Seed Investor Agreement: Everything You Need to Know
A seed investor agreement refers to a document that clearly specifies the terms and conditions of a specific investment.3 min read
Updated July 31, 2020:
A seed investor agreement refers to a document that clearly specifies the terms and conditions of a specific investment. Its length varies between one and five pages, and it is usually a non-binding document. The only binding parts may be clauses referring to confidentiality or exclusivity.
Vital Clauses in the Seed Investor Agreement
In situations where startup companies are approached by seed investors, the agreement can be prepared by either of the parties. All such agreements must contain some key clauses:
- The first vital clause is the structure of the investment. There are usually three types of securities: common shares, convertible preferred shares, and convertible debt. In the first two cases, the parties involved will value the company at a certain amount, thus setting the investment price. If the seed investors choose to invest in convertible debt, they technically loan money to the startup, that later get turned into equity shares. The advantage is that the company will not be valued right away, but at a later date when more investments come in, making the seed investor's equity shares worth more.
- Another key element of the agreement is defining its most important economic terms. The first term that needs to be settled is how much of the investment the startup will return to the seed investor before paying other investors. The second vital term is defining the accruing returns of the investment, meaning the investment can be returned either by dividends and shares or by an interest rate that usually is automatically converted into debt.
- Defining the seed investor's exact position within the newly started company is also a very important step. Typically, investors require some form of representation on the startup's board so that they can observe, rather than be actively involved in, the company's decision making.
Things to Consider When Writing the Seed Investor Agreement
From a startup founder's standpoint, a seed investor agreement is almost always necessary when dealing with people or companies that want to invest in your idea. When writing, it's important that the founder has some clear things in mind:
- The seed investor genuinely believes in you and your business; therefore, even if things don't go smoothly from the very beginning, good communication between the two parties will retain the investor's support.
- Don't rely on a sole investment. Instead, once you've gained the investor's trust, you can start planning ways to attract future investments
- When negotiating the seed investor agreement, keep in mind that the rights you give investors now will have consequences in the future. Create a structure that allows multiple investors but with guarantees that they won't interfere in your decisions.
- Personal communication usually matters more than a contract. No matter how well-written the agreement's clauses are, a solid and honest communication between the founder and the investor will maximize chances for a successful long-term collaboration.
Common Misconceptions Regarding Seed Investor Agreements
Standardized seed investor agreements are avoided by startup lawyers because it makes their role less important. The reason startup lawyers usually discredit such standardized contracts is because of their simplicity. Complicated clauses are not added to contracts just for justifying the lawyer's involvement but to prevent any issues from arising in the future. The lawyer's main role in such a deal is not writing the contract but providing counsel at every step of the negotiation.
Another common misconception is that standardized seed investor agreements open up the legal domain for everyone. While it's true that some parts of the law are getting automated and easier to understand by the general public, the law remains a complex field, and it is always advisable that you hire a professional to guide you along your way.
Finally, it is tempting to think that a standardized seed agreement is what you need to convince an investor to fund your ideas. However, most investors with enough quality to help your business will not be convinced by such a document. They also tend to discredit the option of returning the investment as convertible debt, when in fact it is the most advantageous option for both parties in many situations.
If you need help with a seed investor agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.