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Doing an Equity Round - Negotiating Price
 

Doing an Equity Round - Negotiating Price

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Explores negotiating the Series A price, pre-money and post-money valuation, and option pool.

Explores negotiating the Series A price, pre-money and post-money valuation, and option pool.

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    Doing an Equity Round - Negotiating Price Doing an Equity Round - Negotiating Price Presentation Transcript

    • Doing an Equity Round – Negotiating Price Jen Berrent Inga Goldbard October 22, 2013 Attorney Advertising
    • Negotiating the Series A Price Economic Terms of a Series A Investment:  Pre-Money Valuation  Series A Investment (“New Money”)  Any outstanding Notes that may convert  Post-Money Option Pool – Expressed as a percent of post-money shares outstanding – Change in option pool is implemented immediately prior to the financing (so included in pre-money fully diluted shares outstanding)  Post-Money Valuation © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 2
    • What is Pre-Money Valuation?  Generally negotiated by the Company with the “lead” investor  As a rule, the investor wants a lower valuation, and Company wants a higher valuation – However, there can be drawbacks to setting the valuation TOO HIGH in an early financing round (“valuation overhang”)  More an art than a science for early stage companies – Often determined based on the percentage of the company investors and founders are willing to exchange for the amount of cash being put in (e.g. 20% for $1M = $5M pre-money valuation) © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 3
    • Calculating Pre-Money Valuation  Company-Specific Factors investors may consider: – Market opportunity (size, growth potential, competition) – Strength of management team (track record, vision, credentials) – Strength of product – Progress to date  Ask investors to explain their valuation analysis – This may not get you more money, but will at least give you more information  Negotiable in tandem with other terms of the financing (liquidation preferences, dividends, anti-dilution, etc.) © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 4
    • What is the Series A per share price? Price per share = Pre-Money Valuation ($) (Current Shares + Options Outstanding [+ Conv. Note Shares] + Unallocated Option Pool) But this is circular! © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 5
    • What is the Series A per share price? Quick Note on Convertible Notes:  If there are convertible notes outstanding that either automatically convert into Series A shares, or may elect to convert into Series A shares, the value of the notes may be included as part of the pre-money or the post-money valuation – More favorable for the Company for Notes to be part of postmoney (higher price per share)  Can be negotiated in tandem with other financing terms © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 6
    • What is the Series A per share price? Post-Money Option Pool The circularity is:  The price per share for the Series A stock is based on the fully diluted number of shares prior to the financing including the option pool  The size of the option pool is based on the fully diluted number of shares after the financing  The fully diluted number of shares after the financing is based on the price per share for the Series A stock © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 7
    • The Option Pool Shuffle The following narrative is from a blog (venturehacks.com/articles/option-pool-shuffle) and it illustrates the option pool circularity  The punch line is: Don’t let your investors determine the size of the option pool for you. Use a hiring plan to justify a small option pool, increase your share price, and increase your effective valuation.  Our focus: The Series A per share price calculations (i.e., math). © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 8
    • The Option Pool Shuffle You have successfully negotiated a $2M investment on a $8M premoney valuation by pitting the famous Blue Shirt Capital against Herd Mentality Management. Triumphant, you return to your company’s tastefully decorated loft or bombed-out garage to tell the team that their hard work has created $8M of value. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 9
    • The Option Pool Shuffle Your teammates ask what their shares are worth. You explain that the company currently has 6M shares outstanding so the investors must be valuing the company’s stock at $1.33/share: $8M pre-money ÷ 6M existing shares = $1.33/share. Later that evening you review the term sheet from Blue Shirt. It states that the share price is $1.00… this must be a mistake! Reading on, the term sheet states, “The $8 million pre-money valuation includes an option pool equal to 20% of the post-financing fully diluted capitalization.” You call your lawyer: “What?!” © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 10
    • The Option Pool Shuffle As your lawyer explains that the so-called pre-money valuation always includes a large unallocated option pool for new employees, your stomach sinks. You feel duped and are left wondering, “How am I going to explain this to the team?” The option pool lowers your effective valuation. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 11
    • The Option Pool Shuffle Your investors offered you a $8M pre-money valuation. What they really meant was “We think your company is worth $6M. But let’s create $2M worth of new options, add that to the value of your company, and call their sum your $8M ‘pre-money valuation’.” For all of you MIT and IIT students out there: $6M effective valuation + $2M new options + $2M cash = $10M post or 60% effective valuation + 20% new options + 20% cash = 100% total. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 12
    • The Option Pool Shuffle Slipping the option pool in the pre-money lowers your effective valuation to $6M. The actual value of the company you have built is $6M, not $8M. Likewise, the new options lower your company’s share price from $1.33/share to $1.00/share: $8M pre ÷ (6M existing shares + 2M new options) = $1/share. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 13
    • Post-Money Valuation So what is the Company actually worth after the Series A financing? $5M Pre-Money Valuation + $1M New Money + $500k [Value of Convertible Notes] _______________________________________ $6.5M Post-Money Valuation Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/codeof-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 14