Seed Financing vs Venture Financing: How do They Differ?

Startups have a variety of tools available to raise capital to fund operations before the company is cash flow positive, including business loans, convertible debt or other convertible security financings, preferred stock financings, and issuances of other equity. Two types of preferred stock financings commonly used by startups are venture financing and seed financing. These preferred stock financings are referred to as “priced rounds” because the company and its investors must agree on a valuation of the company as part of the transaction.

The key elements of venture or seed financing is the investment of money in the company by one or more investors in exchange for shares of preferred equity. Typically, in one of these financing rounds there are one or two lead investors, either a venture capital firm, an angel investor or, occasionally, a strategic investor and several smaller investors. Recently, there have also been “party rounds” which do not involve a lead investor.

Seed and venture financings follow a familiar process:

1. The company’s executives prepare an investor presentation (or, in some instances, private placement memorandum, which is more common where there are dispersed and unrelated investors);
2. Next, interested investors conduct initial business due diligence and negotiate a term sheet or a letter of intent with the company. The term sheet provides the company’s valuation and purchase price for the shares and any other key economic terms, along with any control rights agreed to with the investors.
3. Once the term sheet or letter of intent is signed, the parties complete business and legal due diligence while counsel drafts and negotiates the principal financing documents.
4. After the financing documents are completely negotiated, the parties sign the agreements and funding typically occurs simultaneously (but may be delayed to address certain closing conditions that cannot be met simultaneously with signing).

Venture financings and seed financings are very similar. The key difference between the two types of priced rounds is that the documents for a seed financing tend to be more streamlined, as summarized in the chart below. The tradeoff is that venture financing documents are drafted to adapt to future rounds of financing, whereas series seed documents tend to be more cumbersome for future rounds and may require the company and its counsel to duplicate some prior efforts at a Series A venture financing.