SG Startup Company :  5 key points to note when raising seed funding

SG Startup Company: Seed investing as a concept largely originated from Silicon Valley and unlike most traditional business ventures where the shareholding is dependant on bargaining and negotiation and the amount of money invested into a venture, the seed investor in that funding round will usually get about between 15% to 20% of the shares of the company on a post-diluted basis.  For a more nuanced elaboration on how seed funding works, you can read the article at Y-Combinator.

This article will highlight 5 key issues that any founder should note when raising seed round funding.

#1: What legal entity to use for fund raising for your startup

In Singapore, most traditional business ventures can be set up as sole proprietorships (SP) or partnerships, but for a Singapore Startup Company, most of them are set up as private limited companies.

Please also try to ensure that your company qualifies as a “Small Company” so you do not need to spend money on audit at such an early stage.  A company qualifies as a small company if:

(a) it is a private company in the financial year in question; and

(b) it meets at least 2 of 3 following criteria for immediate past two consecutive financial years:  

1. total annual revenue ≤ $10m;
2. total assets ≤ $10m;
3. no. of employees ≤ 50.  

#2: How to determine valuation for your startup

If you have a startup that can be VC funded, the method commonly used for valuing early startups is known as the “Venture method” of valuation.  As a startup goes through subsequent funding rounds, it may cease becoming a startup and become a mature tech company and then its valuation will then approximate the valuations commanded by listed technology firms.

Explaining how the Venture Method of valuation works would require a long article by itself. Y Combinator’s article on Seed Funding does quite a good job to explain this.

#3: How much dilution to expect from this funding round

Unless the investor joins as a “Co-Founder”, the usual maximum dilution from each funding round for every SG Startup Company should be between 20% to 25%.  Since the dilutive effect of each funding round stems from the negotiated valuation of the startup, the founders should spend a lot of time studying on the market standard valuation of their startup and also studying the venture capital method in great detail.  If necessary, a startup should also have an adviser to help them build their capitalization table and also help with negotiations with external investors.

#4: What investment instrument to use for fund raising for your SG Startup Company

Before we cover this topic, we need to highlight a few key concepts.

A priced round versus a non-priced round. 

If a startup can agree with an external investor on the issue price per share, then this funding round will be known as a priced funding round.

If a startup cannot agree with the investor(s) on the valuation of the startup and by extension the issue price per share, this will be known as a non-priced funding round.

For a priced funding round, the investor will usually enter into a subscription agreement with the company to subscribe for shares at a fixed price per share.

For a non-priced funding round, the investor can choose to enter into any of the following instruments with the SG Startup Company:

1. SAFE instrument – equity convertible – This was created by Y Combinator a TOP US Incubator
   1. KISS note – equity convertible – This was created by 500 Startups a TOP US Incubator
   2. CARE instrument – mixed equity/debt instrument – This was created by the Singapore Venture Capital Association
   3. Convertible Bond – This was originally created by Y Combinator (but created SAFE to supersede this as SAFE was deemed to be more founder friendly).  An investor will enter into a convertible bond usually if the investor determines that the investment is riskier so the investor rather holds debt (rather than equity).

#5: Strategic Investors versus financial investors for your SG Startup Company

When screening investors, some investors are mere financial investors (i.e. those who are looking for financial returns), while other investors are strategic (from the point of view of the SG Startup Company). 

To give a practical example, if your startup is a logistics tech startup, you may want to see if you can get an angel investor from one of the largest logistics families in the South East Asian region.

In conclusion, fund raising at the seed stage for a SG Startup Company is tough, but hopefully this article will help startup founders to understand the key legal issues that need to be ascertained when determining what investment instruments to use for a seed stage fund raising exercise.

If you have any comments on our article, please leave a comment below.

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