Negotiating the Preferred Stock Term Sheet    in Today’s Market Place    Presented by Bart Greenberg    Haynes and Boone, ...
Certain Preliminary Matters© 2010 Haynes and Boone, LLP
Market Conditions Impact Terms     • Shortage of willing investors leads to       aggressive terms     • Desire by Investo...
Prior Rounds Impact Terms        • Severe down round/cramdown (leads          to most aggressive terms)        • Flat roun...
Valuation • Means many different things • $2.5 million pre-money with $2.5 million new money   could mean:          – Orig...
Defining the Terms of the                      Preferred Stock© 2010 Haynes and Boone, LLP
Dividends        Considerations                               • Priority of Payment                                   •Com...
Dividends                  Pre-         • Non-mandatory, non-cumulative                  Bubble        8% per year        ...
Dividends            Example             “Annual $_____ per share dividend on the Series ___             Preferred Stock, ...
Liquidation Preference        Considerations                               •   Should the holder have a                   ...
Liquidation Preference       A                   B         C              D               E               F              G...
Liquidation Preference              Pre-             •• 1X purchase price, plus participation              Bubble         ...
The “Waterfall”                                         First: Creditors Satisfied                                       S...
The “Waterfall” (an illustration) Amount Available for Distribution: $15,000,000      Term Sheet: 1x preference for Series...
Liquidation Preference   Example 1: Full Participation                    “First pay the original purchase price [plus pre...
Liquidation Preference      Example 2: Cap on Participation Rights            “First pay the original purchase price plus ...
Liquidation Preference      Example 3: Non-Participating            “First pay the original purchase price [plus          ...
Redemption        Considerations                               • Who can trigger?                                   • Perc...
Redemption                  Pre-         • Not Common                  Bubble                  Post-        • At option of...
Redemption   Example 1: Lump Sum            “Series ___ Preferred Stock redeemable at the            election of holders [...
Redemption   Example 2: Three Tranches            “[See Example 1], to the extent of 1/3 of the shares            of Serie...
Conversion Rights        Considerations                               •   The number of shares of common                  ...
Antidilution Adjustments        Considerations                               •   Way to “fix” earlier valuation           ...
Antidilution Adjustments                 Pre-          • Standard broad-based weighted                 Bubble          ave...
Antidilution Adjustments (an illustration)  Scenario:              Common Stock Outstanding      1,000,000 shares         ...
Antidilution Adjustments - Pay to Play     • If stockholder does not purchase pro rata       share in subsequent offering,...
Antidilution Adjustments   Example 1: With Pay to Play            “Conversion ratio for Series ___            Preferred St...
Antidilution Adjustments   Example 2: Pay to Play with Cram Down            “Any Existing Holder that does not fund its Pr...
Antidilution Adjustments   Example 3: Specified Exceptions            “Dilutive issuance” shall not include: (i) up to    ...
Protective Provisions        Considerations                               • Control Provisions                            ...
Protective Provisions                               • Investor approval of: senior securities,                Pre-        ...
Protective Provisions   Example            “Votes on an as-converted basis, but also has            [class/series] vote as...
Protective Provisions     Example (cont.)               increase or decrease in the number of authorized shares           ...
Defining the Terms of the             Stock Purchase Agreement© 2010 Haynes and Boone, LLP
Representation and Warranties        Considerations                               • Scope/Coverage                        ...
Closings        Considerations                               • When will the Investors                                 go ...
Closings                Pre-                               • Single Tranche Investment                Bubble              ...
Conditions to Closing        Considerations                               • Satisfactory Completion of                    ...
Employee Matters        Considerations                               • Employment                                 Agreemen...
Expenses        Considerations                               • Company Typically                                 Pays Reas...
Defining the Terms of the           Investors’ Rights Agreement© 2010 Haynes and Boone, LLP
Registration Rights        Considerations                               • Types of Registration Rights                    ...
