Oftentimes in connection with an angel or seed rounds of financing, start-ups will raise initial capital through the sale of convertible promissory notes as opposed to selling preferred stock. One of the key considerations in a note financing is whether the notes will be secured by the assets of the company. A secondary issue is whether the security interest extends to all assets, including IP, or whether IP assets are carved out. The necessity / appropriateness of a security interest in such financings is often debated.
We recently conducted an informal poll of the partners in Goodwin Procter’s Technology Companies Practice asking how often we encounter security interests in seed or angel round bridge note financings. The responses varied but the consensus was that security interests are present minority of transactions. The logic for the lack of security interests appears to be based on a cost-benefit analysis, as there are incremental transactions costs (legal time, filing fees, etc.) in implementing and perfecting security interests, particularly with respect to IP. The benefits of such security interests may be marginal, as there is often little value to the assets of a start up relative to the amount of debt raised, particularly if the start up never completes its Series A financing and there is no going concern.
This post on Seed Financing was authored by Ian Engstrand.