Overview of Venture Terms Part I
M. James Faison, attorney at the Faison Law Group, discusses important topics for young and growing companies navigating the venture capital process. These topics include key terms in venture capital and the importance of selecting the right entity type and state of incorporation.
Starting with venture capital terms, two main funding rounds exist: price (equity) rounds and non-price (non-equity) rounds. In price or equity rounds, the company is assigned a value, and shares or stocks are issued accordingly. The process requires creating different classes of stocks and seed rounds. This process is generally more costly and time-consuming, making it more suitable for later stages in a company’s growth.
On the other hand, non-price or non-equity rounds, also known as friends and family rounds or convertible rounds, do not require placing an immediate value on the company or issuing shares. Instead, convertible securities are issued, which later convert into shares. This approach is faster and cheaper, making it more viable for early-stage companies. Types of convertible securities include convertible notes, KISS (Keep It Simple Security), and SAFE (Simple Agreement for Future Equity). Legal costs for coordinating these two funding rounds can vary greatly.
Regarding the choice of business entity, James discusses common options. S Corps have limitations on share classes and shareholder count, while C Corps has the potential to be publicly listed and tax benefits under the qualified small business benefit. Finally, Delaware remains popular for historical reasons concerning the state of incorporation. More states, however, are adopting business-friendly corporate laws. Sophisticated investors may continue to prefer Delaware incorporation in the later stages of the venture process.