Version 2.0 and why Series Seed Documents are better than capped convertible notes

“First they ignore you. Then they laugh at you. Then they fight you. Then you win.” Mahatma Gandhi

I hesitate to use a quote from one of the greatest people ever to grace planet earth, and certainly the question of how to structure early stage investment is a laughable cause as compared to the rights that Ghandi (also a lawyer) fought to advance.  That said, I think this quote accurately captures the life-cycle of creating a simple set of documents for early stage investment.

I’ve attached version 2.0 of the Series Seed Documents as well as a red-line showing the changes I’ve made from the original set.  If you peruse the red-line, you will see that there are not many changes.  That’s because there are not that many issues to negotiate in a simple equity financing.  Of course, one could argue, that I’m just not taking comments I disagree with (or that nobody cares enough to comment), but I am of the opinion that these documents represent the 95% consensus of what should be in a very basic set of equity financing documents.  Based on the comments received, both on the blog and in the many deals in which these documents have been used, I am convinced that the terms of a simple set of equity documents are really not an issue.  I don’t mean to say that the Series Seed are infallible, but there are no major objections to their content.

Why use Series Seed Documents instead of capped convertible debt?  This seems to be the real issue.  In my opinion, the reason that capped convertible debt is the current market leader is that entrepreneurs have been conditioned over time to believe that convertible debt is (a) faster (b) cheaper and (c) better for them than equity investment.  This is EXACTLY why I created the Series Seed Documents.  With Series Seed:

·    Costs should be roughly the same (if not cheaper) than using industry standard debt documents.  There are a number of different convertible debt documents out there and there will likely be some back and forth whereas these are standard documents.

·    Same point for speed.  If parties agree to Series Seed Documents, should be faster than debt documents since there is some negotiation with debt documents from sophisticated investors.

·    Series Seed Documents are transparent: no hidden gotchas can get served up in definitive documents.  You can review them right now if you want.

·    Equity documents give investors more clear definition around rights, more stability and less potential squabbling in the next round.

·    Equity gives investors the opportunity to get long term capital gains tax treatment if early exit.

·    With minor manipulation, Series Seed enables multiple board structures without tortured and non-functioning agreements (a real problem for convertible debt documents); and

·    Entrepreneurs get price certainty instead of the lower of two different prices as with capped debt.

In sum, Series Seed creates a level playing field between capped debt and equity documents in terms of speed and cost.  When one studies the (admittedly highly technical) benefits of Series Seed vs. price debt, Series Seed is a better solution.

There has been a robust debate on this topic with folks like Fred Wilson, Paul Graham and Seth Levine all chiming in.  To clarify, there is no question that as an entrepreneur you would prefer uncapped convertible debt to equity.  As Josh and many others point out, this is typically not a fair deal for the investors and many investors won’t do it, or will only do it for people that they are blindly in love with.  Also, Seth raises some interesting points about ecosystem health, though most entrepreneurs I know aren’t too concerned about killing the golden goose. Once a price cap has been introduced, however, Series Seed Documents are a better solution to getting the first round complete for both entrepreneurs and investors. 

Redlines

Redline - Series Seed COI (1 v. 2)

Redline - Series Seed IRA (1 v. 2)

Redline - Series Seed Term Sheet (1 v. 2)

Series Seed Documents

Series Seed COI (v 2.0)

Series Seed IRA (v 2.0)

Series Seed Term Sheet (v 2.0)

Series Seed Form SPA

 BEFORE DOWNLOADING THESE DOCUMENTS PLEASE READ THE DISCLAIMER



Disclaimer

Neither I nor Fenwick & West, LLP assumes any responsibility for any consequence of using these documents. These documents have been prepared for informational purposes and is not intended to (a) constitute legal advice (b) create an attorney-client relationship (c) be advertising or a solicitation of any type.  Each situation is highly fact specific and requires a knowledge of both state and federal laws and therefore any party should seek legal advice from a licensed attorney in the relevant jurisdictions.  Both I and Fenwick & West expressly disclaim any and all liability with respect to actions or omissions based on this website.

