This is a guest post by Anthony Millin, the founder and chair of NEXT powered by Shulman Rogers, a Technical.ly client and one of the financial supporters that helps ensure our site remains a free news resource. A version of this article was previously published on the NEXT powered by Shulman Rogers website.
What is Series Seed Preferred financing, and when and why would you use it? This is a funding round typically undertaken by early stage companies.
It comes after initial seed funding and before more substantial rounds like Series A. Investors in a Series Seed Preferred financing are often angel investors, early stage venture capital firms, or specialized seed-stage funds. They provide capital to the company in exchange for preferred stock, which offers several advantages over common stock:
- Series Seed Preferred stock typically includes a liquidation preference, giving holders priority in asset claims if the company is sold or liquidated.
- Holders also benefit from conversion rights, allowing them to convert preferred shares into common stock under specific conditions, potentially benefiting from future company growth.
- Series Seed Preferred shareholders usually have voting rights on important company decisions, influencing company management.
- Some Series Seed Preferred stock may include preemptive rights, providing investors an opportunity to invest in future rounds so as to maintain their percentage of ownership if the company issues additional shares, and anti-dilution provisions, protecting investors if those additional shares are issued at a lower valuation than the Series Seed Preferred.
Several key documents are involved in outlining the terms, rights, and obligations of the early stage company and the investors in a Series Seed Preferred financing.
- The Certificate of Incorporation outlines the structure and governance of the company, including provisions for preferred stock issued.
- The Stock Purchase Agreement formalizes specific investment terms, such as the share price, and contains various representations and warranties about the company.
- The Investors Rights Agreement specifies investor rights, including information rights, registration rights, and sometimes governance rights.
- A Voting Agreement details the voting rights and processes for Series Seed Preferred shareholders often including the right of the Series Seed Preferred Investors to appoint a Board Member.
- Additionally, a Right of First Refusal (ROFR) and Co-Sale Agreement are typically included to grant shareholders rights to purchase shares sold by the founders, or to tag-along in those sales under the same terms.
Overall, Series Seed Preferred financing provides investors advantageous terms and downside protection while offering companies valuable access to capital for business expansion. If considering this type of financing round, it is critical to consult competent counsel to ensure all legal considerations are properly addressed.
Regulatory compliance
Whenever you raise a round of financing, whether a SAFE, Convertible Note or Priced Preferred (or Common) Stock round of financing, one of two things must happen from a regulatory perspective:
- You file a full “Registration Statement” with the Securities and Exchange Commission. Similar to an IPO filing, it’s very expensive and time consuming.
- You qualify for an exemption to avoid filing a Registration Statement. For example, you are exempt and file under 506(b) or 506(c) of Regulation D (“Reg D”) of the Securities Act.
If you do not file a Registration Statement or qualify for an exemption such as 506(b) or (c) under Reg D, and are not otherwise exempt under Section 4(a)(2), YOU HAVE VIOLATED THE SECURITIES LAWS.
Federal securities regulations (dealing with the SEC)
The Securities and Exchange Commission (SEC) is a federal agency tasked with administering the Securities Act of 1933, as amended, along with others. The Securities Act of 1933, as amended, is also known as the Securities Act or ’33 Act.
Even when your offering of securities is exempt, you often will need to file a form of some kind with the SEC to perfect the exemption. Careful attention must be given to selecting the correct form and properly completing it.
All forms are filed with “EDGAR”, the SEC’s Electronic Data Gathering, Analysis, and Retrieval System.
Blue Sky laws (dealing with states)
State-level securities statutes and regulations are commonly referred to as “Blue Sky laws.” The Blue Sky laws of each state are different, and generally require some action be taken at the state level to perfect your exemption.
Blue Sky issues relating to securities offerings arise primarily in three areas:
1. Securities exemptions and filing requirements.
2. Antifraud liability that may arise from a securities offering.
3. Licensing and registration requirements for securities industry personnel participating in a securities offering.
It is recommended to seek legal counsel on regulatory compliance whenever you raise funding.