Registration Rights   Example 1: Demand Rights            “Beginning on the earlier of [3-5] years from            Closing...
Registration Rights   Example 2: Piggyback Rights         “Investors in Series __ Preferred Stock will have          [unli...
Registration Rights   Example 3: S3 Rights            “[Unlimited] S-3 Registrations of at least $500,000            each ...
Registration Rights   Example 4: Termination         “Registration rights terminate [(i) [3-7] years after          the IP...
Market Stand-Off        Considerations                               • Time of Lock-Up                               • Who...
Market Stand-Off   Example            “Prior to the Closing, all shareholders shall agree that in            connection wi...
Right of First Offer        Considerations                               • Who Owns the Right?                            ...
Right of First Offer                Pre-           • Right to maintain pro-rata ownership in                Bubble        ...
Right of First Offer   Example            “The Investors shall have a pro rata right, based on            their percentage...
Financial Information        Considerations                               • Financial Statements                          ...
Board of Directors        Considerations                               • Determination of Authorized                      ...
Board of Directors   Example            “[The Company’s Articles of Incorporation shall provide that            the] Board...
Defining the Terms of                           Other Agreements© 2010 Haynes and Boone, LLP
Restrictions on Transferability     • Rights of First Refusal     • Co-Sale Rights     • Drag-Along Rights© 2010 Haynes an...
Rights of First Refusal                  Pre-         • Right to purchase any shares proposed                  Bubble     ...
Rights of First Refusal      Example            “Any [vested] Common Stock acquired            by [employees] [founders]  ...
Co-Sale Rights                Pre-           • Right to sell alongside any founder that                Bubble           se...
Co-Sale Rights   Example            “Until the IPO, the Investors also shall have the right            to participate on a...
Drag-Along Rights               Pre-            • None               Bubble                               • None          ...
Drag-Along Rights   Example            “So long as the Investors own shares of Series ___            Preferred Stock repre...
Founder Vesting                Pre-           • 3- or 4-year vesting with some up-front                Bubble           ve...
Founder Vesting   Example 1: Single Trigger            “If a Founder voluntarily terminates his or her            employme...
Founder Vesting   Example 2: Double Trigger            “Upon termination of the employment of the            shareholder, ...
Certain Term Sheet Terms© 2010 Haynes and Boone, LLP
Capitalization   Example            “The Company’s capital structure before and after the Closing            is set forth ...
Publicity   Example     • “The Company will not discuss the terms of this Term       Sheet with any person other than key ...
No Shop   Example     • “From the signing date hereof until 5:00 P.M. Pacific       Standard Time on __________, the Compa...
Questions?                                   Bart Greenberg                                          Partner              ...
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Negotiating the Term Sheet in Today's Market

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This slide show outlines and discusses the key elements of a preferred stock term sheet, and shows the range of negotiability of those terms in the best and worst of times.

