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Seed Financing and Term Sheets
 

Seed Financing and Term Sheets

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Explores valuation, debt capitalization, equity capitalization, term sheet provisions, and terms of new series of preferred stock.

Explores valuation, debt capitalization, equity capitalization, term sheet provisions, and terms of new series of preferred stock.

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    Seed Financing and Term Sheets Seed Financing and Term Sheets Presentation Transcript

    • 2012 Summer Legal Series Seed Financing and Term Sheets Attorney Advertising
    • © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 1
    • A. Valuation 1. Comparables – Search for comparable companies based on growth rate, risk profile, capital structure, size and timing of cash flows. – Industry-specific metrics may include subscribers, members, “clicks”, etc. – Problem of information gaps with private companies; difficulties with comparability of private and public companies. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 2
    • 2. Net Present Value – Discounted present value of projected cash flows and assumed terminal value; terminal value a large component of total value. – Assumptions and estimates critical (growth rate, discount rate, exit multiple, etc.) to value. – Analysis difficult for start-up companies with significant outflows in the early years followed by speculative projected inflows in uncertain future periods. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 3
    • 3. Venture Capital Method – Projected terminal value, discounted to present value. – Often adjusted for expected subsequent dilutive rounds of financing. – Designed to arrive at desired investment return. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 4
    • B. Debt Capitalization 1. Loans – Fixed in principal amount, maturity, interest rate. – First claim against assets. – Terms capable of being modified or extended. – Preserves equity at the cost of ongoing debt service and specified maturity date. – Lender control issues. – Adequacy of capital issues. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 5
    • 2. Convertible Notes – Debt and equity features. – Debt: fixed principal amount, maturity, interest rate. – Debt claims against assets. – Principal (and sometimes accrued interest) may be converted into equity. – Conversion may be at the option of the holder or the company, and may be subject to certain contingencies. – Often convertible (sometimes at a discount) into securities issued in first equity round raised from outside investors; effectively postpones need for valuation until outside investors have set a value. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 6
    • C. Equity Capitalization 1. Common Stock – Basic unit of equity ownership. – Entitled to share in residual assets after payment of liabilities to creditors and lenders and claims of holders of senior equity securities. – Entitled to dividends if, as and when declared by the board of directors. – Except for matters expressly governed by a vote of senior equity securities, entitled to vote on all matters presented to stockholders. – In special cases, common stock may be divided into classes with disproportionate or no voting rights; often used to maintain control of founding family shareholders or for regulatory reasons. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 7
    • 2. Preferred Stock – Preferred stock may be a “straight” preferred (non-convertible into common stock) or convertible into common stock at the option of the holder or upon the occurrence of certain events. – Preferred stock may be “permanent” (not redeemable under any circumstances) or redeemable (at set times or at the option of the holder or the company). – Generally, has a preference over common stock or other junior equity securities as to rights in liquidation and/or rights to receive dividends. – Liquidation event includes dissolution or winding-up of the company and, typically, a merger or sale of the company or other transaction involving a change of control. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 8
    • D. Term Sheet Provisions Scope of Financing – Size of offering – Price per share – Pre-money valuation – Resulting capitalization © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 9
    • Terms of New Series of Preferred Stock 1. Dividends – Specified dividend rate not typical for venture investments; preferred stock will generally prohibit dividends on common stock as long as the preferred stock is outstanding or unless comparable dividends are paid on the preferred stock and common stock – Preferred stock with a specified dividend rate may either provide for “cumulative” or “non-cumulative” dividends – Cumulative dividends will accumulate, whether or not declared by the board, and will be added to amounts payable in liquidation; in certain cases, cumulative dividends may compound, usually either quarterly or annually; dividends may also be payable in certain events, such as upon conversion or upon the closing of an IPO; may also be used to increase amount of shares issuable upon conversion into common stock © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 10
    • 2. Liquidation Preference – Liquidation event includes dissolution or winding-up of the company and, typically, a merger or sale of the company or other transaction involving a change of control – Liquidation preference generally equal to invested capital, plus declared and unpaid dividends or, in some cases, accrued dividends – Liquidation preference may be a multiple of invested capital, guaranteeing a minimum positive return if conversion into common stock not financially superior – A participating preferred stock will be entitled to a liquidation preference plus the right to share with the common stock in residual assets based on the assumed conversion of the preferred into common stock © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 11
    • 3. Convertible Into Common Stock – Typically, preferred stock convertible into common stock at any time at the option of the holder into a number of shares based on the following formula: Original Issue Price Conversion Price – Initially, the Conversion Price is typically set equal to the Original Issue Price so that each share of preferred stock will be convertible into one share of common stock – Conversion Price will be proportionally adjusted for subsequent stock splits, stock dividends, recapitalizations and similar organic changes – Conversion Price will also be adjusted for subsequent dilutive offerings (offerings below the then current Conversion Price of the preferred stock); exceptions for issuance of common stock upon conversion of existing convertible securities, employee stock plans up to a certain amount or as approved by the board, shares issued in correction with acquisitions or to lenders, vendors or others in connection with various business arrangements © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 12
    • − “Full ratchet” adjustment will adjust the Conversion Price downwards to the price of any dilutive offering, regardless of the number of shares issued in the dilutive offering − “Weighted average” adjustment is more typical and takes into account the price and size of the dilutive offering relative to the previously outstanding stock − “Broad-based” versus “narrow-based” weighted average antidilution formulas; “broad-based” will count all outstanding options and convertible securities in the fully-diluted calculation of shares outstanding and will result in a smaller adjustment then a “narrow-based” formula which may include only outstanding common stock and stock issuable upon the conversion of the preferred stock © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 13
    • 4. Mandatory Conversion Provisions − − Requires conversion upon closing of a “Qualified Public Offering” Defined typically as an initial public offering with minimum net proceeds to the company ($50 - $75 million) and a minimum price to the public (representing a multiple of the preferred conversion price) 5. Redemption of Preferred Stock − Right of holders to require redemption by the company at specified time or times − Mechanism to force liquidity event after sufficient time to implement business plan − Corporate law prevents company from redeeming equity without adequate “surplus” − Remedies for failure to redeem may include additional board seats © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 14
    • 6. Preferred Stock Covenants − Affirmative: delivery of financial and other information, access to management and corporate records, board representation and frequency of meetings, payment of obligations, etc. − Negative: merger, sale or change of control transaction, sale of assets, capital expenditures, incurrence of debt, affiliate transactions, adoption of employee equity plans, change of business strategy, issuance of senior or pari passu equity securities, etc. − Covenants may require decisions by preferred shareholders, by the board of directors or by representatives of the preferred shareholders on the board; importance of group dynamics with multiple rounds of financing − Remedies problematic since preferred stock cannot be declared “due and payable” like debt; often limited to damage claims, equitable remedies or rights to additional board seats © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 15
    • 7. Voting Rights − Class vote on matters specifically affecting the preferred stock; changes to the rights of the preferred stock, issuance of additional preferred stock or senior equity securities, election of preferred stock designees to the board, merger or sale, etc. − Typically, will vote on an as-converted basis with the common stock. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 16
    • © 2014 Wilmer Cutler Pickering Hale and Dorr LLP WilmerHale 17
    • Bob Schwed Robert.Schwed@wilmerhale.com +1 212 937 7276 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/code-of-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