It’s not Shangri-la for everybody. But for a certain kind of tech company, especially in Silicon Valley, attracting professional investors, angels, VCs and the like, is how success is initially validated.
There are various names these days for the first professional financing round, for example “Series Seed” financing, or “Preferred Stock” financing. They refer to the first round of financing after founder bootstrapping or friends and family financing of the Startup.
I happily advise Founders on rounds of professional investment in Startups. But often professional investors prefer to select the Startup’s counsel going forward. Wilson Sonsini Goodrich & Rosati, where I worked for three years in Palo Alto during the original internet bubble, is a regular choice of these investors.
As the investors are effectively paying the much higher fees of these law firms, Founders are normally comfortable with the arrangement. Plus, Founders feel that it’s quite a boost for them when one of Silicon Valley’s prestige law firms take over their legal reins.
Professional rounds of financing typically begin with term-sheets, in which the Startup and potential investors set out what they feel that the investors should receive in exchange for their investment. The crucial issue of the Start-Up’s valuation is addressed here.
The combination of negotiations between the investors and the Founders, and the due diligence that the investors often bring to an investment at this level, makes for a process that is regularly time-consuming during the initial professional financing round.
Be patient, and don’t cut corners!
The basic contracts are typically:
1. A Preferred Stock Purchase Agreement, covering the investors’ purchase of their equity in the Startup. The investors obtain comfort here that there are no significant surprises in store for them after they invest, no hidden defects, to use a phrase from the real estate context. The Startup needs to be careful to inform the investors about its situation, and in particular to disclose anything unusual or worrying.
2. An Amendment to the State Charter of the Startup to provide for the terms of the equity issued to investors, who will have rights superior to Founders and other common stockholders. That is why the stock is called “Preferred” stock, and this Charter Amendment is where the famous preferences are defined, as Founders and investors both seek a fair and appropriate return from the collective pie.
3. An Investor Rights Agreement, a kind of Shareholders Agreement, covering the investors’ and Startup’s rights if there is an IPO, and other matters such as who designates Board members and preferential rights to purchase newly-issued shares or shares being sold by Founders or investors.
If it all looks a bit complicated, that’s because it is!
Rest assured: I have been involved in angel and venture capital financings on both sides of the Atlantic involving hundreds of millions of dollars.