Determine What Type of Seed Funding Is Right For You

Ed Zimmerman is a funding expert. In 1991, Ed joined the firm Lowenstein Sandler as a summer associate and later co-founded the Lowensteins Tech Group in 1998. In 2013, Dow Jones ranked Lowenstein among the five most active law firms in America for venture capital and private equity deals.

In addition to his work as a lawyer, Ed has been an Adjunct Professor of Venture Capital at Columbia University Graduate School of Business since 2005. He has personally invested as an angel investor in more than 50 startups and more than 20 venture funds, and co-founded and runs VentureCrush, which also includes FirstGrowthVC  (which Pando Daily called New York’s best Accelerator) and AngelVineVC.

Ed cares deeply about and advocates on issues concerning the LGBTQ community and women. In the Spring of 2014 at VentureCrushNY, Ed announced a personal pledge against Gender Bias in Tech, which he later published on the Wall Street Journals Accelerators page and which was subsequently covered in Fortune Magazine. As an advocate wanting to see more companies get funding, he shared his expertise on seed funding with the SheWorx community.

Convertible notes versus priced equity rounds: the definitions.

As defined by Christopher Mirabile in Inc. Magazine:

A priced round is an offering and sale of newly-created stock in your company at an agreed-upon per share price. Once stock is sold, investors are part owners of your company.

Convertible debt is a loan from those investors that is never meant to be paid back. It is intended to convert into stock at a future date, based on some yet-to-be-determined price.

Or, as Ed translates: “When you price a round, you agree on valuation with your investor and you’re then off to the races. You’ve negotiated pretty much what you’ve agreed to negotiate. If you do a convertible note, you’ve decided to largely the kick the can down the road on what the evaluation is.”

A convertible note also means that difficult discussions on specific rights are deferred, so entrepreneurs can end up finding themselves in a position where they must negotiate not only with new investors, but also negotiate with their noteholders.

Think critically about your company’s context to decide which type of seed funding is right for you.

“There is this perception that convertible notes are more founder friendly and that preferred stock is more labor intensive,” said Ed.

Yet, consider if you were offered two cars at the same price: one a used Porsche, and the other a Toyota Camry Hybrid. Though the price to buy them today might be the same, a smart buyer would likely want to know other information besides pricing—maintenance, insurance, amount of time spent in the shop, for example. The two cars would likely not run neck to neck on all these variables.

“You do a lifecycle cost analysis, and convertible notes are more expensive than preferred stock (priced rounds). If you're thinking in terms of ‘How do I spend the least amount of time negotiating with my investors today?’ convertible notes are better,” said Ed.

“But if you actually have an event 6.5 months later, you probably would have preferred preferred stock. That’s the way I think of it, because you wouldn’t build a bridge or hospital without thinking about life cost analysis.”

An example of a situation in which it might be more rational to take money via convertible notes is if the company is in its very early stages, and all investors are close friends who understand that the money is being used as more of a short term test to determine the company’s viability.

Ed's one piece of advice for convertible notes: “You want to say in your term sheet that your liquidation preference will never be greater than whatever money is put in—if you don’t understand it, if you walk away from today’s session with no other piece of advice, write that down and tell it to your lawyer when negotiating convertible notes. That’s important to avoid the getting a dollar’s worth of stock for 25 cents problem.”

Your lead investor is not determined by the math—it is determined by conviction and persuasion, and you should be sure you’re aligned.

“If there isn’t a lead investor, you kind of need to create one,” said Ed.

The lead investor does not necessarily mean the investor who is writing the largest check, nor the first investor to commit. Rather:

“Lead means the person who is willing to put her or his name on a term sheet and help you galvanize other investors to coalesce around a deal structure and a set of terms.”

Ed recommends seeking someone you know well, who has done other investments, and who is willing to serve as a reference for you and the deal, even if they don’t know the market super well.

Moreover, your investors should seek to create wealth on your project as well so that you are both aligned.

“One way to ensure that you have funding problems is to create lots of misalignment, so you really don’t want to be in the situation where you thought the market was x and you convinced an investor who believed in you and trusted you, but wasn’t sophisticated about investing in startups, and then you and your investor find out later that you were way off.”

After due diligence and homework and conviction on your lead investor’s part, the ability to help galvanize other investors is critical.

“It is really tough to convert conversations into airplanes that actually land.”


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