Do You Really Need A Lead Investor In Seed Financings?

downloadAccording to The Macro, the ecosystem for seed or early financing is far more complex now than it was just five years ago. From super angels or micro VCs to VC firms themselves with an emphasis on seed funding, the landscape has multiple layers inside the seed funding market.

Even the size of seeds has changed. The average size of a seed round on the rise anywhere from  €200,000 to €6 million (what we call a super-sized seed).

There’s a lot of advice out there too. Philipp Moehring, Head of Europe for AngelList, has some tips for raising a seed round without a lead investor including getting 1,000 users before you even talk to anyone and keeping it lean and mean by using standardized legal documents.

A Sea of Seed Funding

But, that being said, there’s a lot of seed money out there. A 2015  eBan report listed the total European early stage investment market to be worth around €8.6 billion euros. Business angels represent the biggest share of the investment market with €6.1 billion euros of investment, followed by the venture capital industry investing €2.1 billion euros in early stages. Equity crowdfunding investments continue to grow.

The UK is leading the European angel market in 2015 with with €96 million of investment which is a 10% increase from 2014.

With all that early stage funding out there, for an entrepreneur, there are many things to think about when you’re about get that first round of seed funding for your startup.

One of the questions entrepreneurs ask us about the most is the issue of whether or not they need a lead investor in a round comprised of angels.

That lead investor is the company’s primary capital provider and traditionally plays a more critical role than any of the other investors. No matter the size of the round, the lead investor is someone who’s fundamental to the company. And, at an early stage, they can be the difference between moving to the next round or starting over.

The Lead Investor

But when it comes to lead investors, it seems to be a bit of a catch-22.  You’re raising a small amount of money which should be simple with a fast and easy close. But small deals are often unorganized and take the longest to close and often times end up moving in multiple directions at the same time because there’s no lead investor at play to steady the ship (or herd the cats, as we often hear the phrase).

Some may argue that without a lead investor you could you get a better deal. We see entrepreneurs going out on their own to try and negotiate all these investors. It’s not uncommon, however, for some investors to ask for conflicting terms and then the process gets hijacked. The next thing an entrepreneur might see is they’re in the middle of a full blown VC-style round that could have been done through a VC more smoothly in the first place.

The advantages of a lead investor in a seed round is that the entrepreneur typically negotiates with only one investor. Once the terms are set, other investors tend to follow along. This doesn’t mean you may not need to change any terms, but it’s a good step forward setting the scene.

Alternative Financing

With a sophisticated lead investor, it’s easy to establish terms that make sense. For instance, in a funding round below €500,000, it’s typical to see a non-priced round (either convertible note or a SAFE-type arrangement), with the only terms to consider being discounts, valuation caps and conversion dates.

The advantages of not pricing at this stage include not getting it wrong, because if you price too low, you give away too much.  If you price too high, you may have trouble with further funding. If the round is being priced, simpler is better with the best case scenarios for a round below €500,000 not requiring a shareholder agreement or any special investor rights, other than pre-emption and tag along rights.

To simplify things further, we believe in standardization at the seed stage. JAG Shaw Baker created several documents that standardize seed funding and that can help facilitate a smoother process, including UKiss documents with 500 Startups, the EFAST with Entrepreneur First and convertible notes for Entrepreneur First and Seedcamp.

Next week, Imran Bhatia, a rising associate on our Corporate team at JAG Shaw Baker, looks at innovative financing along these lines. Stay tuned.

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This post was written by Tina Baker, Co-founder and Partner, JAG Shaw Baker.

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