Term Sheets 2 Common Stock

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Term Sheets 2 Common Stock

  1. 1. Term Sheets
  2. 2. Common Stock (Common Equity) <ul><li>Common Stock: the least senior claim on a venture’s asset (residual ownership) </li></ul><ul><ul><li>Voting rights </li></ul></ul><ul><ul><li>Right to legal dividends </li></ul></ul><ul><ul><li>Preemptive rights: </li></ul></ul><ul><ul><li>right for existing owners to buy sufficient shares to preserve their ownership share </li></ul></ul>
  3. 3. Preferred Stock (Preferred Equity) <ul><li>Preferred Stock: </li></ul><ul><li>equity claim senior to common stock providing preference on dividends and liquidation proceeds </li></ul><ul><ul><li>Dividends as a percent of par </li></ul></ul><ul><ul><li>Non-cumulative v. cumulative </li></ul></ul><ul><li>Participating Preferred Stock: </li></ul><ul><li>preferred stock with rights to participate in any dividends paid to common stockholders or preferred stock with an investment repayment provision that must be met prior to distribution of returns to common stockholders </li></ul>
  4. 4. Preferred Stock (Preferred Equity) <ul><li>Paid in kind (PIK) Preferred Stock: </li></ul><ul><li>preferred stock that has the option of paying preferred dividends by issuing more preferred stock </li></ul><ul><li>Redemption Feature: </li></ul><ul><li>preferred stock feature permitting venture to redeem (buy back) preferred security </li></ul><ul><li>Convertible Preferred Stock: </li></ul><ul><li>preferred stock with option to exchange into common stock </li></ul><ul><li>Conversion ratio vs. conversion price </li></ul><ul><li>Down (reset) round: </li></ul><ul><li>venture round priced below most recent previous price </li></ul>
  5. 5. Convertible Debt <ul><li>Convertible debt: </li></ul><ul><li>debt that converts into common equity </li></ul><ul><ul><li>Has bankruptcy rights </li></ul></ul><ul><ul><li>Has security interests in venture’s assets senior to preferred shareholders’ interests in venture’s assets </li></ul></ul>
  6. 6. Options <ul><li>Option: </li></ul><ul><li>right to buy or sell additional shares of stock </li></ul><ul><li>Call Option: </li></ul><ul><li>right, not the obligation, to purchase a specified asset at a specified price </li></ul><ul><li>Put Option: </li></ul><ul><li>right, not the obligation, to sell a specified asset at a specified price </li></ul><ul><li>American-Style Option: </li></ul><ul><li>an option that can be exercised at any time until expiration </li></ul><ul><li>European-Style Option: </li></ul><ul><li>an option that can be exercised only at expiration date </li></ul><ul><li>Bermuda-Style Option: </li></ul><ul><li>an option that can be exercised only at a specific set of dates </li></ul>
  7. 7. Option Payoffs <ul><li>Out of the money options: </li></ul><ul><li>not currently worth exercising </li></ul><ul><li>At the money options: </li></ul><ul><li>breakeven current exercise </li></ul><ul><li>In the money options: </li></ul><ul><li>profitable current exercise </li></ul>
  8. 8. Warrants <ul><li>Warrants: </li></ul><ul><ul><li>call options issued by a company granting the holder the right to buy a common stock at a specific price for a specific period of time </li></ul></ul><ul><ul><li>Typically involves new shares </li></ul></ul>
  9. 9. SOLICITING INVESTMENTS: Suppliers of Venture Capital – 25-Year Average
  10. 10. OBTAINING COMMITMENTS: Arrangements with Fund Investors <ul><li>Capital Call: </li></ul><ul><li>when the venture fund calls upon the investors to deliver their investment funds </li></ul><ul><ul><li>Common to require subsequent investments consistent with the levels of investors’ initial contributions </li></ul></ul>
  11. 11. DUE DILIGENCE AND ACTIVE INVESTING: VC Fund Management <ul><li>Deal flow: </li></ul><ul><li>flow of business plans and term sheets involved in the venture capital investing process </li></ul><ul><li>Due diligence (in venture investing context): </li></ul><ul><li>process of ascertaining the viability of a business plan </li></ul>
