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I wish to seed my new business with about $120k, of which I need to raise about $90k.

I prefer not to go professional seed investors as:

(a) it could take some time (which I don't have); (b) it may be a problem down the line with new investors if the original ones don't stay; (c) i have a network of business associates that would each be willing to part with small amounts (say, parcels of $3k-$5k)

I heard a rule of thumb that says equity could be split as 50% to the workers and 50% to those providing funds. Using this rule, raising $90k and providing $30k would leave my associates with 37.5% of the company - or 1.25% for every $3k put in. Does this sound right, or is this too high?

Similarly, what sort of vehicle (terms) would you typically use for such a transaction and how do you address the risk of investor dilution for future funding rounds?

Thanks all

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1 Answer

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The terms all depend on your overall fund raising strategy. If the $120k is a bridge to your first funding round (A-round), then the best way to go about this would be a convertible note.

The convertible note would convert at the A-round price once you raised the A-round. This has several advantages, which include:

  • You don't have to set a price since you really have not built anything yet.
  • It's a loan which means no issues of governance or control.
  • It gives you more flexibility on the A-round price since if you get VC money, they will want to do a proper evaluation.
  • Dilution is not an issue until the A-round price is set.
  • You don't really have to worry about percent ownership until the big money round.

Investor dilution will depend on the A-round size and price. This is unavoidable and can be dealt with using preferences.

Typical stock splits for a VC backed deal is 80% for investors and 20% for employees but that depends a lot on the amount of money you take in total (since the 80/20 will settle to that over time).

Terms for notes like this include:

  • Interest on the loan
  • Conversion preferences
  • When the note converts (e.g. a certain threshold of money raised).
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Thanks Jarie. Something else to add to the mix - the company is incorporated in the UK and there is a scheme here called "Enterprise Investment Scheme" (EIS). It allows personal investors a number of tax breaks (20% of investment can be offset against their tax liability for the year or previous year, gains are free from capital gains tax, losses can be offset against income, capital gains elsewhere can be invested into the venture to defer capital gains tax). It seems the perfect vehicle, but still leaves me with the question of how much to give in equity. Do you agree? – Stealth Mar 16 '10 at 14:29
Interesting idea. I would still try and keep it to like 20-30% if you can. – Jarie Bolander Mar 16 '10 at 16:16

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