When it comes to raising your seed round, the most common method by far is using a convertible note or convertible equity instrument. However, some seed rounds are comprised of issuing convertible preferred stock to investors; similar to a Series A round. The purpose of this post is to familiarize you with this method of raising funds in your seed round.
Convertible Preferred Stock
Issuing convertible preferred stock to investors is not as common in a seed round as in later rounds (Series A, etc.). However, it does happen and it is something that you should be familiar with. Before we dive into the specifics, we need to know what convertible preferred stock is.
Convertible preferred stock is a class of stock given to investors with certain rights and priorities over the common stock held by the founders. The investors also have the ability to convert their stock into common upon certain, specified events, or at their leisure. Convertible preferred stock issued in a seed round is often designated as Series Seed preferred stock.
As mentioned above, convertible preferred stock comes with many rights as compared to the common stock; this is especially true in your Series A round. When it comes to your seed round, the Series Seed preferred stock issued usually has far fewer rights attached to it than the stock issued in your Series A. For example, most Series Seed preferred stock does not contain any registration rights, rights of first refusal and co-sale, price based anti-dilution provisions, drag along rights, and investor designees on the board of directors. We will dive into these rights later in Series A posts.
When to sell series seed preferred stock
It all comes down to investor preference and the dynamics of the round. Series Seed preferred stock is typically used when you have a sophisticated investor funding the largest amount in the round (often called a lead investor), and they are primarily negotiating the terms of the financing with the company.
pros and cons
Using Series Seed preferred stock in your seed round has the benefit of allowing you and your investors to know exactly how much of the company they own immediately after the financing closes, which is not possible when using convertible notes or convertible equity. It can also decrease the complexity and cost of subsequent financing rounds (Series A, etc.) as the same documents used in the seed round can be used as a basis for subsequent convertible preferred stock rounds.
The disadvantage of using Series Seed preferred stock in your seed round is that it takes a lot longer to close the round and therefore increases the legal costs associated with it.
As always, consulting with a startup attorney is a must when it comes to raising your seed round by selling Series Seed preferred stock.