Worst seed round terms for startups

The terms that can potentially cause harm to startups at the seed financing stage and should be flagged.

 

1. Control

 

Investors typically will require some level of control to protect their investment. Overbroad control, which may allow investors to control the board and interfere with the daily operations of the company, should be avoided.

 

2. Dividends

 

Startup entities may not be in the position to pay dividends. All investments and any earned cash are usually utilized for further business development. Dividends may be cumulative, which means that they are not paid regularly, but rendered as a lump sum only upon certain events, such as the sale of the company. If investors want to receive dividends on a regular basis, they may be better off investing in a national publicly traded corporation rather than a startup.

 

3. Tranched Investment

 

An investor commits to invest a certain amount of money, but it is split in portions and every portion is released once a milestone that has been agreed upon is met. It is difficult to come up with the definition of milestones and each separate milestone may not be a good indicator of the business performance. Additionally, it may push entrepreneurs to make decisions based on short-term results rather than on the overall welfare of the company.

 

4. Non-Dilution

 

Investors typically want some anti-dilution protections to ensure their investment won’t disappear in the near future. However, no dilution at all may not be fair to other parties and hurt future development of the business. If additional equity is to be issued either for employees’ compensation or future partners, investors should be on the same side with the founders and be diluted pro rata.

 

5. Personal Guaranty

 

Investment in the business should be subject to all risks associated with regular business activities. Investors know that. Investing in an operational business enterprise is different from depositing money into a savings account. If business does not live up to the expectations, all parties, founders and investors who factually become partners in the business, should be in the same boat. If business takes off, all parties enjoy the benefits in proportion to their share of ownership.

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