The division of assets is invariably a challenging part of divorce, made even more so when a business involved. The picture can become even more complex when the business in question is an early-stage startup. The seed funding such a venture has secured to develop their product, conduct market research, make key early hires, purchase equipment, and rent office space as they try to get a business up and running may sound like a simple pot of money to be divided fifty-fifty in a divorce. Further, the non-founder spouse may be eager to extract what value they can out of the business, given that there is no guarantee even the most promising startup will become a commercial success. However, the status of seed funding as a potential marital asset is far more complex than one might assume at first glance.
To understand why there is no simple answer to the question, “Do I have access to my spouse’s seed funding in divorce?” it’s necessary to examine the terms under which the seed funding was obtained and when. Depending on the circumstances, a seed funding investment may affect the share of equity the founder has in the startup now, or it may affect that share in the future as (or if) the company grows. The assistance of knowledgeable legal and financial professionals is essential to determine what portion of the startup and its assets are subject to division.
- What Is Seed Funding?
- Seed Funding and Marital Assets in Divorce
- Divorce Settlements and Seed Funding
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What Is Seed Funding?
While the terms “venture capital” and “seed funding” are sometimes used interchangeably, they aren’t precisely the same thing. Seed funding refers to the money raised by a startup in its earliest stage to allow it to grow (thus the name “seed”). Generally, this just covers the initial stages of development to try to get the company to the point where it can attract further, larger funding rounds from venture capitalists. The typical progression is seed funding, then Series A, Series B, Series C, etc., assuming the company continues to grow and thrive.
The level of investment at the seed stage is relatively modest—anywhere from $500,000 to $5 million. Seed funding is where cash investment starts to come into play, although it doesn’t necessarily net investors any actual ownership in the company immediately. Seed funding tends to come from private “angel” investors rather than large venture capitalists, although some VC firms may provide seed-stage investments. These types of investors trade high risk (after all, the startup may not ever achieve success) for the potential of gaining an interest in the company before it goes up in value.
Seed funding rounds can be either priced or convertible. In a priced round, a number of shares of preferred private stock are sold to the investor at a set price per share to raise capital. This gives the investor an equity share in the company. In convertible seed funding, a Simple Agreement for Future Equity (SAFE) or a convertible note is sold for capital amounts that will later convert into stock or equity in the company if it succeeds. For the investor, their seed investment has no real set value while it is still in the SAFE or note stage because they haven’t received stock in exchange for it yet. In short, depending on the terms, seed funding can yield equity in a startup, but it doesn’t necessarily mean there is equity right away.
Less commonly, seed funding could be provided in the form of a loan to be repaid, which would make it a liability to the business rather than an asset.
Seed Funding and Marital Assets in Divorce
In general, the first thing a court will look at in determining which property is subject to division in a divorce is when it was acquired. Property that each party brought into the marriage is considered separate property, while that which was earned by either party during the marriage is typically considered community property. (Gifts and inheritances, if kept separate, are also separate property even if received during the marriage.) If one spouse founded the startup and received seed funding prior to the start of the marriage, then it would most likely be considered separate property. A prenuptial or postnuptial agreement can also be effective in establishing a startup and its assets as separate property.
In the absence of such a legal agreement, seed money invested in the startup is considered marital property if it was received during the time of the marriage. However, it’s not always clear what the initial value of that asset is if it is in SAFEs and notes. It may also not be immediately obvious what impact seed funding has on a founder’s share of the company’s equity and its value.
Add to this consideration the fact that business valuations for early-stage startups can be particularly difficult, and it becomes clear that both parties in a divorce should take care to avoid making assumptions. Instead, consultation with legal professionals well-versed in family law, as well as financial professionals able to provide insight into the startup’s value and its obligations regarding seed funding, will be essential in determining what portion of a founder’s share in a startup is subject to division and what it is worth.
Divorce Settlements and Seed Funding
While California law requires an even split of marital property, couples who negotiate a settlement agreement have flexibility in how they divide their marital property. A startup founder who prioritizes maintaining control and ownership of their company and its funding may be motivated to exchange their share of other assets to produce an equitable division. This approach puts added importance on accurate valuation and asset characterization, however, because the risk of producing an unfair division of marital property increases when parties are not walking away with identical shares of each asset in question. Each party should consult with their respective attorneys to decide if working out such a deal is possible and, if so, if it is in their best interest.
Family Law Expertise for Startup Founders
The end of your marriage can cast a cloud of uncertainty over the status of your startup’s seed funding. The experienced family law attorneys at Hoover Krepelka can help provide clarity and expert assistance with complex property division that can help founders protect their entrepreneurial endeavors while achieving an equitable division of property with their spouse. To schedule your consultation, fill out the form below.
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