Preparing for the Raise: The Terms Most Founders Ignore Until They Matter Most

Founders: Approaching your first priced round — a Series Seed or Series A, often with SAFEs converting into it?

Here's a mistake we see founders make: focusing so heavily on valuation that they don't pay enough attention to the terms that only matter later, when things aren't going perfectly.

Liquidation preference determines how the proceeds from an exit or other liquidation event are distributed among the company's securities. A 1x non-participating preference generally means investors get their original investment back first, and then the remaining proceeds are shared among the common and other applicable holders. That's the standard founder-friendly position. Some investors ask for 2x, meaning they receive twice their original investment before junior securities participate in the remaining proceeds. The higher the preference, the more value the company needs to generate before founders and employees fully participate in the upside.

And don't overlook participation. A 1x participating preference can be much more expensive for common than a 1x non-participating preference because the investor gets its preference and then also participates in the remaining proceeds.

These rights are typically established in the company's Certificate of Incorporation when the first preferred stock is issued. If your company has raised only on SAFEs, this may be the first time you're negotiating them. Once established, they're not something you want to discover you dislike when you're negotiating an exit.

Anti-dilution protection is designed to protect investors if the company later issues securities at a price below the applicable preferred stock's conversion price — most commonly in a down round.

There are two terms founders should know.

Full ratchet is the founder-unfriendly version. If an investor bought preferred stock at $10/share and the company later issues stock at $5/share, full ratchet can adjust the investor's conversion price all the way down to $5. That can result in significant additional dilution to common.

Broad-based weighted average is the usual venture-market formulation and is generally the one founders want. Instead of a full reset, it uses a formula that considers both the old price and the size of the new issuance, producing a partial adjustment.

The precise anti-dilution provisions — including exclusions and the formula itself — are negotiated in the financing documents, and a new preferred series can have different terms from earlier series.

The catch with both provisions is timing: you're negotiating them while you're excited about raising money and probably not thinking about a bad exit or down round.

But if either situation happens, the terms you've agreed to are already governing the economics.

Get them right when you're negotiating the financing — not when you need them most.

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TRANSCRIPT:

Lindsey S. Mignano:

Hi everyone, I'm Lindsey Mignano. I'm the founder of Mignano Law Group. I'm so happy to be here today. We're talking about venture capital financing today. I've got Ariana with me. I'm gonna let her introduce herself.

Ariana Shaffer:

Yes, of course. I'm really excited for this discussion today. Venture financing is one of my favorite areas of startup laws. Not only because it's such a monumental part in any startup, you know, you're finally raising money and but also it's just a really interesting time as a lawyer to get to negotiate on behalf of your clients. And it's where I started my career. I started my career at a big law firm doing startup financing, formations, all the way to MA exits and public company representation and then I went to a small startup where I was a founding attorney working on legal tech AI and then decided to round out that experience going to a public company and just learning the ins and outs of what it takes to go from a a small company all the way to a a big public company.

Lindsey S. Mignano:

Approaching a priced round raise. And this could be a series seed or a series A, right? You're likely a founder who might have had some safe notes, probably post-money valuation cap safes, which is the most common instrument that we're seeing today because they're investor friendly. But let's talk about what things we have seen our startup founders do in the past that maybe were like mistakes or like maybe just in retrospect they shouldn't have done

Ariana Shaffer:

Yeah, definitely. So I would start by saying ninety-nine percent of you know Series A financings that I've done have been on the NBCA documents, which are standard documents. They are available online. So if you're really eager, you can go download them now and start reading them to prepare for your first financing. And they have within them terms that are standard, but also they have options for different terms or

Different ways you can update the language based on if something's more company friendly or investor friendly. So they're a big negotiation piece. You know, you're going to have to do a a game of give and take when you do a financing round. With that being said, I think as attorneys and company counsel, our job is to just to make sure that you give yourself the best terms that are gonna allow you to grow and not have, you know, investors be too much in the way, right? Like you want your investors to be partners and to be able to, you know, advise you. And, you know, obviously you want them to give you more money over time, but you don't want them to be in the day-to-day operations or or to have too much control over what happens. And also if things aren't going well, and you know, unfortunately this happens sometimes, you have to raise what's called a down round, which means you're raising out a lower valuation than your previous.

You don't want them to have so much economic sway in that, where then you, as a founder, who's, you know, working day to day really hard on this, has no upside in the event you have to sell or or anything else. So that context kind of brings us to the key terms we're talking about in this section, which would be your preference stack and some other terms like broad base weighted average and and full ratchet, which we'll explain a little bit, but again, there's lots of, you know, thought leadership on this online. I'm sure at some point we'll put some up on our website as well. And so this isn't meant to be a class on these. It's just meant to kind of make you aware of what you should be looking for. So one mistake we see is the preference stack, which I mentioned, which typically what you would like to negotiate for is a 1x liquidation preference, which means that your investors are gonna get paid.

1x their liquidation when you have an exit. And you know, it could be MA, it could be IPO, et and what you sometimes see is investors being a little overzealous and they ask for 2x. I've never seen more than 2x, but I'm I'm sure it's happened. somewhere, some unlucky founder might have found themselves in that situation. But why that matters is because when you think about your preference stack. You know, you're gonna have your debt paid off first, then your investors, and then and then you as founders and, you know, employees. And so you don't want your investors to take more of that pool when it's time to sell the company or to go public than they're owed. And not even that they're owed, but that it doesn't leave anything left for you as a founder or for your employees. And so that's just something to really keep in mind, obviously, you know, investors are taking a risk investing in you, but you don't want that risk to then overshadow any economic upside that you would be given by giving them too much, you know, economic power, if you will, over the terms. And that term goes with a full ratchet and broad-based weighted average, which again will come up if you have to do a down round.

