Tuesday, July 26, 2011

Seed Money - Keep It Simple

Money is money.  People use the terms pre-seed, seed, and first round to describe different type of financings. There is supposed to be some correlation between the stage of the company and the type of financing.  It doesn't always work like that.

Many times, I have seen people use these terms to describe the size of the round.  So pre-seed round would generally be up to $300,000-$500,000, seed round would be between $300,000-$1,000,000, and round A would be above $1,000,000.

The size usually also determines the type of equity/securities being issued.  So if it is a pre-seed round or seed round, you should expect to issue a convertible promissory note, which is a debt convertable to shares in the next round of financing.  If it is not a convertible note, it would likely be common stock.  As the amount of the investment increases you may see a right to appoint a director and limited veto rights, but not necessarily.

If it is a round A, you should expect to see all the usual suspects such as preferred stock, anti-dilution protection, veto rights, etc.

The problem is that there are a lot of variations out there.  You could see small investors who would ask to get preferred stock on a $150,000 investment.  You may see professional VCs, who would invest $500,000 without asking for any veto right, except for an oversize preemptive right, just to be there if the startup becomes successful.  You may see a serial entrepreneur who is able to raise $5,000,000 with just a powerpoint presentation.   Try to stick to the usual structures.  If you raise $200,000, you need to keep it simple.  Keep your creativity for the technology, not the legal structures that are more expensive than the round, and will take an hour to explain in the next round.

There are also no rules for valuations.  The only rule I see is that if this is not your first company and you had a great exit before, you will get better valuation on your idea.  A great idea is wonderful, but sophisticated investors know that startups evolve all the time and the initial idea is rarely the end product.  The ability to adjust and adapt is more important than the idea itself and is based, among other things, on experience  You always get more value if this is not your first time.  It is a waste of time to fight it.

Finally, who should you raise it from?  Most people (if not all) who tell me that they don't want to raise from a VC cannot raise from a VC.  If you can raise from a first tier VC go for it.  I know all the stories.  If you cannot raise from a VC go to raise money from angels.  Your family should always be the last resort.  Obviously, if you can get a super angel involved from day one, that's great, but a real-estate mogul who is now interested in social networking because his daughter told him that google+ is great, should not be your first choice, even if the valuation he is offering is higher than that of a VC.

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