How do the sample Series Seed financing documents differ from typical Series A financing documents?

March 14, 2010

After the recent announcement of the Series Seed Financing documents by Marc Andreesen, Brad Feld points out that there are now four sets of “open source” equity seed financing documents:

My general opinion is that anything that makes the financing process faster and easier or otherwise educates entrepreneurs is a good thing.  (A reminder that anything I write on this site is only my personal opinion and does not represent the views of WSGR or anyone else from WSGR.)  In addition, I think that a “peace treaty” between early-stage investors and startup companies on standard terms (at least at a term sheet level) is a step in the right direction.

I previously wrote a post titled “How do the sample Y Combinator Series AA financing documents differ from typical Series A financing documents (or what’s the difference between seed and venture financing terms)?“  Much of the commentary on the Y Combinator documents is also applicable to the Series Seed documents.  (In fact, I recyled part of that post in writing this post.  I also reviewed the TechStars documents last year and they are similar in concept to the Y Combinator documents as the chart below indicates.)

This post assumes that you have a basic understanding of Series A financing terms.  If you don’t, please educate yourself on this site, Venture Hacks and the term sheet seriesby Brad Feld/Jason Mendelson, among other places. If you really want to understand the nuances in venture capital financing documents, please review the NVCA model venture capital financing documents

What situations should the Series Seed documents be used in?

The Series Seed documents are probably fine in situations where the investor (i) wishes to purchase equity rather than convertible debt, (ii) is otherwise somewhat indifferent on terms other than percentage ownership of the company, liquidation preference and right of first offer in future financings, (iii) is investing at a fairly low valuation (i.e. a couple of million dollars), and (iv) is only investing a small amount (i.e. under $500K).

I was actually somewhat surprised that the following investors have agreed to use the Series Seed documents in certain of the their deals:  Baseline, Charles River Ventures, SV Angel (Ron Conway), First Round Capital, Harrison Metal Capital, Mike Maples, Polaris Venture Partners, SoftTech VC and True Ventures. In contrast, Fred Wilson says while he is ”hugely supportive of his intent here, I can’t and won’t get behind the Series Seed forms because they leave out some critical stuff that we simply won’t do a deal without.“ 

I think that there are certain situations where the Series Seed and other stripped down equity financing documents might be appropriate, but I know that there are lots of situations where early-stage investors probably wouldn’t agree to the Series Seed terms.

Recently, I have seen a lot of seed stage financings being structured as convertible debt with a price cap, which is an alternative to the equity financing contemplated by the Series Seed documents. Certain angel investors refuse to do convertible debt deals, but will be okay if there is a price cap. In fact, I have seen convertible debt used to raise up to $1.0 million, but it seems like the sweet spot is around $500K.  Convertible debt documents are generally much more simpler to draft and read than equity financing documents, so I typically recommend convertible debt for companies raising below around $750K.

In my experience, if a company is raising, say $1.0 million, the investors expect to receive a full set of Series A documents with rights essentially the same as venture capital investors.  Therefore, the Series Seed documents may not be acceptable in these situations.  I think that the Series Seed documents are probably most appropriate in a friends and family equity seed financing, as opposed to a round led by a professional investor.

Why is it called Series Seed?

To differentiate it from typical “Series A” preferred stock, which comes with certain expectations with regard to rights.  There is no real rule to what a particular series of preferred stock is called.

What rights does the Series Seed have?

Ted Wang explains most of the highlights of the documents.  The primary rights in these documents, ranked in order of importance in my opinion are:

  • Future rights.  If new investors get better rights in a future equity financings (such as registration rights, price-based anti-dilution, redemption rights, etc.), then the holders of the Series Seed get these better rights.
  • Board seat.  The Certificate of Incorporation gives the Series Seed a board seat, while the common get two board seats. 
  • Information rights.  The investor receives unaudited annual and quarterly financial statements.
  • Drag along.  The Series Seed documents include a fairly harmless drag-along provision, which requires the investors and the key common stockholders to vote in favor of a “deemed liquidation event” (which basically means sale of company transaction) if a majority of the holders of common stock, a majority of the holders of the Series Seed and the board approve the transaction.  Given the general theme of the documents to eliminate unnecessary provisions, it strikes me as somewhat odd that there would be a drag-along. If I represent investors in a later Series A financing, I would probably use the existence of the drag-along as an excuse to implement a more aggressive drag-along provision — which does not require the approval of the holders of common stock to trigger.
  • Legal fees.  The company is obligated to pay $10K for investors counsel.  I suspect that this seems reasonable if there is basically no due diligence due to the early stage of the companies.  (By the way, the TechStars documents and the Y Combinator documents do not have a provision to reimburse counsel for the investors, probably on the theory that the situation where the documents are used don’t require counsel to review the documents on behalf of the investors.)

