The last method you can employ to raise your seed round is to sell common stock to investors. This is rarely done and is generally not recommended, but it is important that you know this option is available to you. The purpose of this post is to explain this method, the pros and cons, and highlight why it is typically not recommended.
Seed Round Common Stock
Your seed round will most likely consist of convertible notes, convertible equity, or preferred stock. Very rarely will a startup raise its seed round by selling common stock. Before we can dive into the specifics, we first need to know what common stock is.
Common stock is the same security that the startup’s founders hold. Common stockholders generally have the right to:
- Vote for the company’s board of directors and on other stockholder matters.
- Receive dividends, if and when declared by the board.
- Receive their proportional share of the company’s remaining assets if the company is liquidated.
Pros and Cons
Common stock is by far the simplest of the seed investment instruments. It typically does not include any special rights, preferences, or privileges. As a result, common stock investments can often be completed quite inexpensively. In addition, some founders and investors like that their two groups receive the exact same security. Their rationale is that this closely aligns the incentives between the founders and investors since they are all treated the same.
However, many seed investors naturally prefer to have the additional rights, preferences, and privileges that institutional investors who purchase preferred stock in future financing rounds (Series A, etc.) receive. Structuring a seed investment using common stock typically has the most adverse effect of all the seed investment instruments on the fair market value of the company’s common stock for equity incentive purposes.
Final Thoughts
Selling common stock in your seed round is something you only really see if the investor is a wealthy close family member or friend of a founder who does not normally invest in startups. More professional investors will want the protections and rights that convertible notes, convertible equity, or preferred stock provide. Also, the impact on the fair market value of the common stock by selling it to investors is something that should give founders pause. Based on all of this, selling common stock to seed investors is not generally recommended or done. However, you should always consult with your attorney to see if this is the best option for your startup.