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Negotiating the Term Sheet in Today's Market

  1. 1. Negotiating the Preferred Stock Term Sheet in Today’s Market Place Presented by Bart Greenberg Haynes and Boone, LLP OCTANe Foundation for Innovation’s Building Blocks Series July 21, 2011© 2010 Haynes and Boone, LLP
  2. 2. Certain Preliminary Matters© 2010 Haynes and Boone, LLP
  3. 3. Market Conditions Impact Terms • Shortage of willing investors leads to aggressive terms • Desire by Investors to “correct” prior valuation errors (i.e., overvaluations) and pull up returns on whole portfolio may lead to more aggressive terms • Desire by Investors to avoid future errors may lead to more aggressive terms, such as by imposing self-adjusting valuations, guaranteed returns, downside protection, more bridge financings© 2010 Haynes and Boone, LLP
  4. 4. Prior Rounds Impact Terms • Severe down round/cramdown (leads to most aggressive terms) • Flat round (could be considered a “win” in unfavorable market conditions) • Up round (best chance to get reasonable or favorable terms)© 2010 Haynes and Boone, LLP
  5. 5. Valuation • Means many different things • $2.5 million pre-money with $2.5 million new money could mean: – Original investors get $2.5 million if sold for $5 million – Original investors + optionees (current or all future) get $2.5 million if sold for $5 million – Original investors + founders and optionees (current or all future) will each have equivalent ownership percentages if “go public” (and convert to common stock) – but not necessarily under other liquidity scenarios • Conversion concept vs. liquidation concept© 2010 Haynes and Boone, LLP
  6. 6. Defining the Terms of the Preferred Stock© 2010 Haynes and Boone, LLP
  7. 7. Dividends Considerations • Priority of Payment •Common •Other Preferred • Dividend/Coupon Rate • Cumulative vs. • Non-Cumulative • Form of Payment •Cash “coupon” •Payment-in-Kind Securities (PIKs)© 2010 Haynes and Boone, LLP
  8. 8. Dividends Pre- • Non-mandatory, non-cumulative Bubble 8% per year Post- • Mandatory, cumulative 8% per year • More Extreme: Mandatory, cumulative, Bubble payable in kind up to 15% per year© 2010 Haynes and Boone, LLP
  9. 9. Dividends Example “Annual $_____ per share dividend on the Series ___ Preferred Stock, payable when and if declared by Board, prior to any dividends paid to the Common Stock; dividends are [not] cumulative. No dividends will be declared or paid on the Common Stock unless and until a like dividend has been declared and paid on the Series ___ Preferred Stock.”© 2010 Haynes and Boone, LLP
  10. 10. Liquidation Preference Considerations • Should the holder have a “preferred” return before other equity holders? • When should the preference apply (e.g., non-conversion contexts such as a merger or upon liquidation)? • Key Characteristics: • Priority of Distribution • Amount of Preference • Participation Rights© 2010 Haynes and Boone, LLP
  11. 11. Liquidation Preference A B C D E F G HReturn cost Cost + Cost + AROI Cost + AROI Cost + Cost + Cost + AROI Multiple ofonly, or else annual to PS; same to PS; AROI to PS; AROI to PS; to PS; then cost to PS;convert ROI amount per negotiated cost + AROI then pro pro rata then pro (“AROI”) share to CS; amount to to CS; then rata up to participation rata or else then pro rata CS; then pro pro rata multiple of participation convert participation rata participation PS cost; or participation else convert More favorable to More favorable to common holders preferred holders© 2010 Haynes and Boone, LLP
  12. 12. Liquidation Preference Pre- •• 1X purchase price, plus participation Bubble rights up to 3X • 1X to 3X with some participation rights Post- (the lower the X, the greater the Bubble participation rights) • Participation Rights are sometimes subject to a management carve out • More extreme: 3X purchase price, plus participation rights with no cap© 2010 Haynes and Boone, LLP
  13. 13. The “Waterfall” First: Creditors Satisfied Second: Distribution to holders of preferred stock Third: Distribution to holders of common stock (with possible participation by holders of preferred stock)© 2010 Haynes and Boone, LLP
