Lesson #116: Seed Investment Terms & Trends

Fenwick & West, the big Silicon Valley law firm,  publishes an annual Seed Financing Survey in recognition of the growing importance of seed financing to entrepreneurs and the venture capital environment, especially in the internet/digital media and software industries.  Below is a summary of the results, based on studying 56 transactions in 2011 and 52 in 2010.

Overview of 2011 Seed Financing Survey Results

• The use of convertible notes increased by 10 percentage points (to 41% of deals), and likewise the use of preferred stock decreased by 10 percentage points (to 59% of deals).
• The median size of convertible note deals increased from $662,500 to $1 million, while the median size of preferred stock deals remained basically flat around $1 millon.
• The pre-money valuation in preferred stock financings increased from $3.4 million to $4.0 million for internet/digital media deals, and from $2.7 million to $3.5 million for software deals.
• The median valuation cap on convertible notes increased from $4.0 million to $7.5 million.  Notes are capped 82% of the time.
• If notes are repaid prior to next financing, they are typically repaid at 2.0x the principal amount, on average ($1 million note gets $2 million if company sold and note repaid).
• Notes paid an interest rate of 5.5%, on average, and had a term of 18 months, on average.  Notes were typically unsecured (96% of time).
• The percentage of convertible note deals that convert at a discount to the next equity valuation increased from 67% to 83%, with that discount being 20% from the next round, on average.
• The lead investor was a seed fund (46% of the time), professional angel (28% of the time) or VC fund (27% of the time)
• Investors were given a board seat 70% of the time in preferred stock deals, and 4% of the time in convertible note deals.

For purposes of this survey, a "seed" financing is defined as the first round of financing by a company in which it raises between $250,000 and $2,500,000, and in which professional investors play a lead role (excludes financings led by "friends and family", which terms may not be negotiated on an arms-length basis). For this reason, the survey may not be representative of all companies receiving early stage financing, and is likely over-weighted to more promising companies funded by more established seed investors.

Overview of Current Seed Financing Environment

The seed financing environment for internet/digital media and software companies is expanding and becoming increasingly varied. Not only is the amount of seed investing increasing, but the diversity of seed funding sources is also increasing (e.g., friends/family, individual angels, angel networks, incubators/accelerators, seed funds, VC's investing earlier, crowdfunding). With this proliferation of seed capital and diversity of sources, the "leverage" in seed transactions seems to be leaning in favor of entrepreneurs, as preferred stock valuations, convertible note usage and convertible note cap amounts are increasing.

For the full detailed report, please visit the Fenwick & West website or contact Barry Kramer at 650-335-7278 | bkramer@fenwick.com or Steven Levine at 650-335-7847 | slevine@fenwick.com at Fenwick & West.

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