Will I Save Legal Fees by Doing My Seed Round with Notes Instead of Stock?By http://profile.typepad.com/1237764140s22740 // September 2, 2010 in Convertible Notes
If an investor or fellow entrepreneur tells you that you will save legal fees by doing your seed round with notes instead of stock, what she really means is that the kind of investment that can be done with a note or notes will be less formal, will involve less scrutiny and due diligence, than a round that is priced.
There are good, very pro-founder reasons to use notes (assuming the amounts and terms and investors are mixing right!), and these include managing and mitigating founder dilution.
But there's often the implication - misleading, I think - that legal fees can and should be minimized as a byproduct of choosing to use notes. I say, don't ice your strategic cake this way!
The level of formality of the seed round has to do not only with how seriously your investor takes the investment, but also with how seriously you take the investor. It is not a function of whether you issue notes or stock.
Even if you have the friendliest angel in the world, or even if the world's savviest super-angel tells you she can't be bothered to read a term sheet, you'll independently have your own good reasons to put your company through something like the drill you'd encounter in a modestly-diligenced, priced round.
If you've done this before, you'll know what I mean. If you haven't, ask your lawyer: has she ever, ever done a Series A or priced early round, with even the lightest set of reps and warranties in the purchase agreement, and not found a significant problem needing to be cleaned up? An assignment of inventions that was missed? License terms that morph when you move from prototype to commercial release?
Founders benefit as much as investors do from having the company organized and ready to do business.