A Guide to Negotiating Series A Funding: Key Terms, Traps, and Pitfalls PART 1

Negotiating a Series A funding agreement is one of the most critical tasks for any startup. You are giving away a degree of ownership and control in the business you have founded and built from scratch. Knowing your rights at this stage is ESSENTIAL in making sure you don’t turn your most prized possession over to a group of inventions who many times do not have the specialized knowledge of your product or market. 

Knowledge is power. Be aware of the common terms that come into play and the potential pitfalls to avoid. The following is a brief overview of what you need to know to ensure a smooth and successful Series A negotiation. At the end of the day, its wise to either hire an attorney or spend a good bit of time researching and reading deeper into the following topics. 

Key Terms to Negotiate in a Series A Funding

1. Valuation and Ownership

   - Pre-money vs. Post-money Valuation: Your company’s pre-money valuation reflects its value before the investment, while post-money valuation includes the new investment. Be clear on how much equity you are giving up based on the capital raised.

   - Ownership Dilution: Carefully negotiate how much ownership the founders retain post-funding. The size of the employee stock option pool also needs to be agreed upon before the investment, as it impacts dilution.

2. Amount of Capital Raised

   - Clarify how much capital is being raised in this round and whether additional investors can come in after the initial close. This can open opportunities for more funds but may affect future dilution.

3. Equity Structure

   - Preferred Stock: Investors in Series A usually receive preferred stock, which comes with certain rights and privileges over common stockholders.

   - Liquidation Preference: This determines what investors get paid in the event of a liquidation or sale. Most common are 1x preferences, which means investors get their investment back before others. You’ll also need to negotiate whether investors will “participate” in the proceeds after their preference is met.

4. Board Composition

   - Investors may request a board seat as part of their investment. Striking a balance between founder representation and investor oversight is key to maintaining control over the company's direction.

5. Investor Rights

   - Protective Provisions: These allow investors to veto certain key decisions, such as raising more capital, issuing new shares, or selling assets. Make sure these provisions don’t overly limit the founders' ability to manage the business.

   - Pro Rata Rights: Investors may negotiate the right to participate in future financing rounds to maintain their ownership percentage.

6. Anti-Dilution Provisions

   - These provisions protect investors if the company raises capital in a future round at a lower valuation. While important for investors, certain anti-dilution mechanisms, like “full ratchet,” can severely dilute founders. “Weighted average” anti-dilution is often a fairer compromise.

7. Founder Share Vesting

   - Founders are often required to have their shares on a vesting schedule to ensure long-term commitment to the company. A common schedule is four years with a one-year cliff, meaning a portion of shares vest each year, with the first batch vesting after one year.

8. Employee Option Pool

   - Investors often require an option pool for employee equity compensation. This pool is usually created before their investment, diluting founders. Negotiating the size of the pool is crucial—make sure it’s realistic for your company’s hiring needs.

9. Future Financing Control

   - Investors may seek control over the terms of future funding rounds. Be careful not to give up too much flexibility, as it may restrict your ability to raise funds under favorable conditions later.

10. Dividends

   - Preferred shareholders may demand dividends, which can be cumulative (accrue until paid) or non-cumulative. Clarify whether these dividends will be paid out regularly or only under certain circumstances.

Final Tips for Series A Negotiations

- Build in Flexibility: Avoid overly restrictive covenants that could limit the company’s ability to make future strategic decisions.

- Consult with Experts: Don’t hesitate to bring in financial and legal advisors who are experienced with venture capital deals to avoid missteps.

- Long-Term Alignment: Ensure that the terms of the deal incentivize all parties—founders, employees, and investors—to stay aligned toward the company’s long-term success.

Negotiating Series A funding is about finding the right balance between securing the capital you need and maintaining control over your company's direction. By understanding the key terms, anticipating potential pitfalls, and negotiating thoughtfully, you can set your company up for success well beyond this funding round.

Need Help with Your Series A Negotiation? 

If your company is preparing for a Series A round, having an experienced legal team can make all the difference. Contact us to ensure your interests are protected at every stage of the process.