The typical way we like to see it and the most in the middle is called broad base weighted average, but you can sometimes see full ratchet. broad base weighted average, as the name implies, means it's taking a weighted average of the purchase price and so it adjusting the investor's purchase price to that. So they are getting a little more, right? Because you're doing a down round, they should get a little adjustment.

But it doesn't mean that they get the same price that the down round is now at. So full ratchet means they go from whatever their price was. So if it was $10 and now you're at $5, now they go to $5. And you can see how that would be really dilutive and, you know, economically not ideal for you. But broad-based weighted average uses a formula where it takes the weighted average of the two. And so that's more in the middle and what we always stress with founders because

When you're negotiating these, obviously you're not hoping that you have a down round. You're not even thinking about a down round. You're just thinking about how excited you are to be raising money. But when it is, you know, unfortunately when it happens that you have a down round, you want to just make sure you're protected because that's not the time to then negotiate whether it's full ratchet or or broad base weighted average. It's already gonna be baked into the documents and it can make a big difference for you.

Preparing for Pre-Seed: The #1 Securities Mistake Founders Make in Friends & Family Rounds

Raising a pre-seed or seed round from angels, family and friends?

Here's something worth knowing before you take those checks.

Many early-stage private rounds are structured to rely on Section 4(a)(2) of the Securities Act — the private-placement exemption for transactions “not involving any public offering.” But Section 4(a)(2) itself is a facts-and-circumstances standard. That's why we generally prefer Rule 506(b), a safe harbor for satisfying Section 4(a)(2) when its requirements are met.

Rule 506(b) permits unlimited accredited investors and up to 35 non-accredited investors, provided those non-accredited investors satisfy specified sophistication requirements and receive the required disclosures. It also prohibits general solicitation.

That can create a trap for founders. If a non-accredited investor participates, the Rule 506(b) conditions applicable to non-accredited investors come into play — including the sophistication and disclosure requirements. That's the kind of legal and administrative burden many early-stage founders aren't set up to handle.

And “accredited investor” is a legal standard that many friends-and-family investors don't think about. You don't necessarily have to ask a friend whether their net worth exceeds $1 million — that's just one way an individual can qualify. Income, certain professional credentials, and other categories can also establish accredited-investor status.

That's why we generally recommend that every investor — even someone you've known for twenty years — complete an accredited-investor questionnaire identifying the basis for their status and make a written representation. For a Rule 506(b) offering, the company generally needs a reasonable belief that an investor is accredited. The questionnaire helps document that determination, but it isn't a substitute for the company's reasonable-belief analysis.

If someone isn't accredited, that's not necessarily fatal to the round. But it changes the compliance analysis and can trigger additional disclosure and sophistication requirements. You can't simply have the investor acknowledge the risks and waive those requirements.

We also generally recommend avoiding a cap table cluttered with a bunch of very small checks — think $5,000–$7,000 contributions — not because small checks are inherently problematic, but because they can add administrative, governance and legal complexity without adding much capital. If you want to accept lots of small checks, there may be better structural options than putting every investor directly on the cap table.

None of this is meant to scare you off friends-and-family money. It's meant to help you avoid the securities-law and administrative problems we've actually seen play out.

The best practice is simple: establish your exemption, document each investor's status, and get the securities paperwork signed before the money moves — not after.

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Transcript:

Lindsey S. Mignano:

I do think we see a lot of founders who, you know, might take a round, a pre-seed or a seed round and include people who may not be accredited. it's not fatal per se. but I do, you know, note that we usually rely on 482 and 506B as a safe harbor in terms of securities exemption. So we try to get people to be accredited. We also try to limit like the small checks that are on the cap table. So like we don't see a bunch of five to seven thousand dollar contributions. Any anything to say on that in terms of like if I'm a founder and I have you know, a bunch of family and friends who are giving me smaller checks and may or may not be accredited, you know, how do I approach that? Is there anything that you would that you would say, just since we're talking about like kind of forward-looking advice?

Ariana Shaffer:

Yeah, definitely. I mean, and everything we say is because as, you know, lawyers, we've seen worst case scenarios. So it's never to scare you to say this is definitely what's gonna happen. It's more just that these are things we've seen and how we would prevent them. On the accreditation, as we've been talking about with safe rounds, a lot of times those are your first round and you might have family and friends that are investing with you.

And I mean, I don't know about you, but I don't go around asking my friends how much money they make and is their net worth over a million dollars. But if you technically as an accredited investor, those are some of the requirements. and you can look them up online that you know someone would have to have in order to be accredited. And the reason you want them accredited is because then safe financing would have safe harbor status, meaning you're not getting in trouble under, securities laws. And so what we like to do is just recommend that you have all of your investors do an accredited investor questionnaire. You can Google them, find them online. We can provide you with one. it asks them, their net worth or how much they make. And they have to kind of attest that they fit into one of the criteria required to be an accredited investor. And if they don't, then you know, at least you have that in writing that they aren't and they're aware of the risk with you know investing because the whole point of accredited investor is to protect people that might not have the knowledge or financial background from making, you know, maybe a financial decision that's not in their best interest. And so as long as you know that they're not accredited and they're comfortable with that and attest to that, that's you know the best we can do. But like best is obviously to have everyone that's investing to actually be able to say they have accredited investor status.