  12. 12. VC Screening Criteria <ul><li>1. Venture Capital Firm Requirements </li></ul><ul><li>2. Characteristics of the Proposal </li></ul><ul><li>3. Characteristics of the Entrepreneur/Team </li></ul><ul><li>4. Nature of the Proposed Industry </li></ul><ul><li>5. Strategy of the Proposed Business </li></ul>
  13. 13. VC Screening Criteria <ul><li>1. Venture Capital Firm Requirements </li></ul><ul><ul><li>Cash out potential </li></ul></ul><ul><ul><li>Equity share </li></ul></ul><ul><ul><li>Familiarity with technology, product, market </li></ul></ul><ul><ul><li>Financial provisions for investors </li></ul></ul><ul><ul><li>Geographic location </li></ul></ul><ul><ul><li>Investor control </li></ul></ul>
  14. 14. VC Screening Criteria <ul><li>Venture Capital Firm Requirements (cont’d) </li></ul><ul><ul><li>Investor control </li></ul></ul><ul><ul><li>Investor group </li></ul></ul><ul><ul><li>Rate of return </li></ul></ul><ul><ul><li>Size of investment </li></ul></ul><ul><ul><li>Stage of development </li></ul></ul>
  15. 15. VC Screening Criteria <ul><li>2. Characteristics of the Proposal </li></ul><ul><ul><li>Requirement for additional material </li></ul></ul><ul><ul><li>Stage of plan </li></ul></ul>
  16. 16. VC Screening Criteria <ul><li>3. Characteristics of the Entrepreneur/Team </li></ul><ul><ul><li>a. Ability to evaluate risk </li></ul></ul><ul><ul><li>b. Articulate regarding the venture </li></ul></ul><ul><ul><li>c. Background/experience </li></ul></ul><ul><ul><li>d. Capable of sustained effort </li></ul></ul><ul><ul><li>e. Managerial capabilities </li></ul></ul><ul><ul><li>f. Management commitment </li></ul></ul><ul><ul><li>g. References </li></ul></ul><ul><ul><li>h. Stake in firm </li></ul></ul>
  17. 17. VC Screening Criteria <ul><li>4. Nature of the Proposed Industry </li></ul><ul><ul><li>Market attractiveness </li></ul></ul><ul><ul><li>Potential size </li></ul></ul><ul><ul><li>Technology </li></ul></ul><ul><ul><li>Threat resistance </li></ul></ul>
  18. 18. VC Screening Criteria <ul><li>5. Strategy of the Proposed Business </li></ul><ul><ul><li>Product differentiation </li></ul></ul><ul><ul><li>Proprietary product </li></ul></ul>
  19. 19. Screening Outcomes <ul><li>1. Seek lead investor position </li></ul><ul><li>2. Seek a non-lead investor position </li></ul><ul><li>3. Refer venture to more appropriate financial market participants </li></ul><ul><li>4. SLOR (standard letter of rejection) the venture </li></ul>
  20. 20. Structuring a VC Investment <ul><li>Term Sheet: </li></ul><ul><li>summary of the investment terms and conditions accompanying an investment </li></ul><ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Valuation </li></ul></ul><ul><ul><li>Ongoing funding needs </li></ul></ul><ul><ul><li>Size and staging of financing </li></ul></ul><ul><ul><li>Preemptive rights on new issues </li></ul></ul><ul><ul><li>Commitments for future financing rounds and </li></ul></ul><ul><ul><li> performance conditions </li></ul></ul><ul><ul><li>Form of security or investment </li></ul></ul><ul><ul><li>Redemption rights and responsibilities </li></ul></ul>
  21. 21. Structuring (cont’d) <ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Dividend structure (Number of VCs and outsiders) </li></ul></ul><ul><ul><li>Additional management </li></ul></ul><ul><ul><li>Conversion value protection </li></ul></ul><ul><ul><li>Registration rights </li></ul></ul><ul><ul><li>Exit conditions and strategy </li></ul></ul><ul><ul><li>IPO-dictated events (e.g. conversion) </li></ul></ul><ul><ul><li>Co-sale rights (with founders) </li></ul></ul><ul><ul><li>Lock-up provisions </li></ul></ul>
  22. 22. Structuring (cont’d) <ul><li>Typical Issues Addressed in a Term Sheet </li></ul><ul><ul><li>Employment contracts </li></ul></ul><ul><ul><li>Incentive options </li></ul></ul><ul><ul><li>Founder employment conditions: compensation, benefits, duties, firing conditions, repurchase of stock o termination, term of agreement, post-employment activities and competition </li></ul></ul><ul><ul><li>Founder stock vesting </li></ul></ul><ul><ul><li>Confidentiality agreements and protection for intellectual property </li></ul></ul>

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