At the Green Startup Legal Discussion on Day 2 of the San Jose Green Business Academy, the attorney panelists covered important legal issues for social entrepreneurs. Topics included approaches to legal structure, options for incorporation, and funding.

Green dollar bill

Attorneys from Starter Law, a law practice focused on helping entrepreneurs launch and grow their businesses, outlined a few common ways investors fund start-ups. Below are overviews of the funding methods along with notes from the panelists.
3 Ways Investors Fund Social Entrepreneur Startups

1. Convertible notes.  Also known as convertible debt, this is money an early-stage start-up raises in the form of a loan. It usually “converts” to equity (i.e. shares) sometime in the future with a discount (so that the angel investor often pays 15-30% less than the sticker price on each share). Depending on the provisions of the convertible note, the debt may automatically convert to equity when the start-up receives its next round of funding. This arrangement may feature a maximum price per share the angel investor will be required to pay if the convertible debt automatically converts to equity.

Notes from the panel: Convertible notes are inexpensive to set up and do not generally require very complex agreements. They are fairly flexible. Notably, investors are not equity-holders, they are creditors (which only convert to equity by provisions of the note).

2. Preferred Stock Financing. As the name suggests, preferred stocks enjoy preferential treatment over common stock. Startup companies issue preferred stocks to investors, giving the company needed financing and giving the investor valuable stake in the company. Preferred stocks are generally valued higher than common stocks, in scenarios of liquidation or acquisition preferred stocks are paid out first, and preferred stocks often include voting and anti-dilution provisions.

 Notes from the panel: This method of funding gives investors equity in the company, a seat on the board of directors, and all the bells and whistles that come with preferred stock. One type of preferred stock financing is Series A.*

3. Series Seed Financing. Similar to preferred stock financing, investors receive preferred stock in exchange for investing in the startup. Series seed financing generally refers to simplified version of preferred stock financing, which streamlines & expedites the purchase of preferred stock by seed capital investors. This mode of financing may not include some of the protective provisions valuable to social entrepreneurs and impact investors.

Notes from the panel: This financing model is not as complex as Series A and gives some, but not all, of the rights as Series A.

*This post has been edited to accurately capture the points made by panelists. 

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