What are the primary rights that are missing from the these documents that would be in a typical Series A financing?

In the Series Seed documents, there are various terms that are missing that one would typically expect in a company-friendly Series A term sheet.

  • Dividend preference.  Almost all startup companies don’t declare dividends, so deletion of a dividend preference is irrelevant to an investor.  The only practical situation that I can think of where a dividend preference is beneficial to a stockholder is where a company does a partial sale of assets and wishes to distribute the proceeds to stockholders. The liquidation preference would not apply in this situation, and any distribution to stockholders would trigger the dividend preference.
  • Registration rights.  As a practical matter, I don’t think that investors should really care about registration rights.
  • Anti-dilution protection.  Deleting anti-dilution rights saves several pages of text in the Certificate of Incorporation. Given that the Series Seed is issued at a fairly low valuation, anti-dilution protection is probably not that important, as a “down round” from a low valuation in the Series Seed is unlikely.
  • Comprehensive protective provisions.  The Series Seed documents are fairly light on protective provisions compared to a typical Series A financing.
  • Co-sale rights.  These rights are missing, which is probably okay since I have never heard of a co-sale right being used before.
  • Voting agreement.  In a typical venture financing, there is a voting agreement that governs how specific board seats will be filled.  In angel financings, I typically eliminate the voting agreement anyway and simply have a closing condition that the board consist of certain persons.
  • Comprehensive representations and warranties.  The Series Seed Stock Purchase Agreement has fairly limited reps and warranties.  As a practical matter, investors don’t sue companies for a breach of reps and warranties, so reps and warrants basically serve to flush out diligence issues.  In an early stage company, extensive reps and warranties are probably unnecessary.
  • Legal opinion.  A company counsel legal opinion is missing in these documents.  A legal opinion for a newly-incorporated early stage company probably doesn’t add much to the due diligence process and is probably unnecessary compared to the incremental cost to prepare.

Why will or why won’t people adopt the Series Seed documents?

  • Investor pressure.  The only way that the Series Seed documents will be widely used is if investors demand use of the documents.
  • Investors want additional protections. I suspect that things like lack of anti-dilution protection, a desire to have participating preferred stock and weak protective provisions will make it difficult for some investors to agree to use the documents without modification.  Once you start making substantial changes to the forms, then I think some of the value of standardization goes away.
  • Law firm resistence.  As a reference point, WSGR generally does not use the NVCA documents in a Series A financing when it represents the company unless the investor specifically demands that the NVCA documents be used.  This represents approximately 20% of all venture financings in the U.S. I’ve read the WSGR form Series A documents hundreds of times (and probably have most of the provisions memorized).  I think I’ve only come across the NVCA forms a couple of times, and both times were on deals with Boston-based company counsel, where use of the NVCA documents is more widespread.  In addition, WSGR’s Series A documents can be created using the document automation software behind the WSGR term sheet generator. Therefore, using WSGR form documents when I represent a company is much more efficient than using the NVCA documents.
  • Drafting issues in later rounds. One thing that I don’t like about stripped down documents is that adding provisions in the future is painful — especially if the documents are not written in a modular fashion.  For example, adding in the anti-dilution provisions into the Series Seed documents requires the insertion of a couple of pages of text into the Certificate of Incorporation.  It’s somewhat painful to ensure that all of the section references (including Microsoft Word auto-reference codes) and defined terms work properly.  Therefore, in my opinion, it’s actually more difficult to add the modular sections than it would be to start from a new robust template and tweak it to fit the term sheet.  I’d encourage the Series Seed project to have redlines of at least the Series Seed Ceritificate of Incorporaiton against the form of Series A Certificate of Incorporation that it was based on in order to show that the documents can easily be modified in a Series A financing to include anti-dilution and other provisions.  (It seems like the Series Seed Certificate of Incorporation is mostly based on the NVCA form of Certificate of Incorporation with various formatting and simplification-related changes.)
  • Use of different forms for later Series A financing.  As a practical matter, in a typical Series B financing, the Series A documents will generally be tweaked slightly for the Series B, and company counsel will send redlines to investor counsel to show changes from the Series A (which are typically minimal).  When a company does a Series A financing and the Series Seed documents are in place, the Series Seed Stock Purchase Agreement and Investors Rights Agreement will probably not be re-used.  As discussed above, the Certificate of Incorporation will need to be amended and restated and various provisions will need to be plugged in.  (By the way, restated means that the entire document is redone in its entirely, as opposed to just an amendment, which might refer to discrete sections like: “Article IV shall be amended such that the number of shares of Common Stock shall be 15,000,000.”)  The Series Seed Stock Purchase Agreement has no lingering obligations, so Series A investors will want a more traditional stock purchase agreement with closing conditions and closing certificates — and it is much easier to use a typical Series A Stock Purchase Agreement than modify the Series Seed Stock Purchase Agreement.  In addition, there will be so many new provisions added to the Investor Rights Agreement (such as registration rights) that starting from a more robust form is easier than adding provisions to the Series Seed Investor Rights Agreement.

