Josh Cook – PreMoney Presentation
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  • Hi, I’m Josh Cook and I’m a partner a gunderson Dettmer. A couple key stats on our activity as a firm . . .
  • A few high level stats about gunderson
  • And of course Dave’s been keeping us busy. He likes to say he’s made me into the most active startup lawyer in the world.  Dave asked me to talk about current affairs on legal docs in the seed and angel world.
  • I want you to pay lawyers less!!
  • I can tell you a lot has changed in recent years. young companies are running leaner, more efficiently and at much lower costs. And that’s put pressure on the legal community to keep costs down as well. The good news is that we’ve responded for the most part and that translates into more company for the companies to leverage growth. overall documents have gotten simpler. legal fees have come way down. And, if this were a different conference, I tell you why that was good for our business.
  •  Suffice to say, if you’re doing a deal, you’re basically looking at two structures – CN and Series SeedTalk about 500k priced and 3.5M convert noteI’ll save you the suspense and tell you that I’m generally a proponent of priced seed rounds.
  • Convert into preferred AND commonConvert pre-money and take dilutionConvert into shadow series with varying preference prices to match conversion pricesLower pre-money valuation but agree to adopt a post-money pool (so noteholders don’t get benefit of pre-money shares)
  • – [ANECDOTE ABOUT PUBLIC COMPANY VENTURE ARM AND “BUYING” RIGHT TO NEGOTIATE. I GAVE THEM SHIT ON MAKING CHANGES WHEN INVESTED 250K BUT WAS RECEPTIVE IN THE 20M ROUND. THEY THOUGHT I WAS BEING INCONSISTENT. I AGREED.]OPTIMIZE FOR COMPANY SUCCESS NOT CORNER CASES OR LOW PROBABILITY RISKIN context of series seed, don't solve for low probability of riskin context of giant merger, tend to solve for outside risksIf we’re saying most will fail and its about
  • [reference dave’s stats for failure from moneyball for startups]
  • Definitely stole that from Dave!
  • [speaker note feels like the best investors out there really don’t.][SPEAKER NOTE Don’t optimize for every event – REMEMBER – if this hits big, let the next investor be the bad guy. True Ventures is fantastic at this. Just closed a seed round where they didn’t use lawyers so long as I agreed that I “wouldn’t screw them” but next investors where notes convert will ask for full blown set of docs with all the bells and whistles]OPTIMIZE FOR COMPANY SUCCESS NOT CORNER CASES OR LOW PROBABILITY RISKCOMPARED TO MERGER – WHERE YOU SPEND CONSIDERABLE TIME OPTIMIZING FOR THOSE CORNER CASES
  • Again, if thesis is many of these will die, then align that thesis with paperworkIf we’re going to fail fast, we need to fail cheaply and frequentlyYou don’t need a full set of docs, but you do need folks that have done this more than once in the last year. Achieve consistency in the portfolio youre building and how you’re achieving that goals
  • [Speaker note: I don’t care]
  • (like my early days on Digg and LinkedIn)

Transcript

  • 1. Term Sheet [R]Evolution: Notes, Caps, & Other Josh Cook
  • 2. LETS TALK ABOUT ME > 2,000 company clients > 950 venture financings annually >60 venture fund formations annually Oh, by the way, we have been #1 firm in Dow Jones survey 3 years in a row and #1, #2 or #3 in every year the survey has been done. (true story)
  • 3. And, of course, for
  • 4. My mantras . . . REMOVE FRICTIONS DO ONLY WHAT WE MUST FAST AND EFFICIENT DON’T INNOVATE ON SEED STAGE LEGAL
  • 5. ANCIENT HISTORY Several years ago . . . • Very few angel investors • Many companies start with $3-5M Series A • 4-6 weeks close • Board seat and negotiated investor rights • $50K legal fees for both sides • Fewer “forms” • Lucite deal toys () and velobound closing books ()
  • 6. AND NOW? • Lots of seed deals and even more angel investors • Sub $1M with varying “caps” or valuations • Close within days and floating or rolling closes over months • No board seat and limited investor rights • $5-15k legal fees • “Preferred forms” for YC, Techstars, seriesseed, and varying institutional angels • No Lucite toys () and no velobound books ()
  • 7. THE BASICS Two types of investments • Convertible Notes • Series Seed Preferred Stock Rule of thumb: • > $1M tend to be Series Seed • < $1M tend to be convertible note
