Seed funding provides founders with capital to help them get their ideas off the ground. Part of preparing for your first seed funding raise is knowing what documents you need to have in place beforehand and how much equity to give away. Here, we explain the seed funding process from a legal standpoint and how much equity you should give away to get sufficient outside finance.
What’s the process of raising seed funding from a legal perspective? Do I need a term sheet?
Before seeking seed funding, it is important to consider the material terms on which you are prepared to accept the investment. For instance, it’s useful to consider:
- The dilution the investor will offer;
- The rights that will be afforded to the investors;
- And how the company will continue to function following the completion of the investment round and how decisions are made at board and shareholder level.
Founders are often presented with a term sheet from the investor setting out the material terms of a proposed investment and this should be negotiated to make sure that founders are comfortable with these terms as they will form the basis of the legal documents. If a term sheet is not presented, founders can take the lead and prepare the term sheets themselves to make it clear from the outset what the terms of the investment are – this helps with the investment process as it identifies any red flags from either parties’ perspective from the outset before time and money is spent preparing the legal documents.
Once the term sheet is agreed, the legal document can be drafted to incorporate these terms. There is still often some level of negotiation going forward but the material commercial terms should not require too much negotiation. Keep in mind that the term sheet itself is not legally binding so it could still be subject to negotiation as the deal progresses.
How much equity of my business should I give away?
Although this can vary, as corporate solicitors, we usually advise between 10-20%. Founders should be careful about the percentage equity they decide to give away in seed funding as they are likely to require additional investment in the future, which will result in further dilution of their shares. As a founder, if you choose to exit the company at some point, holding a sufficient percentage of your business will mean that you are rewarded adequately on an exit.
Do I need a cap table?
We encourage founders to create and maintain a cap table so they can keep track of the allocation of ownership through the stages of fundraising and growth. A cap table is a particularly useful tool for seed stage start-ups to help them document their financial obligations and potential risks in terms of dilution as the business grows.
Want to find out more about seed funding? See our seed funding FAQ to learn more about how seed funding works, the difference between seed funding and angel investing, what documents are required and more.
If you’re seeking legal advice on preparing for a raise, contact one of our funding lawyers today via the contact form below.