Seed Round: The First Institutional Money

A seed round is the first round at which an institution agrees a price per share for a company's equity. In Aravalli Learning Systems Private Limited, invented, the seed set Rs 30.00 a share, raised Rs 6,00,00,000 against a pre-money of Rs 24,00,00,000, and left four holders: the founders, an option pool, a venture fund and an angel syndicate.

A seed round rests on one small idea that does a great deal of work. A round is a price agreed on shares that already exist, and then applied to shares that do not exist yet. Fix two things, the number agreed for the company before the money arrives and the number of shares already in issue, and everything after them is division. The price falls out. The count of new shares falls out. Every percentage on the record afterwards falls out. A seed round is the first time an institution does that arithmetic with a company, and the record it leaves behind is the one every later round has to work on. The size of the cheque is not the thing to hold on to. The register is.

What makes a seed round a round rather than just money arriving?

Money reaches a young company in many shapes. A relative lends it. A customer pays in advance. A bank extends a small facility against a receivable. An instrument gets signed that deliberately postpones the price until somebody else sets it later. None of those is a round. A round has three parts and all three have to be present: a price per share is agreed on the shares that already exist, new shares are issued at exactly that price, and the record of who holds what changes by an amount anybody can recompute from those two numbers.

The third part is the one readers skip, and it is the one that matters. A seed roundThe first round at which an institution agrees a price per share for a company's equity. is checkable. Given the pre-money, the raise and the shares in issue beforehand, a reader can produce every number that follows without being shown any of them, and where the figures presented disagree with the computed ones, one of the two is wrong. No other habit is worth as much when a table of round numbers is put in front of somebody.

Aravalli Learning Systems Private Limited did all three at Aravalli Year 1, on Aravalli's own clock. The word seed describes how early the company was, not the size of the cheque or the kind of paper it was written on. One of the two buyers was a pooled vehicle answerable to its own investors rather than a person spending personal savings, and that is what made the round institutional.

Who is on the share register before the money arrives?

Before a single rupee of outside money reaches Aravalli, the company already has a share registerThe record of who holds how many shares in a company., and it already has three rows on it. Founder A holds 42,00,000 shares. Founder B holds 28,00,000. An employee option poolShares set aside for employees, including ones not yet hired. holds 10,00,000. 42,00,000 plus 28,00,000 plus 10,00,000 is exactly 80,00,000 shares in total.

Two of those rows belong to people and one of them belongs to nobody yet. The pool row is not a person, not an entity and not an investor. The pool is a block of shares set aside for employees who have not all been hired, counted in the total as though they were already issued. Counting a reserved share as though it were already issued has a name. Shares counted that way are counted fully dilutedCounted as if every reserved share were already issued.. The arithmetic then behaves as though the reserved shares are already out in the world, and nobody is surprised by them later.

Why is there an option pool before anybody has been hired?

Reserving shares for people who do not yet work there sounds like a trick and it is not. A company at this stage has almost no cash and needs to hire people who could earn more elsewhere. The company can offer a share of whatever it becomes instead. To offer that, the shares have to exist, or at least be reserved, and reserving them is far easier to agree at a calm moment than at a contested one. The pool is created before the round because creating it after the round would mean asking a brand new investor to accept dilution for hires nobody had even named yet.

One detail decides everything that follows. The 10,00,000 pool shares sit inside the 80,00,000 that exist before the money arrives, so they sit inside the pre-moneyThe value agreed for the company before the new money arrives. side of the table. Nobody paid for them. The pool shares were carved out of what the founders would otherwise have held. The pre-round arithmetic shows it directly. Of the 80,00,000 shares in issue the two founders hold 70,00,000 between them, being 87.5 per cent exactly, and the pool holds 12.5 per cent exactly. Founder A alone is 42,00,000 over 80,00,000, being 52.5 per cent, and founder B is 28,00,000 over 80,00,000, being 35.0 per cent, and those two add back to 87.5.

So even before an outside investor exists, the founders do not hold all of their own company. The founders hold 87.5 per cent of it, and they agreed to that themselves, in advance, for a reason they could name. A later round can require the pool to be made larger, and where those extra shares are taken from is a genuinely different question with a different answer, covered separately.

Where does the price per share actually come from?

The price comes from a division and only from a division. The pre-money agreed for Aravalli was Rs 24,00,00,000. The shares already in issue numbered 80,00,000. The first divided by the second is Rs 30.00, and that is the price per shareThe pre-money divided by the number of shares already in issue. for the round. Nobody negotiated Rs 30.00. The two sides negotiated Rs 24,00,00,000, and Rs 30.00 fell out of that once the existing share count was on the table.

