Newly formed companies have a multitude of requirements when starting up. These almost invariably call for outside capital to be injected into the venture. Seed capital is a vital lifeline for these companies to gain traction and eventually succeed. Here is a look at the pros and cons of some instruments a startup can use to raise seed financing. It's advisable to engage a startup lawyer in NYC in guiding you through them comprehensively.

1. Common Stock

Common stock is a unit of ownership in a company. A founder can trade these stocks in return for an agreed sum of capital.

Pros

  • It is the most straight-forward form of instrument to use when raising seed financing. It does not feature any specialized privileges, preferences or voting rights. It is, however, possible to give common stock the same specialized features that preferred stock has. A business lawyer in NYC can draft amendments to the company’s documentation if necessary.
  • It helps ensure that both the founder and investor have the same interests as they hold the same class of security. A surety like this fosters equality, which can positively impact the investment.
  • It is cheaper to institute as it attracts lower legal fees when issuing it to additional investors after incorporation. 
  • If no more common stock is required when adding investors, then the paperwork previously used can be tweaked, saving on processing fees. Consult a business attorney in to help draft any additional paperwork.

Cons

  • The equality it provides can be a drawback for investors. Financiers backing an enterprise typically prefer holding common stock that has the additional preferences and rights. The reason for this is because when they exit they have greater leverage in selling to other investors coming in. 

2. Convertible Notes

A convertible note is a short-term debt instrument that gives an investor the right to convert it into equity in the future.

Pros

  • It has seen a surge in popularity and as a result, a large number of seed investors are familiar with it. It is cheaper to institute compared to other instruments that might call for a redrafting of the company’s documentation. The additional documentation incurs processing fees. A business attorney can help an entrepreneur sort through the lighter paperwork.
  • It does not impact the value of the company’s common stock as deeply. That helps in preserving the fair market value of the stock for future use.

Cons

  • The impending conversion to equity can lead to some uncertainty over the exact amount to surrender.
  • It matures at the end of the agreed period which has the potential to give the note holder extra leverage. If the firm has not been able to successfully have them converted they may incur additional interest as a penalty.

3. Simple Agreements for Future Equity

These instruments are popularly known as SAFEs. An investor puts money into an enterprise and receives stock later. 

Pros

  • It doesn’t accrue any interest, and this makes it cheaper for the firm. Created as an alternative to convertible notes, it bears the same hallmarks. Seed investors are therefore familiar with it.
  • It is cheaper to create as it involves relatively less paperwork. A startup lawyer should be able to draft it for the firm.
  • It has a bigger impact on a company’s fair market value of the common stock. Future incentives via equity therefore reduce. 

Cons

  • It bears no interest which can be a put off for investors looking for interest income.
  • There is still some uncertainty in dealing with how tax matters related to it.
  • It creates some uncertainty about the amount of equity to be surrendered the future.

Conclusion

An enterprise can raise seed capital in several ways depending on what they settle on. Each approach has its dynamics and engaging a business lawyer helps to understand the implications.