How to Structure Financing for Your Startup

David Young is a partner at DLA Piper (http://dlapiper.com/). You can watch more content here on Docstoc.

Here are three ways to set up for initial financing:

  1. Convertible promissory note. This option is faster and cheaper.
  2. Structure a preferred stock round. If there is five hundred thousand dollars being invested, this should be considered.
  3. Common stock. This is generally not advisable.

Transcription

When structuring investment for a startup, there are really three basic alternatives to setting up with investors. One, which is very common for initial financing, is convertible promissory note. What that is, it’s basically bringing in the cash, parking it as debt which converts automatically typically at some discount once an equity financing or Series A financing is completed. So the advantages of this are really two. One is cost. Instead of having hundred pages of preferred stock financing documents, you have a two-page convertible note. And the other one is just speed where it can be done very quickly and at the same time, these investors who often known as angel investors are able to—you don’t have to negotiate valuation. You basically just tell them you’re going to enjoy the bells and whistles of what the venture capital or larger investors negotiate. You’re going to get all those same terms but you’re going to get some discount 10, 20, 30% off the price that they pay.

Second alternative is to go ahead and structure preferred stock round whether it’s called Series A, whether it’s called Series C. This typically had cut off. A lot of times you’ll consider but at least $500,000 being invested is worth that list considering going ahead and pricing around and doing it as preferred stock. There’s an increase cost to this especially the investor’s employee council but then at the same time, they’re getting percentage of the company. You’re not sort of bridging the future round. The round is just done.

The third alternative would be common stock which is generally not advisable because it’s going to resolve any issues later when you want to build the grand stock options to employees and that owns you with a little low price. And so really the two main structures considered whatever is fine in your company are either convertible notes or preferred stock.