1. How to Raise Seed Capital
Without Spending a Lot
9.17.14
Benjamin M. Hron
bhron@mccarter.com
617.449.6584
@HronEsq

2. Overview
♦ Framing the Issue
♦ Means of Raising Seed Capital
♦ Costs of Raising Capital
♦ Controlling Costs

3. Framing the Issue
Q: What is Seed Capital?
A: Small amounts of capital invested in a business
in the idea or concept stage to fund initial product
development and cover operating expenses until
the company is able to raise venture capital.
Typically < $1M

4. Framing the Issue
Q: How should we think about the cost of capital?
A: Two ways:
– Absolute Cost v. Cost:Capital (Capital Efficiency)
– Explicit Costs v. Hidden Costs

5. Means of Raising Seed Capital
Sources of Seed Capital
♦ Government (esp. grants)
♦ Public (ex. donations via Kickstarter or Indiegogo)
♦ Friends and Family
♦ Angels and Angel Groups
♦ Venture Capitalists

6. Means of Raising Seed Capital
Sources of Seed Capital
♦ Government (esp. grants)
♦ Public (ex. donations via Kickstarter or Indiegogo)
♦ Friends and Family
Securities
♦ Angels and Angel Groups
Transactions
♦ Venture Capitalists
A “security” is an ownership interest in a common
enterprise where the holder is led to expect profits
solely from the efforts of others.

7. Means of Raising Seed Capital
Q: What’s missing from the list?
A: Securities-based Crowdfunding.
♦ Raise ≤ $1M from the public through a “portal”
♦ Authorized by the JOBS Act in April 2012
♦ Rules proposed by SEC in October 2013
♦ Still waiting on final rules

8. Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Common Stock
♦ Convertible Debt
♦ Preferred Stock

9. Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Common Stock
– Same stock as founders
– Usually valuation is the main issue negotiated
– Best for raising small amounts from friends and
family

10. Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Convertible Debt
– Loan that is intended to convert to stock
– Handful of terms to negotiate (*not* valuation)
– Usually simpler/cheaper than preferred stock
financing
– Best when company and investors can’t agree on
valuation

11. Means of Raising Seed Capital
Securities Used in Raising Capital
♦ Preferred Stock
– Equity with preferences over Common Stock
– Variety of terms to negotiate adds complexity/cost
NVCA forms facilitate “Series A” financing
No standard, yet, for “seed” stage preferred
– Best when raising $500K from angels or micro-
VCs where there is a clear lead investor and
parties agree to a valuation

12. Costs of Raising Capital
Q: What is the largest expense in a financing?
A: Legal Fees (of course).
Q: What are typical legal fees for company counsel
in a financing?
A: It depends (of course).
– Common Stock: $5,000
– Convertible Debt: $5,000 to $15,000
– Seed Stage Preferred Stock: $5,000 to $25,000
– Series A Preferred Stock: $20,000 to $50,000

13. Costs of Raising Capital
Q: Why haven’t we established universal terms and
standards that would reduce legal fees?
A: It’s not as easy as it sounds …
– Broad agreement among lawyers, VCs and angel
investors about appropriate terms;
– “Model” forms available from NVCA and others;
– BUT, getting everyone to agree to a single set of terms
is unlikely because everyone has a different risk
profile.

14. Costs of Raising Capital
Q: What variables impact legal fees?
A: Complexity of terms and deviation from “norms;”
presence/absence of a lead investor; sophistication
of investors; number of investors; risk profile of
investors and entrepreneurs; need for “clean-up” of
company records; quality and rates of attorneys.
Q: How can I minimize legal fees?
A: Control the variables.

15. Controlling Costs
1. Hire a good attorney
2. Get your house in order
3. Choose an appropriate financing structure
4. Stick close to “standard” terms
5. Start with a detailed term sheet
6. Select your investors carefully
7. Find a strong lead investor

16. Controlling Costs
1. Hire a good attorney
– Cost is not (necessarily) indicative of quality
– If you don’t know enough to evaluate expertise,
get recommendations or references
– Think long-term
Mutual interest in an ongoing relationship is key
Trust must go both ways

17. Controlling Costs
2. Get your house in order
– Sloppy capital structures and poor records can
delay or even derail a financing
– Investors may use unresolved issues to drive
down valuation or negotiate more favorable
terms

18. Controlling Costs
3. Choose an appropriate financing structure
– Evaluate the key issues
Economics
Control
– Be pro-active in proposing terms so you
anchor the negotiation

19. Controlling Costs
4. Stick close to “standard” terms
– Be pro-active in proposing terms so you
anchor the negotiation
– Incremental changes in most terms have little
long-term impact
– Don’t sweat the small stuff
– Don’t be greedy

20. Controlling Costs
5. Start with a detailed term sheet
– Much more cost effective to work out material
terms before documents are drafted
– Involve your lawyer in drafting the term sheet
(better yet, have him/her draft it) – the cost up-front
will save you much more on the back end
– Get buy-in from your lead investor(s) before
definitive documents are drafted

21. Controlling Costs
6. Select your investors carefully
– Only include “accredited” investors
Significantly reduces regulatory burdens
Reduces risk of future claims
– If possible, select investors with ample
experience investing in early stage companies
Less likely to needlessly haggle over terms

22. Controlling Costs
7. Find a strong lead investor
– Someone who understands what terms really
matter
– Someone more interested in long-term payoff
than scoring short-term points
– Someone who has the clout to dictate terms to
other investors

23. Final Thoughts
♦ Cost of raising capital depends on several
variables
♦ Companies can reduce costs by controlling
variables
♦ Absolute cost is not always as important as
capital efficiency
♦ Hidden costs can dramatically increase the
long-term cost of capital
♦ Hiring a good attorney can help reduce
costs. Seriously.

24. McCarter English LLP
Questions?
Benjamin M. Hron
bhron@mccarter.com
617.449.6584
@HronEsq

25. Appendix
♦ Summary definition of “Accredited Investor”
– Natural Person with
Net Worth (w/ or w/o spouse) $1M (excl. home)
Income $200K in past 2 years and current year
Joint income $300K in past 2 yrs and current yr
– Director, executive officer or general partner
– Business in which all the equity owners are accredited
investors
– Entities with $5M in assets