What’s the difference between the Series Seed documents, the TechStars documents, the Y Combinator documents and TheFunded Plain Preferred term sheet?

The Y Combinator documents were released in August 2008.  The TechStars documents were released in February 2009. TheFunded released their “Plain Preferred” term sheet in August 2009.  The Series Seed documents were released in March 2010.  Below are some of the material differences between the Series Seed, Y Combinator and TechStars documents.  (I won’t bother outlining the differences in TheFunded term sheet, as it was more intended for a typical Series A institutional venture capital financing, as opposed to the seed stage contemplated by the other documents.)

 

Series Seed

Y Combinator

TechStars

Name of security

Series Seed

Series AA

Series AA

Principal documents

COI, SPA, IRA

COI, SPA, IRA

COI, Subscription Agt.

Dividend preference

Pro rata with common

Silent

Pro rata with common

Liquidation preference

1x non-participating

1x non-participating

1x non-participating

Redemption rights

None

None

None

Anti-dilution

None

None

Broad-based weighted average

Board composition

2 common; 1 preferred

2 common, 1 preferred

2 common, 1 preferred (if Series AA is at least 5% of fully-diluted)

Protective provisions

Typical list for company-friendly VC financing

Changes in preferred and merger/sale of assets only

Changes in preferred only

Information rights

Unaudited annual and quarterly

Unaudited annual and quarterly

Unaudited annual

Registration rights

None

None

None

Right of first offer on new financings

Yes

Yes

Yes

Right of first refusal and co-sale agreement

Assignment of company right of first refusal to investors

Silent

Silent

Drag-along

Yes for Series Seed holders and founders. Triggered upon (i) majority of common, (ii) majority of Series Sees, and (iii) board approval.

No

No

Future rights

Yes

No

Yes

Legal opinion

None

None

None

Legal fees

$10K to investor counsel

None

None

 

What would you change about the documents?

I’m still pondering and will update this post later after I speak to some early-stage investors.

Comments

  • chrissheehan

    Excellent overview Brad. Most of our financings are in the $1M – $2M range so we generally use a full set of Series A documents. This also tends to make it easier when negotiating with new investors on the B round. But I believe there is merit in considering these scaled down seed financing documents for smaller rounds. I have not reviewed in any detail the various sets of documents out there but this is a tremendously helpful starting point. Thank you. Chris

  • Saul_Lieberman

    Thanks for all of your hard work. Two comments:
    1. “Therefore, using WSGR form documents when I represent a company is much more efficient than using the NVCA documents.” I think you are ignoring the efficiencies afforded because the other side is already familiar with the NVCA documents.
    2. Use of different forms for later Series A financing. Spend time and money now to save the same amount later? Also, there is no guarantee that the same form would be used in a later financing.

