TL;DR: We’ve created a publicly downloadable template for a seed convertible note (with useful footnotes), based on the template we’ve used hundreds of times in seed convertible note deals across the U.S. (outside of California). It can be downloaded here.
I’ve written several posts on structuring seed rounds, and how for seed rounds on the smaller side ($250K-$1MM) convertible notes are by far the dominant instrument that we see across the country. When SAFEs had pre-money valuation caps, they gained quite a bit of traction in Silicon Valley and pockets of other markets, but outside of SV convertible notes were still the dominant convertible instrument. Now that YC has revised the SAFE to have harsher post-money valuation economics (see above linked post), we’re seeing SAFE utilization drop significantly, though it was never close to the “standard” to begin with; at least not outside of California. For most seed companies, convertible notes and equity are the main options.
For rounds above $1-1.5MM+, equity (particularly seed equity) should be given strong consideration. We are also seeing more founders and investors who really prefer equity opting for seed equity docs for rounds as low as $500K. The point of this post isn’t to get into the nuances of convertibles v. equity. There’s a lot of literature out there on the topic, including here on SHL.
What this post is really about is that many people have written to me regarding the absence of a useable public convertible note template that lawyers and startups can leverage for seed deals; particularly startups outside of SV, which has very different norms and investor expectations from other markets. Our boutique firm, Egan Nelson (E/N), specializes in emerging companies work outside of California: markets like Austin, Seattle, NYC, Boston, etc. We see a lot of seed deals every year across the country. Here is a list of funds our lawyers have worked across from in negotiating financings. Here is my personal bio to confirm I’m not just some random guy with a blog.
Cooley actually has a solid convertible note available on their Cooley GO document generator. I’m a fan of Cooley GO. It has strong content. But as many readers know, there are inherent limitations to these automated doc generator tools; many of which law firms utilize more for marketing reasons (a kind of techie signaling) than actual day-to-day practical value for real clients closing real deals. Your seed docs often set the terms for issuing as much as 10-30% of your company’s capitalization, and the terms of your long-term relationship with your earliest supporters. Take the details seriously, and take advantage of the ability to flexibly modify things when it’s warranted.
The “move fast and mindlessly sign a template” approach has for some time been peddled by pockets of very clever and vocal investors, who know that pushing for speed is the easiest way to take advantage of inexperienced founders who don’t know what questions to ask. But the smartest teams always slow down enough to work with trusted advisors who can ensure the deal that gets signed makes sense for the context, and that the team really knows what they’re getting into. Taking that time can easily pay off 10-20x+ in terms of the improved cap table or governance position you get from a little tweaking. The investor trying to rush your deal isn’t really trying to save you legal fees. They’re trying to save themselves from having to negotiate, or justify the “asks” in their docs.
As a firm focused on smaller ecosystems that typically don’t get nearly as much air time in startup financing discussions as SV, I realized we’re well-positioned to offer non-SV founders a useful template for convertible notes. The fact that, to avoid conflicts of interest, we also don’t represent Tech VCs (trust me, many have asked, but it’s a hard policy) also allows us to speak with a somewhat unique level of impartiality on what companies should be accepting for their seed note deals. There are a lot of players in the startup ecosystem that love to use their microphones to push X or Y (air quotes) “standard” for startup financings, but more often than not their deep ties to certain investors should raise doubts among founders as to biases in their perspective. We’ve drafted this template from the perspective of independent company counsel.
So here it is: A Convertible Note Template for Seed Rounds, with some useful footnotes for ways to flexibly tweak the note within deal norms. Publicly available for download.
A few additional, important points to keep in mind in using this note:
First, make sure that the lawyer(s) you are working with have deep (senior) experience in this area of law (emerging companies and vc, not just general corporate lawyers), and don’t have conflicts of interest with the people sitting across the table offering you money. When investors “recommend” a specific law firm they are “familiar” with they’re often trying to strip startup teams of crucial strategic advice. See: Checklist for Choosing a Startup Lawyer. Be very careful with firms that push this kind of work to paralegals or juniors, who inevitably work off of an inflexible script and won’t be able to tailor things for the context. You want experienced, trustworthy specialists; not shills or novices.
Second, be mature about maturity. You’re asking people to hand you money in a period of enormous uncertainty and risk, while getting very little protection upfront. As long as maturity is long enough to give you sufficient time to make things happen (2-3 yrs is what we are seeing), you shouldn’t run away from the most basic of accountability measures in your deal. Think about how bad of a signal it sends to investors if a 3 year deadline terrifies you.
Third, do not for a second think that, because you have a template in your hand, it somehow means you no longer need experienced advisors, like lawyers, to close on it. Template contracts don’t remove the need for lawyers any more than GitHub removes the need for developers. The template is a starting point, and the real expertise is in knowing which template to start from, and how to work with it for the unique context and parties involved. Experienced Startup Lawyers are incredibly useful “equalizers” when first-time entrepreneurs are negotiating with experienced money players. Don’t get played.
Fourth, pay very close attention to how the valuation cap works, particularly the denominator used for ultimately calculating the share price. We are seeing more openness among investors to “hardening” the denominator at closing, either with an actual capitalization number, or by clarifying that any changes to the option pool in a Series A won’t be included. These modifications make notes behave more like equity from a dilution standpoint, allowing more clarity around how much of the company is being given to the seed money.
Finally, don’t try to force this template on unwilling investors. It can irritate seasoned investors to no end to hear that they must use X template for a deal because some blog post, lawyer, or accelerator said so. There is no single “standard” for a seed round. There never has been, and never will be, because different companies are raising in different contexts with investors who have different priorities and expectations. We’ve used this form hundreds of times across the country, but that doesn’t mean there aren’t other perfectly reasonable ways to do seed deals.
Have a dialogue with your lead money, and use that dialogue to set expectations. See: Negotiation is Relationship Building. If they’re comfortable using this template, great. If they need a little extra language here or there, don’t make a huge fuss about it if your own advisors say it’s OK. And if they prefer another structure, like seed equity or even more robust equity docs, plenty of companies do that for their seed round and it goes perfectly fine, as long as you have experienced people monitoring the details.
If any experienced lawyers out there see areas of improvement for the template, feel free to ping me via e-mail.
Obligatory disclaimer: This template is being provided as an educational resource, and is intended to be utilized by experienced legal counsel with a full understanding of the context in which the template is being used. We (myself or Egan Nelson LLP) are not responsible at all for the consequences of your utilization of this template. Good luck.