One misreading of that agreed figure does more damage than any other. A pre-money is not a valuation of a business. Nobody measured Aravalli, weighed it, discounted anything and found Rs 24,00,00,000 sitting inside it. A pre-money is a number two parties agreed on in order to divide ownership between them, and the only thing it is capable of doing is deciding what fraction of the company the incoming money buys. Change the pre-money and the fraction changes. Deciding that fraction is the pre-money's entire job.

The same discipline applies to the number on the other side. The post-money of Rs 30,00,00,000 is 1,00,00,000 shares multiplied by Rs 30.00 and nothing more. The post-money is also Rs 24,00,00,000 plus Rs 6,00,00,000, a useful check and not an independent fact. Nobody would pay Rs 30,00,00,000 for the whole company, no auditor would carry the company at that figure, and it is not evidence about the future. A post-money is a share count multiplied by the price of the round that just closed.

How many new shares does the raise buy, and who takes them?

Rs 6,00,00,000 divided by Rs 30.00 is 20,00,000 new shares. The 20,00,000 new shares are added to the 80,00,000 that already existed, so the company has 1,00,00,000 shares afterwards. Once the pre-money and the existing share count are both agreed, the number of new shares is a division rather than a negotiation, and there is nothing left in it to argue about. This is why founders who spend their energy on the size of the raise and none of it on the pre-money have argued about the wrong number.

Two buyers split the 20,00,000. Rs 4,50,00,000 divided by Rs 30.00 is 15,00,000 shares, and Nilgiri Venture Fund I, an invented fund, subscribed exactly that many for Rs 4,50,00,000. Rs 1,50,00,000 divided by Rs 30.00 is 5,00,000 shares, and an angel syndicateA group of individuals investing together, each on their own account. of six individuals subscribed those for Rs 1,50,00,000. Both checks close in both directions: 15,00,000 plus 5,00,000 is 20,00,000, and Rs 4,50,00,000 plus Rs 1,50,00,000 is Rs 6,00,00,000.

One habit to carry away from that cheque. Nilgiri Venture Fund I has Rs 1,50,00,00,000 of commitments, so its Rs 4,50,00,000 into Aravalli is 3.0 per cent of its commitments, and commitments are the only denominator attached to that figure. The 3.0 per cent is not 3.0 per cent of anything else, and a percentage quoted without naming what it is a percentage of has said almost nothing.

Who is on the register afterwards, and what is each holder?

Four holders, 1,00,00,000 shares. Divide each holding by that total and the percentages appear. The founders hold 70,00,000 shares, being 70.0 per cent, and inside that founder A holds 42,00,000 at 42.0 per cent and founder B holds 28,00,000 at 28.0 per cent. The option pool holds 10,00,000 at 10.0 per cent. Nilgiri Venture Fund I, invented, holds 15,00,000 at 15.0 per cent. The angel syndicate holds 5,00,000 at 5.0 per cent. Add them: 70.0 plus 10.0 plus 15.0 plus 5.0 is 100.0.

The percentage column of a register is produced by the share count column, and reading it in the other direction is where most errors in these tables begin. Shares are the primitive. A percentage is a derived quantity that exists only relative to a total, and the total changes at every round. A memorised percentage will be wrong soon; a share count, once held on to, allows the percentage to be regenerated against whatever the total becomes.

Two checks run on that table and both have to close. First, 1,00,00,000 shares at Rs 30.00 is Rs 30,00,00,000, the post-money, and the pre-money plus the raise comes to the same figure. Second, the round issued 20,00,000 of the 1,00,00,000 shares, being 20.0 per cent, for Rs 6,00,00,000, and Rs 6,00,00,000 is 20.0 per cent of Rs 30,00,00,000. The percentage of the company sold equals the percentage of the post-money paid, and that identity holds at every priced round anywhere. Where the two disagree on a table, something in it is wrong.

If the price was the same, what is different about institutional money?

Nothing about the price. Nilgiri Venture Fund I paid Rs 30.00 a share and each of the six angels paid Rs 30.00 a share. The round did not favour one over the other, and any story that says the institution got a better entry is simply not true of this round. The difference is not the price but the kind of holder the register has acquired.

Institutional moneyMoney invested by a pooled vehicle answerable to its own investors, rather than by an individual. arrives attached to machinery. Nilgiri Venture Fund I is a pooled vehicle settled as a trust, with Nilgiri Alternatives Advisors Private Limited as its investment manager, Nilgiri Trusteeship Services Private Limited as trustee and Nilgiri Financial Holdings Private Limited as sponsor. How that vehicle is put together, where its money comes from and how its manager is paid are covered separately. On Aravalli's register the consequence is one holder, one decision-making process, one signature, and an obligation to report the position to somebody else. When Aravalli needs an answer, it asks the fund a question and receives an answer.

