In our practice we have seen significant interest in recent months in “preferred seed” financing rounds.

The idea of a preferred seed round is that early stage investors take a preferred interest in the company. In contrast to a convertible note financing (which is generally more common and remains popular for seed investment), the preferred investor sets a price for preferred shares and ends up with actual equity in the Company.

The terms and conditions of a preferred seed round are usually less stringent (and the financing less large) than a traditional Series A round. However, the preferred investor usually ends up with some type of liquidation preference, pro rata participation rights, and drag along rights, along with various other protective provisions.

Here are some things to consider when doing a preferred seed round:

– Preferred investors may or may not want a board seat, or may elect to take board observer status. Whether a board seat will be part of the agreement should be communicated during the term sheet process. Board seats are very common in Series A rounds; but preferred rounds involve less financing and a board seat may be negotiable.

– The same securities laws and regulatory issues will apply to a preferred seed round as with any other type of financing. Investors should be accredited where possible to ease disclosure requirements, and depending on the specific facts, the company may decide that a filing of a Form D may be appropriate.

– Founders should make sure that their Common Stock has already been issued and relevant filings (such as Section 83(b) filings) turned in. Unlike a convertible note round, a preferred seed financing will place a value on some portion of the Company equity. While there are important distinctions between Common Stock and the preferred stock, and while they are not the same form of equity, a very low valuation on the Common Stock (such as $.001 cents a share) is much more defensible when such stock has already issued prior to the preferred equity round

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