  • Ted Wang

    Yokum

    Great summary. I agree with all of the technical analysis but I disagree with one key issue You wrote that you were surprised to see top name investors sign up for Series Seed Documents and implied that they were unlikely to use them for $1m rounds.

    I think investors are hugely supportive of this type of short form for the typical professional seed round (i.e. $750k to $1.5m) but they needed a vehicle to express this. The list of folks who have signed up and the number of deals that have already been done with these forms are the best evidence of this. The goal of these documents were to find the right balance of brevity and simplicty with the key rights required to protect a seed investment. To use an analogy from our childhood, I think the TechStars document is too cold (not enough rights for the investors to use) and the Founder Plain Preferred is too hot (good Series A documents but really just a traditional Series A financing set of forms) and the Series Seed is just right.

    A few other thoughts

    I wish that folks would stop referring to these documents as Fenwick & West documents. Although I did write them, I got comments from a lot of people outside the firm. I intentionally did not put any Fenwick branding on the site or in the press so as to avoid this issue. I will be happy to hand over the curation of these documents to a non-Fenwick person.

    The law firm resistance point is the biggest challenge for adoption of these documents. The reason I did not seek to build law firm consnesus is that I don't think it's acheiveable. There are numerous historical examples where the law firms tried to have an accord and it collapsed. Gordy Davidson, the chairman of my firm, told me about one such effort in the 70's. In more modern history (sorry Gordy) there was an opinion accord amongst some firms that collapsed about 10 years ago. I ABSOLUTELY agree that investors will need to push the lawyers on this or it just won't happen.

    I also agree the next round edits are the most difficult issue with these documents. From an investment point of view, however, I think it makes more sense to pay lawyers to work at that stage of the company's life (where it appears there is a company) than at the seed stage. I promise to post a set of redlines showing how to transform these into Series A documents.

    Finally, the issue I'm most concerned about is that these are portrayed as competing documents with other forms. I have been inspired by some of the early efforts to put documents online and my hope was that the Series Seed Documents would take things a bit further by making them open source and not tying them to my firm. I do not see myself or these documents as in competition with the other documents. Rather I'm trying to come up with a single standard based on our collective experieince. If there's anything that you, or anyone else, think ought to change in the Series Seeed Documents, let's have that discussion.

    Thanks for your efforts.

  • http://twitter.com/chrisco chrisco

    Model convertible debt documents would be nice. Also a discussion and/or analysis of “Exchangeable Shares for Angel Investors”: http://www.angelblog.net/Exchangeable_Shares.html

  • Name

    Why are you ignoring the documents from TheFunded.com at http://www.thefunded.com/funds/item/5936

  • http://www.startupcompanylawyer.com Yokum

    As mentioned in the post, a discussion of the TheFunded term sheet compared to the other three documents is like comparing apples and oranges. TheFunded term sheet gives investors the full set of rights that would be typically expected in a Series A financing. The Series Seed, TechStars and Y Combinator documents are intentionally stripped down versions of typical Series A financing documents for use in very early-stage seed rounds.

  • http://www.startupcompanylawyer.com Yokum

    @Saul,

    1. I'm suspect that investor counsel at the typical Silicon Valley law firms don't really care what forms company counsel starts from as they as they mechanically work properly (i.e. they don't have to proof the anti-dilution formula). As an investor counsel myself, I don't think reviewing the NVCA forms is any easier than reviewing [fill in name of typical Silicon Valley firm] forms. There are some east coast/west coast differences in philosophy on the NVCA forms, and although I think that the NVCA working group has made strides to make them more neutral in recent iterations, there are still east coast biases that make the documents investor-favorable as opposed to company-favorable or neutral.

    2. The point is simply that there are mechanical hassles in using stripped down forms as they will end up as one time use only — and aren't easily amended and restated.

  • susanmorgan

    Hi Yokum – I believe there is a real benefit in moving in toward a “quasi-standardized” early-stage seed financing terms. I wrote a recent post on this (and used your term sheet comparison to create a “melded” term sheet) in the Walker Corporate Law Group blog (see http://bit.ly/dlxpQu). Thanks for you efforts in helping to move this forward — looking forward to the results of your meetings/conversations with Ted Wang. :)

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