The syndicate is a different object wearing the same Rs 30.00 price. Six individuals each decided alone, each on personal account, each with personal reasons and personal circumstances that can change without warning. There is no manager between them and the company. A question put to them is six questions. The same rupee of price can arrive attached to one decision or to six, and the register records only the rupees.

Why does one row standing for six people matter later?

On the register the syndicate is a single line: 5,00,000 shares, 5.0 per cent. The line is tidy and slightly misleading. Behind it are six separate people who happened to subscribe together. The record of this case fixes the total the six paid, being Rs 1,50,00,000 for 5,00,000 shares, and it does not fix how those shares split between them. No split is stated. A made-up number in a share register is exactly the kind of thing that looks completely real forever afterwards.

A single line on a share register can stand for several holders, and the number of people behind that line decides what can be done quickly at the next round. Rounds routinely need existing shareholders to agree to something: an amendment, a consent, a signature on a document, a waiver of a right somebody holds. One fund gives one answer through one process. Six individuals give six answers on six timetables, and if one of them has moved, changed their mind or become unreachable, the company discovers it at the least convenient moment.

None of that counts against angels. The number of decision-makers behind a row is a structural fact about the register, and the row itself never states that number, so a cap table is worth reading with the count in mind.

What did the fund get for Rs 4,50,00,000, and what did it not get?

The fund got three things, and all three are worth naming. Two of them are commonly overstated and the third is commonly forgotten. First, 15,00,000 shares, being 15.0 per cent of Aravalli measured against the 1,00,00,000 shares in issue after the round. Second, a set of contractual rights. On a seed round those rights typically cover information, consent on certain company actions and a say in who sits on the board. The categories are what a seed round settles. The terms of any specific right are covered separately.

Third, and this is the one people forget: a minority stakeA holding too small to decide anything on its own.. Fifteen per cent decides nothing by itself. Whatever influence the fund has comes from a contract it signed, not from the size of the number, and that distinction runs through the whole of private investing.

Now the part that is not there at all. A share in an unlisted company contracts nobody to pay the holder anything, on any date, ever. Compare it with a loan, which the reader already knows: a lender has an interest rate, a schedule and a date on which the principal is due, and if the money does not arrive there is a breach. The fund has none of that. There is no coupon, no repayment date, no maturity and no dividend assumed here. Cash reaches the fund only if somebody buys the shares from it, and what a sale actually produces is covered separately. Until that happens, the position is a line in a report and not money.

What does a seed term sheet set, read at a structural level?

A term sheetA short document setting out the shape of a proposed investment, read rather than drafted here. is a short document that describes the shape of a proposed investment before the long documents are written. A structural reading, in the sense Feld and Mendelson set out in Venture Deals, 2011, works not clause by clause but by asking which of a small number of structural questions each part of the document is answering. Drafting and negotiating such a document are covered separately, as is the order in which one is best read.

Four structural questions carry a seed term sheet, and a reader who can find the answer to all four has read the document. What is being priced, and against what share count. Who is buying, and for how much each. Anything created before the price is struck, a pool being the usual example. And what changes hands, meaning how many new shares, what fraction of the company that becomes, and what rights travel with them. Every one of those four has a number in Aravalli's seed, and all four have already been computed above.

What does all of this look like without any of the finance words?

Three cousins decide to open a shop. Two of them will actually run it, day in and day out, and between them they take the whole of it: one takes the larger part because the idea and the lease are hers, the other takes the smaller part. Before they open, they agree something sensible. The two of them set aside a portion of the shop, on paper, for a manager they have not yet hired. They will eventually need somebody good and they will have no cash to pay that person properly. Nobody holds that portion. It waits.

Then a fourth person, who will not work in the shop at all, offers to put in money. The three of them have to agree on one number: how much the shop is worth before that money goes in. Not what it will be worth, not what it feels like it is worth, but a number they can both live with. One number and nothing else decides how much of the shop the money buys. Once they agree it, everything else is division, and the arithmetic does not care how anybody feels about it.

Notice the two things the story gets right that the finance vocabulary hides. The portion set aside for the unhired manager came out of the two cousins' share and not out of the newcomer's. And the agreed number was an agreement, not a measurement. Nobody weighed the shop. Swap the cousins for founder A and founder B, the set-aside portion for a 10,00,000 share option pool, the newcomer for Nilgiri Venture Fund I and six individuals, and the agreed number for a pre-money of Rs 24,00,00,000, and the result is Aravalli's seed round exactly.

Where does the reading of these percentages go wrong?