indemnification provisions). This is not to say that late stage investors shouldn’t ask for and get registration rights, but for a seed investment, it’s really a waste of time. One of my fondest memories from my early days as a lawyer was a venture capitalist who specifically prohibited me from mentioning reg. rights to him…ever. Also eliminated are the covenants that often creep their way into these agreements, such as maintaining insurance or not raising employee pay. Although many of these covenants are perfectly reasonable, these seem like overkill for a seed financing and investors can rely on the fiduciary duties of the officers and directors of the company to shield them from self-dealing activities that are often the subjects of such covenants.
One new right set forth in Section 1.2 of the Investors’ Rights Agreement is the notion that the Series Seed investors should get whatever rights the investors in the next round of financing get. One of the most thoughtful objections to the concept of Series Seed documents is the notion that if the early stage investors don’t get their rights in the early stage, they won’t get them in the later documents. Section 1.2 is intended to address that point. On a conceptual level, the Series Seed investors are not really giving up standard venture capital investment rights by way of the Documents as much as they are agreeing to defer getting these full blown rights until the company has sufficient prospects that it would be logical to devote resources (read: money and time) toward enumerating these rights. Accordingly, the Documents provide, not only that the Series Seed investor will get such rights, but also that investors will be reimbursed for legal fees so that their counsel can ensure these rights are properly enforced.
Section 1.3 of the Rights Agreement also represents a material departure from the status quo. This section is meant to replace the full blown right of first refusal and co-sale agreement that is typically seen in venture financings with a simple provision that causes the Company to assign its right of first refusal to the investors, provided that the company elects not to exercise that right. Although lacking a number of the procedural aspects of a typical ROFR Agreement and some of the remedy provisions, this provision effectively gives the seed investors the right of first refusal that is typically set forth in such an agreement. Entirely omitted, however, is the co-sale right. In my experience this is rarely, if ever, used although reams of paper have been generated effectuating a waiver of this right.
At the urging of Sarah Reed I’ve included what is referred to as a “convenience” drag along right, which simply ensures that the smaller investors will approve any deal approved by the larger investors, common holders and the Board. Absent from the Documents, however, is a stand alone voting agreement. These agreements are actually not all that common in seed financings as the most typical board alignment is one (1) investor designee and two (2) common designees. It is not, however, unusual to see some other configuration, most typically either requiring that (a) one of the directors is the CEO or (b) that an independent person take the third board seat. For this reason, Section 4.1 has been included in the Rights Agreement. Instead of trying to adapt the charter to these various scenarios, Section 4.1 simply requires the founders (the “Key Holders” in the document) to vote for a mutually agreed upon person and can be easily customized for that purpose. Of course, this Section 4.1 is a crude instrument and lacks many of the procedural niceties of the typical voting agreement. It should, however be sufficient to get the job done and it does so without too much fuss.
The documents are intended to be modular so that in future rounds additional terms can simply be layered in. Accordingly, the documents are structured quite similarly to the NVCA documents and many other standard venture capital financing forms. Moreover, these documents are not intended in any way to replace the NVCA or other full blown forms. The NVCA documents are an incredibly useful resource for the venture capital community, however, those forms are simply not well suited for a $750,000 angel investment.
This is version 0.1 of the Documents. Although I’ve had a number of other lawyers review them, I have no doubt these documents can and will be improved. I intend to take comments on the Documents which can be made either on seriesseed.com or if you’d prefer you can email me comments or send me mark ups. There is no pride in my authorship and input from all sources is welcome.
I would, however, appreciate if folks can shelve any personal attacks or vituperative comments. We have talk radio for that.
I will review all the comments and then post a revised set of documents (along with a redline showing all changes) and, if I’m very ambitious, a blog post describing what changes have been rejected and why. I intend to do the first set of revisions after one quarter in order to capture all of the bugs and then target my revisions semi-annually. I view this as an open source project and I will endeavor to review all comments with the most objectivity I can muster and with no bias for either the investors or the entrepreneurs. I will undoubtedly fail in this regard in the numerous ways and I thank you in advance for your tolerance of my shortcomings. Finally, while I have assigned myself the role of curator, I do not believe it need be a lifetime appointment. I’ve taken on this task as a contribution to the start up community of which I am fortunate enough to be a member. If some other brave soul emerges who wishes to take over this task in the future, I will hand off the mantle with glee.
I want to thank the many folks who have already contributed to this project and are too numerous to name. The start-up ecosystem benefits all of its participants and this is a useful way to give something back.
This endeavor will only be successful if the Documents gain widespread adoption -- and that will require lawyers to get out of their comfort zones and think about the trade-offs suggested in the Documents. It will not be easy, but once a practitioner takes the plunge and makes the effort to think through the changes, I am convinced that a well thought-through standard set of seed documents will emerge. Moreover, if folks in our line of business do not come up with a set of documents that enable seed financings at a reasonable cost, the market is going to solve this problem in another way. To quote Gen Shinseki “[i]f you don’t like change, you are going to like irrelevance even less.”