How to Raise Seed CapitalWithout Spending a Lot
9.17.14
Benjamin M. Hron
617.449.6584
@HronEsq
Overview
♦ Framing the Issue
♦ Means of Raising Seed Capital
♦ Costs of Raising Capital
♦ Controlling Costs
Framing the Issue
Q: What is Seed Capital?
A: Small amounts of capital invested in a business in the idea or concept stage to fund initial product development and cover operating expenses until the company is able to raise venture capital.
Typically < $1M
Framing the Issue
Q: How should we think about the cost of capital?
A: Two ways:
– Absolute Cost v. Cost:Capital (Capital Efficiency)
– Explicit Costs v. Hidden Costs
Means of Raising Seed Capital
Sources of Seed Capital
♦ Government (esp. grants)
♦ Public (ex. donations via Kickstarter or Indiegogo)
♦ Friends and Family
♦ Angels and Angel Groups
♦ Venture Capitalists
Means of Raising Seed Capital
Sources of Seed Capital
♦ Government (esp. grants)
♦ Public (ex. donations via Kickstarter or Indiegogo)
♦ Friends and Family
♦ Angels and Angel Groups
♦ Venture Capitalists
A “security” is an ownership interest in a common enterprise where the holder is led to expect profits solely from the efforts of others.
Securities Transactions
Means of Raising Seed Capital
Q: What’s missing from the list?
A: Securities-based Crowdfunding.
♦ Raise ≤ $1M from the public through a “portal”
♦ Authorized by the JOBS Act in April 2012
♦ Rules proposed by SEC in October 2013
♦ Still waiting on final rules
Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Common Stock
♦ Convertible Debt
♦ Preferred Stock
Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Common Stock
– Same stock as founders
– Usually valuation is the main issue negotiated
– Best for raising small amounts from friends and family
Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Convertible Debt
– Loan that is intended to convert to stock
– Handful of terms to negotiate (*not* valuation)
– Usually simpler/cheaper than preferred stock financing
– Best when company and investors can’t agree on valuation
Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Preferred Stock
– Equity with preferences over Common Stock
– Variety of terms to negotiate adds complexity/cost
� NVCA forms facilitate “Series A” financing
� No standard, yet, for “seed” stage preferred
– Best when raising > $500K from angels or micro-VCs where there is a clear lead investor and parties agree to a valuation
Costs of Raising Capital
Q: What is the largest expense in a financing?
A: Legal Fees (of course).
Q: What are typical legal fees for company counsel
in a financing?
A: It depends (of course).
– Common Stock: < $5,000
– Convertible Debt: $5,000 to $15,000
– Seed Stage Preferred Stock: $5,000 to $25,000
– Series A Preferred Stock: $20,000 to $50,000
Costs of Raising Capital
Q: Why haven’t we established universal terms and standards that would reduce legal fees?
A: It’s not as easy as it sounds …
– Broad agreement among lawyers, VCs and angel investors about appropriate terms;
– “Model” forms available from NVCA and others;
– BUT, getting everyone to agree to a single set of terms is unlikely because everyone has a different risk profile.
Costs of Raising Capital
Q: What variables impact legal fees?
A: Complexity of terms and deviation from “norms;” presence/absence of a lead investor; sophistication of investors; number of investors; risk profile of investors and entrepreneurs; need for “clean-up” of company records; quality and rates of attorneys.
Q: How can I minimize legal fees?
A: Control the variables.
Controlling Costs
1. Hire a good attorney
2. Get your house in order
3. Choose an appropriate financing structure
4. Stick close to “standard” terms
5. Start with a detailed term sheet
6. Select your investors carefully
7. Find a strong lead investor
Controlling Costs
1. Hire a good attorney
– Cost is not (necessarily) indicative of quality
– If you don’t know enough to evaluate expertise, get recommendations or references
– Think long-term
� Mutual interest in an ongoing relationship is key
� Trust must go both ways
Controlling Costs
2. Get your house in order
– Sloppy capital structures and poor records can delay or even derail a financing
– Investors may use unresolved issues to drive down valuation or negotiate more favorable terms
Controlling Costs
3. Choose an appropriate financing structure
– Evaluate the key issues
� Economics
� Control
– Be pro-active in proposing terms so you anchor the negotiation
Controlling Costs
4. Stick close to “standard” terms
– Be pro-active in proposing terms so you anchor the negotiation
– Incremental changes in most terms have little long-term impact
– Don’t sweat the small stuff
– Don’t be greedy
Controlling Costs
5. Start with a detailed term sheet
– Much more cost effective to work out material terms before documents are drafted
– Involve your lawyer in drafting the term sheet (better yet, have him/her draft it) – the cost up-front will save you much more on the back end
– Get buy-in from your lead investor(s) before definitive documents are drafted
Controlling Costs
6. Select your investors carefully
– Only include “accredited” investors
� Significantly reduces regulatory burdens
� Reduces risk of future claims
– If possible, select investors with ample experience investing in early stage companies
� Less likely to needlessly haggle over terms
Controlling Costs
7. Find a strong lead investor
– Someone who understands what terms really matter
– Someone more interested in long-term payoff than scoring short-term points
– Someone who has the clout to dictate terms to other investors
Final Thoughts
♦ Cost of raising capital depends on several variables
♦ Companies can reduce costs by controlling variables
♦ Absolute cost is not always as important as capital efficiency
♦ Hidden costs can dramatically increase the long-term cost of capital
♦ Hiring a good attorney can help reduce costs. Seriously.
Appendix
♦ Summary definition of “Accredited Investor”
– Natural Person with
� Net Worth (w/ or w/o spouse) >$1M (excl. home)
� Income >$200K in past 2 years and current year
� Joint income >$300K in past 2 yrs and current yr
– Director, executive officer or general partner
– Business in which all the equity owners are accredited investors
– Entities with > $5M in assets