As technology lawyers we have worked with hundreds of companies raising their first equity financing round. We have also come across companies and founders (typically on their next financing round) who completed their seed rounds without using a lawyer.

Proceeding without a lawyer is understandable for early stage tech companies. Venture capital term sheets and long form documents are often presented as standard form agreements. The perception is that engaging a lawyer will add time and cost to a process when getting money in the door and keeping costs low are key considerations.

We may be slightly biased(!), but companies and founders who we have worked with had an easier time closing their fundraising quickly and efficiently. They were also in a much better position following closing and when raising their next funding round. Here are 5 reasons why engaging a lawyer on your first round is important, and some good news on the cost.

more efficient process

Closing an equity financing is often a company’s first experience with a legal process. The round will involve negotiating and executing a term sheet, subscription agreement, shareholders’ agreement, updated constitution, and disclosure letter, along with ancillary documents such as director and shareholder resolutions and waivers.

Having a lawyer to guide the company and founders through this process is critical to getting the round closed as efficiently as possible. Some documents (like the disclosure letter and the updated constitution) are usually prepared on the company side, and others (like resolutions and the investor KYC process) can be prepared in advance with your lawyer liaising with your company secretary, meaning that they don’t hold up signing and closing.

making sure you have market terms

Because we advise on many capital raises, we understand how the material terms of your capital raise compare with what we see as the market standard for seed rounds. This provides founders with comfort on which terms they can regard as standard and which to negotiate. If sticking points arise, we can also suggest ways to resolve them.

We are also familiar with most of the seed investors in Singapore, their documentation, and their expected positions on most items. We find this also makes a big difference in streamlining the drafting and negotiation processes.

understanding your obligations

The venture capital terms and documentation from institutional investors in Singapore are typically of a high quality, and are becoming more standardized across the ecosystem. However, these agreements still include important representations, warranties and undertakings from the company, and in certain cases founders personally. Most of these will be familiar to VCs and other experienced parties, but it is important for founders (especially first timers) to understand what these items mean, and the best way to mitigate any risk.

Broadly speaking these items can be categorised as:

• representations and warranties provided by the company and (usually) founders about the position of the company at the time of investment
• restrictions on the actions of the company and founders going forward, such as investor veto rights (also known as reserved matters), the vesting of founder shares against their continued involvement in the company, and restrictions on the transfer of founder shares (usually lock-in, rights of first refusal, and co-sale rights)
• ongoing positive obligations to the investors, most commonly information and reporting obligations.

Understanding these obligations is important, not just to avoid a technical breach of the company’s governance documents, but also to maintain good relationships with your investors.

Post-closing requirements

Seed round documents usually include one or two post-closing obligations on the company. Most commonly tidying up any items raised during due diligence that could not be dealt with before closing, and/or the establishment of an ESOP.

In the excitement of closing a seed round it can be easy to forget these post-closing matters and, in the absence of a lawyer, this is often not picked up until the due diligence process for the company’s next round. This can create delays in order to address these items before moving ahead with a new investment round.

Having a lawyer will help founders to stay on top of these obligations.

good position moving forward

A company’s seed round investment documents will usually be terminated and replaced at the time of the company’s series A round. However, incoming series A investors will review those documents as part of their due diligence. If those seed documents include terms that are unusually favourable for investors (like a non-standard liquidation preference), your incoming investors may expect the same to be included in your series A agreements. Similarly, your seed investors may reasonably expect to retain their existing rights in the next round documentation (or in some cases your seed investor may even be leading your series A round). It is important that your seed documents are not placing the company in a potentially difficult position for negotiating future funding rounds.

but what about the cost?

We are always excited to assist startups with their seed rounds. These rounds are often a company’s first time accessing a material amount of external capital and represent a major milestone in the company’s life cycle.

To help keep your costs under control at this early stage, we offer a fixed fee of S$6,500 to work with you on your seed round subject to certain conditions. You can read more about our fixed fee offer here. Even if our fixed fee offer does not apply to your circumstances, we are happy to discuss your round and provide an estimate before kicking off.

Back in 2018, Y-Combinator (YC) updated their core investment instrument and launched what is now known as the post-money SAFE.

We analysed the post-money SAFE back in 2020 – see our blog here https://kindrik.co.nz/blogs/a-primer-on-post-money-safes-in-new-zealand/. The main difference between a pre-money and post-money SAFE is that, on conversion, under the pre-money terms the calculation of the number of conversion shares does not include the conversion of the SAFE itself and any other convertible instruments in issue (other convertible securities). With a post-money SAFE all of these other convertible securities are included. The end result is further dilution for existing ordinary shareholders on conversion of the post-money SAFE.

But what about convertible notes? Have they remained drafted on a pre-money basis or, like the SAFE, has the market moved towards the more investor friendly post-money position?

Convertible notes v SAFEs

The terms of convertibles notes differ from SAFEs. SAFEs remain outstanding until a conversion event occurs, or the company has a liquidity event. So, in effect, there is no repayment obligation. In contrast, convertible notes have a maturity date and generally accrue interest. Therefore, startups have no time pressure to close an equity financing under a SAFE. Whereas under a convertible note, they might need to get it done within say 18 months, or the note could be repayable. For that reason, SAFEs are generally the preferred document for founders.

The market has certainly followed YC’s lead when it comes to SAFEs. Most SAFEs we now see are the post-money version. However, the same can’t be said for convertible notes, for which conversion into shares is still calculated on the more founder friendly pre-money calculation. Looking at templates available online, whether provided by law firms (including our own!), VCs or industry bodies, this looks to be the consistent approach across the board. That said, we do occasionally see them on deals where investors are looking to secure a better position or when they simply draft the document incorrectly.

Round up

Founders should be cautious here and take advice at the term sheet stage so there is no ambiguity when everyone comes to drafting the final instrument. If any post-money instrument is used, it may require founders to rethink the valuation cap on the deal.

Investors could argue that there is nothing intrinsically different between a SAFE and a convertible note in terms of how equity should be calculated on a conversion event. I.e. why shouldn’t the number of shares be determined on the same basis for each?

However, YC’s justification at the time of launching the new SAFE was that it makes the conversion calculation simpler and creates more certainty over the future dilution. Which is certainly true. But YC’s model is about speed and efficiency and they invest in multiple companies in their intakes. A SAFE is also a pretty founder friendly investment instrument, and rarely negotiated much. A convertible note, on the other hand, has other disadvantages to founders and more onerous terms, in particular, interest and repayment obligations. Notes also tend to include information rights, a most favoured nation clause, events of default provisions and other covenants that don’t typically appear in SAFEs.

Taking that into consideration, our view remains that convertible notes should be drafted on a pre-money basis, and that post-money notes remain non-market.