Equity Financings

Why Preferred Stock Financings?

• Sets Valuation: Unlike SAFEs or notes, a preferred stock round establishes a firm valuation for your company.
• Investor Protections: Preferred stockholders receive rights and preferences beyond those of common stock.
• Governance Structure: Establishes board representation and stockholder approval rights.
• Future Fundraising: Later investors will expect to build on the structure set by your first equity round.

Key Terms in Preferred Stock Deals

• Liquidation Preference: Determines payout order in an exit—investors often receive their investment back (1x) before common stock participates.
• Dividends: May be declared or accrue, though many early-stage rounds are “non-cumulative.”
• Anti-Dilution Protections: Adjust investor ownership if new shares are issued at a lower price (down rounds).
• Voting Rights: Investors may negotiate veto rights over major actions like selling the company, issuing more stock, or changing the charter.
• Board Seats: Often, lead investors take at least one board seat.
• Information Rights: Investors usually require regular financial reporting and inspection rights.

Process Overview

1. Term Sheet: Non-binding agreement outlining valuation, amount raised, and key investor rights.
2. Definitive Agreements: Stock Purchase Agreement, Amended Charter (Certificate of Incorporation), Investors’ Rights Agreement, Right of First Refusal/Co-Sale Agreement, and Voting Agreement.
3. Disclosure Schedules: Company disclosures qualifying the representations and warranties.
4. Closing: Funds wired, shares issued, and updated records prepared.
5. Post-Closing Compliance: State “blue sky” filings, cap table updates, and ongoing investor reporting.

Preparing for a Round

Before approaching institutional investors, companies should:

• Clean up their cap table—resolve errors or informal equity arrangements.
• Confirm IP ownership through signed assignments and PIIAs.
• Review corporate governance (charter, bylaws, board approvals).
• Organize financials with GAAP-compliant statements where possible.
• Be diligence-ready with contracts, employment records, and compliance materials in order.

Pros and Cons

For Founders:

- Provides significant growth capital, sets a clear valuation, and attracts experienced investors.

- Involves more negotiation, legal cost, and dilution; governance becomes more complex.

For Investors:

- Strong protections and influence over key company decisions.

- Less liquidity and higher risk than later-stage investments.

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What’s the difference between Series Seed and Series A?
Series Seed is a lighter-weight version of preferred stock financing, often used before a full Series A. Both create preferred stock, but Series Atypically involves more negotiation, money, and investor protections.

How long does a financing take?
Equity rounds usually take 6–10 weeks from term sheet to close, depending on diligence and negotiations.

Do I need a lawyer for an equity financing?
Yes. Equity financings involve complex agreements that shape your company for years. Professional guidance is critical.

What happens to my SAFEs and notes?
They typically convert into preferred stock in the equity round, according to their terms (valuation cap, discount, etc.).

How much equity will I give up?
It depends on valuation and amount raised. Early rounds often involve selling 15–25% of the company to investors.

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