I’ve just spent a day looking at different term sheets for seed investments – fun, huh? And I’ve “discovered” what many early stage investors know: that some investments that are called “Series Seed” are pretty close to being as complicated as a Series A. But there’s a good reason they are “Series Seed,” if in name only.
Simpler Seed Investment Options
As a quick recap, the well developed US equity markets spawned several new options for equity (or near-equity) investing in very young companies over the past two decades. Why? Venture capital style Series A Convertible Preferred Shares:
- Are overly complicated for most very young companies
- Are too expensive in terms of legal work for small fundraising
- Take a long time for the legal work once a term sheet has been accepted
- Force agreement on company valuation, views on which at the earliest stages can be very divergent between entrepreneurs and investors.
Convertible notes were the first option to emerge. They solve some of the problems in their simplest forms, but then they got more complicated.
Seed accelerators emerged and proliferated around the planet. This likely increased the volume of seed equity investment significantly by professional investors, i.e., the accelerator operators whose business models are often built around success as seed investors.
They didn’t all like convertible notes. So they innovated.
In 2013, Y Combinator, the best known Silicon Valley accelerator, invented SAFE – Simple Agreement for Future Equity. It’s meant to replace convertible notes, as well as much more complicated convertible preferred share agreements. It basically says that investors will get preferred shares on the terms of a future financing. Like convertible notes, it’s possible for investors to get a capped valuation, or a discount on the future financing price, or both.
Not to be outdone, in 2014 500Startups introduced KISS (Keep It Simple Securities). They offer both a debt version that is pretty close to a convertible note, and an equity version that is close to a SAFE. The stated goal is to find both simplicity and “balance” between company and investor interests.
These innovations followed on the Series Seed documents crafted by law firm Fenwick & West and first released in 2010, updated last in 2014. These in turn echo those from another Silicon Valley law firm, Cooley Go, who also released public domain Series Seed equity documents in 2010. And the online angel investment platform Gust came up with its own Series Seed documents.
All of these “free” public domain options for seed investment documents remind me of a joke from my days in telecom:
The nice thing about standards is there are so many to choose from!
Complicated ‘Series Seed’ Investments?
The common thread among all of these approaches to seed investment is that they try to “kick down the road” some complicated, and legally expensive, investment issues. And many (but not all) also kick the valuation question down the road.
However, “seed stage” ain’t what it used to be.
Literally thousands of companies receive some sort of early seed stage investment. But Series A doesn’t automatically follow within 18 months.
Many of these firms take longer than expected (surprise!) to develop a scalable business model, traction with customers, a viable go to market strategy. Sometimes several years.
As traction builds, if slowly, additional investors may be both interested and needed ahead of a much larger Series A from professional venture capital firms.
The question is: what do you call such an equity investment?
From a fundraising marketing perspective, you call it a Series Seed. Or a Series Seed Extension.
You do this because professional venture capital firms often want to say they invested in the Series A. Even if they are by no means the first outside equity investors.
And you do this even if the “seed” term sheet starts to resemble the NVCA Series A model documents in complexity, which has 41 provisions in the term sheet.
A SAFE agreement has only five provisions, plus a bunch of legal definitions and some other standard legalese, in just five pages.
I’ve seen a Series Seed “in name only” term sheet with 30 provisions. The term sheet itself is 12 pages, but the equivalent to the SAFE with all the other legalese will likely be more than 100 pages.
And yet, this is the right thing to do for the company and for the investors. The more history a company has and the closer it is to a Series A, the better it is to fund the company with “Series A like” preferred shares, rather than true “seed stage” investments.