Comments

[Dam00n]

Looks like the Series Seed IRA (v 2.0) link and Series Seed Term Sheet (v 2.0) link go to the same doc. Is that correct?

[Alexissmirnov]

Ted,

Thank you for summarizing the advantages of Series Seed over capped convertibles.

Have you had anyone from Canada use these documents for financing a Canadian (Quebec) entity? Can you comment on applicability of these documents in this context?

If this version isn't applicable, what do you suggest to a Canadian entrepreneur seeking funding from US angels?

[twang]

I've not had anyone from Canada and I don't know enough about Canadian law to have an informed opinion as to how they would work. I do, however, think that a good Canadian business attorney could use these documents as a source and fairly quickly modify them to meet the needs of Canadian law. That would be my suggestion.

[Bill Burnham]

First off, I think this is a great idea and a great service to both entrepreneurs and investors to effectively "open source" a robust set of very basic preferred financing docs.

One issue I do have with the term sheet though is the provision for $10K in investor legal expenses. Now I know this is likely just a placeholder and people can change it to whatever they want, but I've done a lot of angel deals and never seen one in which the angels get investor expenses. I've also done "Series Seed" deals, but in those cases company counsel has drafted the docs for a few K.

I think by putting this provision in the term sheet you are conferring legitimacy on it and making it seem normal and/or acceptable practice for angels to ask for $10K to cover their seed investing expenses.

This is not normal nor is it, in my opinion, acceptable or for that matter practical given that there rarely is a lead investor counsel in an angel round and if there is one it's likely not a real angel round but an institutional round anyway.

If you need counsel to review these elegantly streamlined docs you shouldn't be doing angel deals in the first place.

[William Carleton]

Ted, I understand why taking down the prior versions could eliminate confusion, but I think it would still be helpful to have them archived somewhere as a reference for those of us who have used them and want to be able to refer folks to an authoritative place to check the integrity of the forms, run redlines against the source forms, etc.

[Ted Wang]

Good point. I'll put them up in an archive.

[Brian]

Ted-

I read through the docs, well done. A question I have is why is there no anti-dilution protection for the investor? I completely understand not wanting to put in an onerous full ratchet but the fact that there is no weighted average ratchet seems a bit bizarre. I have a hard time believing an early investor wouldn't inset some anti-dilution provision. Your input is appreciated!

[Brian]

REDACTION: Let me re-track my statement, 1) I tend to think in with a late stage investor hat on (wrongly in many cases), and 2) I found your justification for leaving those terms out, and it is a well justified position. Again, any addition points you have well not fall on deaf ears.

[Ted Wang]

Brian

Thanks for your comments. To make it clear, I don't have any problem with anti-dilution generally speaking and it is both standard and appropriate in a full blown Series A. In my experience, it is highly unlikely that this term will come into play in a Series Seed since the valuation is presumably very low. The basic Series Seed investment tests a hypothesis. If that hypothesis is correct, the company raises money at a higher valuation. If incorrect, it shuts the doors. Given this background and the fact that a proper anti-dilution clause is lengthy, heavily negotiated and impossible for a civilian to read and understand, I thought it would be better to exclude.

[Brian]

Ted

We are in 'violent agreement' about your point on the necessity of anti-dilution provisions in early seed deals. Thanks for your contributions.

I'm generally curious about who you know has adopted these documents that you're aware of and what constructive feedback you've received that has been polar to your seed docs. I understand if you're unable to share those details.

Thanks again.

-Brian

[Ted Wang]

Brian

So a number of our firm's clients have used the documents (including Blippy and Civic Solar both of whom have done some media around it). Generally, I've not had any negative feedback on the Series Seed Documents themselves. Most of the comments are on the Blog. The lone criticism that I hear consistently is that convertible notes are preferable, which I tried to address in one of my earlier posts.

Thanks for your interest.