  • 8. THE LINGO (NOTES) Material Note terms: • The “cap” and discount • Other stuff: – Conversion triggers – Sale of company treatment • Participation rights (i.e. preemptive rights, the ROFO, or Pro Rata Rights) • Maturity • Interest
  • 9. THE LINGO (SERIES SEED) Material Series Seed terms: • “pre-money” valuation • Sale of company treatment (i.e. preference, almost always “non participating”) • Participation rights • Most Favored Nations – ie don’t treat me worse than the next guy (Notice I left out board seat and protective provisions)
  • 10. notes can suck
  • 11. why notes can suck Do you know what you own? (Hint: You don’t) • Confusion about how these convert: pre- or post-money? • New investors may ask you to do something different from your NPA with the company
  • 12. Other Issues “Phantom preference” or “preference premium” on conversion • $1M convert with 50% discount, can mean noteholders end up with $2M in preference (Pro tip: there are some ways to solve this)
  • 13. Other Issues Full Ratchet (search “Full ratchet mark suster” for more detail) • Hasn’t been an issue recently since valuations have generally been going up No Stockholder Rights ( But you do have creditor rights: you can allege things like fraudulent conveyance instead of appraisal rights) (With acquihires it really doesn’t matter)
  • 14. NOTES STILL COOL FOR SOME REASONS • Paperwork still simpler (although only just slightly) • Less governance overhang – Investors generally accept no board seat and few or no veto rights • Avoids valuation for 409A purposes – – Valuation firms don’t see a “cap” as a valuation (as they would treat a valuation in a preferred equity round) • Investors are accustomed to them now
  • 15. I’m a Series Seed Fanboy Certainty around ownership !!! (Pro Tip: That’s a really good thing) Paperwork about as simple as convertible debt Investors have rights as “stockholder” (but remember that stockholders stand behind creditors (noteholders) in line for payment)
  • 16. But Series Seed has issues . . . • Investors tend to want to negotiate board seats and protective provisions (when they otherwise wouldn’t if it were a convertible note) • Can make for complicated cap table if raising at multiple valuation (compared to multiple caps with notes)
  • 17. Context CONTEXT CONTEXT CONTEXT
  • 18. remember: high failure rate for many of these companies
  • 19. Thanks for the photo Dave
  • 20. Worth Repeating REMOVE FRICTIONS DO ONLY WHAT WE MUST FAST AND EFFICIENT DON’T INNOVATE ON SEED STAGE LEGAL
  • 21. Don’t sweat the small stuff KEEP IT SIMPLE AND ACTIONABLE - dave mcclure Who gives a sh*t about interest? How do lengthy reps and warranties protect you? (Hint: They don’t. But get some basics, IP and litigation.) Maturity only kinda matters
  • 22. STANDARD DOCS ARE YOUR FRIEND 500 startups YC SERIESSEED Angelpad AngelList OTHER INVESTORS ARE YOUR FRIENDS Piggyback off their efforts. Talk to the anchor investors. MOST LAWYERS CARE TOO MUCH Find one that can address your goals without driving up costs.
  • 23. SO WHAT MATTERS? Conversion Triggers for Notes MFN – For both Notes and Series Seed Company Sale – What are your rights and what are EXPECTATIONS? Participation rights – Try to lock these in (Pro tip: Harder for the 25k and under crowd)
  • 24. Conversion • Ask what happens in three events: – Equity financing – most important to trigger to a “qualified financing.” No need to solve for a non qualified financing (although you’ll see that in many forms). Company typically incentivized to want to convert you. They can ask. – Sale of company – ask for either multiple return (2x or 3x) or ability to convert. (Maybe both – we’ll talk about that in acquihire protections.) – Maturity – There a some nuances here in corner cases worth considering. • But generally, you don’t want the company to pre pay when you don’t want them to – either before or after maturity. • Most deals 18-24 months
  • 25. Despite what I said We SHOULD Innovate In Legal • Don’t be an “early adopter,” but be an active lurker • Capped deals – that’s a relatively recent change • Seriesseed.com forms • “Convertible Security” (http://bit.ly/OGgJnF) • Others: – AngelList – Clerky – Eshares – Digital signature services
  • 26. Josh Cook, Gunderson Dettmer 650-463-5267 jcook@gunder.com @joshcook Gunderson Dettmer LLP @gundersonlaw www.gunder.com