How Do I Get Seed Financing For My New Enterprise?


Many start-up enterprises need initial or "seed" financing before they have tested their concept with a strategic partner, launched a web site or the beta version of a new software application, or assembled a complete management team. The founders may have overextended their personal resources and need to turn to others for additional start-up funding.

The best and most likely sources of investment funds at the very beginning of a company's life are usually family members and close friends – the true "friends and family" of the start-up team. These are the people who know the founders and believe in them – and are likely to invest a small sum in their endeavors, whatever the business plan may say and despite the large risks.

Sometimes, these sources will mention a friend or associate who would also like to invest. Your uncle just went to the dentist and told him about your new business. The dentist saw a TV show about your industry and now wants to invest in your start-up.

Anyone investing in your business should have some investment experience. An investor needs to understand he or she is investing in an untested business, in a private company with no track record and no revenues – and that there are significant risks involved in investing in any enterprise at this stage. If you have reason to believe a proposed investor does not understand the risks or the nature of the investment, you should not allow that person to invest. When your seed investors are individuals you have never met or about whom you or the other founders know little, you cannot be confident that your investors have appropriate experience to invest.

On the other hand, you may find an "Angel" investor – a high net worth investor seeking out investments in these early stage companies. True Angels will meet the federal requirements to be considered "accredited investors": a minimum net worth of $1 million or annual earnings of at least $200,000 for each of the last two years ($300,000 combined earnings if married). Your angel may have already been involved in a high tech start-up or another early stage company and may be looking for his next start-up investment.

An angel investor who meets the accredited investor standard and is a sophisticated investor would be preferable to Joe the Dentist (assuming Joe is not accredited and doesn't frequently invest in very early stage companies) for several reasons. The Angel may have contacts with other sources of financing or strategic relationships – Joe probably doesn't. Joe doesn't meet the accredited investor standard and when you accept his investment, you may be risking future claims that you did not provide him with all the written materials that were required in order to comply with the securities laws, that he did not fully understand the risks, and that he has a right to his money back (a "rescission"). As the percentage of the company held by such unsophisticated investors increases, sophisticated investors may be turned off by the perceived risk that the company's assets will be tied up in shareholder litigation.

How Do I Know If I Am Ready To Talk With Venture Capitalists ?


You have a terrific business concept, you drafted an initial business plan, you assembled a team, and you designed a brilliant prototype for your new enterprise. But you might not be ready or able to shop your concept to a venture capital firm (even if you have an introduction to one or two VCs). With less than a few hundred thousand dollars, you could build the prototype and/or ink a key deal with a strategic partner. When you have completed these steps you may be ready to attract the venture capital firms or other seasoned investors who can provide the more substantial financing you will need to recruit a staff and launch your business.

Are There Any Laws I Need To Be Aware Of During The Fund Raising Process ?


Absolutely! Even when you have a group of friends and family or Angel investors lined up for a seed round of investment, you need to be aware of how to legally issue securities to them. There are a number of legal issues and requirements to be concerned about.

Whenever you raise funds by selling convertible debentures, common stock, or some other form of equity, and every time your company issues stock, your company is selling securities and must comply with applicable securities laws. This basic rule applies regardless of the consideration received – services, cash, notes, other property such as stock in another company. Generally, whenever an "issuer" (i.e., your company) wishes to sell any securities, it must register those securities with the SEC and appropriate state regulators. That is, of course, unless one of the many exemptions from the registration requirements applies to the proposed sale. Qualifying for an exemption, however, does not free you from all reporting and other requirements. You must still comply with rules governing the way in which you conduct your offering, the filing of notices, consents to service of process, and in some cases submission of offering documents and the payment of filing fees.

Companies often rely on the so-called "private placement" exemptions from the securities registration requirements. Typically, an issuer can sell stock to any number of accredited investors and to a limited number of investors who don't meet the accredited investor standard in a private (i.e. non-public) offering. Reasonable disclosure about the business must always be made to prospective investors, and if selling stock to investors who are not accredited, specific written information about the business must be provided. When your company relies on these exemptions, it will be required to make certain notice filings with the SEC and with state securities regulators. Failure to comply with the securities laws can subject your company, or you, personally, to investors' rescission claims, along with other penalties.

How Do I Value My Business For Seed Round Fund Raising Purposes?


You may have a reasonably good idea of the amount of money you actually need in a seed round, and you may be able to raise it from a group of a few close friends and family. But how do you determine how much stock the company should issue to them? And at what price?

The founders must grapple with a number of contradictory concerns at this point. They need to price the seed financing sufficiently low so that it doesn't imply an unreasonably high valuation of the company at its earliest stage. Yet they must not price the stock so low that the company will be issuing an inordinately large percentage of the stock of the company relative to the number and strategic importance of the seed investors. Also, if the company plans to issue shares of common stock to its seed investors, which often is the case, too high a price per share of common stock can impede the company's ability later to attract talented staff with low-priced incentive stock options.

Some seed investors may seek preferred stock. Most VCs will expect preferred stock with the rights and preferences that commonly accompany it, such as preferential dividend rights, information rights, possibly special voting rights (e.g. a Board of Directors seat), and preferential "liquidation rights" – the provisions that provide for a premium return to the preferred stock investors upon an early-stage merger or sale of the company or similar "liquidation" transaction. Many Angels also want preferred stock when they invest in start-up companies. But the company will probably wait to issue preferred stock with a complex assortment of rights until a later, more substantial financing round when it may have been able to attract the interest and significant investment commitment from a larger institutional or strategic investor.

Sometimes you may be able to delay resolving some of the more difficult early-stage issues about valuation and appropriate pricing by issuing a convertible promissory note or a convertible debenture to your seed investors rather than shares of stock. The note could be convertible to stock at a later date, such as the closing of a subsequent round of financing, at a price to be determined at a later time but guaranteed to be no greater than the price per share, or a stated discount to that price, in the later offering.

Securities laws are numerous and complex. At the very least, problems now may subject your company to rescission claims later, and failure to be careful at the seed stage could dissuade institutional investors and fundraisers from working with your company later. Whenever your company is dealing with securities law issues, you should consult an attorney.

 

About Us

Niesar & Vestal LLC is a San Francisco Business Law Firm with a diverse transactional and litigation practice. Our clients include individuals, emerging businesses, government entities and publicly held companies. 

 

 

Contact Us

Find us at:

90 New Montgomery St, 9th Floor
San Francisco, California 94105
United States 

Or you can call us:

Phone: (415) 882-5300
Fax: (415) 882-5400

Google Maps