Risks of taking seed investment from a Venture Fund
We have had a number of people ask for clarification on the proposed terms of the seed program.
The seed investment we’d make is up to $250,000. We would consider investing more, participating along side angel investors or share the seed with another venture firm on a case by case basis. Our standard investment is a non-recourse convertible loan. The key benefit of structuring the investment as a loan is that it minimizes the length and complexity of the legal process. If for some reason, things don’t go as planned the company or the founders are not personally liable in the end.
If there is a subsequent financing, that’s when we as investors get certain rights. We get to convert our loan to the new round of financing at a 20% discount - in other words our $250,000 magically becomes $300,000. For example, if you were to issue stock at $1 share instead of getting 250,000 shares of stock, we would get 300,000 shares of stock for the loan.
The other key term in our loan document is the right to particpate in 50% of the round. Let’s say you were going to issue $4M of new stock in your company (i.e. raise $4M in Series A), we get the right to invest at least $2M.
Some may consider this term potentially controversial. The logic goes, if you are seeded by a venture fund and if for some reason they decide not participate in your Series A financing (or participate for less than half the round), that is a major red flag to other investors. The argument follows that you may be better off taking money from a seed only program that has no venture ties and not have that risk when you fund raise again.
That’s clearly a valid concern, one you’d have to live with when you take seed money from a Venture Fund regardles of a participation clause or not.
The other side of the argument is that we take seed investments, like all our investments, very seriously. In my opinion, as an entrepreneur your most valuable asset is your time. The seed investment is a great way to spend your time to find out if you want to dedicate the next 3 to 5 years, maybe more, to your great idea. The best use for seed funding is to prove first to yourself, then to your investors that your idea is worth pursuing for the long term.
Over the last 10 years, personally as a venture investor, I have made a total of 17 investments including 7 seeds. In other words 40% of my investments started with 2 guys, a great idea and sometimes a power point. Of the 7 seed investments, only 2 have failed to get to the next step. In both failed cases, after going at it for a while, the founders decided to call it quits. In one case, it was the wrong product for a good market and in another, a great product but a lousy distribution channel. I still worry if there was anything more I could have done to prevent the 2 failures.
We see it as much our job as it is yours to make you successful. First, we would only make the investment because we are believers in what you are pursuing. We would agree upfront what reasonable milestones we as a team would need to achieve to get the company financed further and we’d be there with you every step of the way. And when you are ready, you’ll have us - your first investor - locked in, which should potentially make finding a second investor to fund your company easier with us behind you all the way.