  14. 14. The “Waterfall” (an illustration) Amount Available for Distribution: $15,000,000 Term Sheet: 1x preference for Series A, 1x participation) First Second Third Total Creditors 0 0 0 $0.00 Series A* 0 $4,100,000 $4,100,000 $8,200,000 Common Stock 0 0 $6,800,000 $6,800,000 (including option pool) $15,000,000 Term Sheet: 3x preference for Series A, full participation First Second Third Total Creditors 0 0 0 $0.00 Series A* 0 $12,300,000 $1,350,000 $13,650,000 Common Stock 0 0 $1,350,000 $1,350,000 (including option pool) $15,000,000 * Original investment of $4,100,000© 2010 Haynes and Boone, LLP
  15. 15. Liquidation Preference Example 1: Full Participation “First pay the original purchase price [plus premium] plus accrued dividends (if any) on each share of Series ___ Preferred Stock. Thereafter, Series ___ Preferred Stock participates with Common Stock on an as-converted basis.”© 2010 Haynes and Boone, LLP
  16. 16. Liquidation Preference Example 2: Cap on Participation Rights “First pay the original purchase price plus accrued dividends (if any) on each share of Series ___ Preferred Stock. Thereafter, Series ___ Preferred Stock participates with Common Stock on an as- converted basis until the holders of Series ___ Preferred Stock receive an aggregate of [ _ ]X original purchase price.”© 2010 Haynes and Boone, LLP
  17. 17. Liquidation Preference Example 3: Non-Participating “First pay the original purchase price [plus premium?] plus accrued dividends on each share of Series ___ Preferred Stock. The balance to holders of Common Stock.”© 2010 Haynes and Boone, LLP
  18. 18. Redemption Considerations • Who can trigger? • Percentage of preferred holders/individually • Company (rare) • Priority among other holders • Staging of Redemption • Device to force conversion • Form of Payment • Legal Restrictions© 2010 Haynes and Boone, LLP
  19. 19. Redemption Pre- • Not Common Bubble Post- • At option of holders after 5 years at Bubble purchase price plus accrued dividends© 2010 Haynes and Boone, LLP
  20. 20. Redemption Example 1: Lump Sum “Series ___ Preferred Stock redeemable at the election of holders [of 66-2/3rds] of the outstanding Series ___ Preferred Stock] on or after ____________ at a price equal to the original purchase price [plus accrued dividends] [plus ___% per year] or as soon thereafter as legally permissible.”© 2010 Haynes and Boone, LLP
  21. 21. Redemption Example 2: Three Tranches “[See Example 1], to the extent of 1/3 of the shares of Series ___ Preferred Stock on the [____], [____] and [____] anniversary dates of the Closing or as soon thereafter as legally permissible[, but in no event will more than 1/3 of the outstanding shares of Series ___ Preferred Stock (plus 1/3 of the aggregate accrued dividends) be redeemed in any 12 month period.]”© 2010 Haynes and Boone, LLP
  22. 22. Conversion Rights Considerations • The number of shares of common stock, if any, into which preferred stock converts: preferred stock share price (fixed) Conversion Price • Typically Based on Certain Triggering Events • Election by percentage of holders of preferred stock • IPO© 2010 Haynes and Boone, LLP
  23. 23. Antidilution Adjustments Considerations • Way to “fix” earlier valuation errors on conversion (i.e. allocate most or all of risk of down round to common stock) • Three Types of Adjustments • “Full Ratchet” • “Narrow-Based” Weighted Average • “Broad-Based” Weighted Average • Specified Exceptions© 2010 Haynes and Boone, LLP
  24. 24. Antidilution Adjustments Pre- • Standard broad-based weighted Bubble average adjustment Post- • Narrow-based weighted average Bubble adjustment • More extreme: Full ratchet adjustment for a period; then narrow or broad- based weighted average adjustment© 2010 Haynes and Boone, LLP
  25. 25. Antidilution Adjustments (an illustration) Scenario: Common Stock Outstanding 1,000,000 shares Series A Preferred 1,000,000 shares at $1.00 (or $1,000,000) Series B Preferred 1,000,000 shares at 75¢ (or $750,000) Adjustments (Upon Series B) • Series A Conversion Ratio Prior to Series B = 1:1 • Upon Series B, Series A Conversion Ratio adjusted as follows: Type of Adjustment Conversion Ratio Full Ratchet 1:1.333 Narrow-Based 1:1.143 Broad-Based 1:1.091© 2010 Haynes and Boone, LLP
  26. 26. Antidilution Adjustments - Pay to Play • If stockholder does not purchase pro rata share in subsequent offering, stockholder loses benefit of antidilution provisions. • In extreme cases, non-participating stockholders must convert to common stock (sometimes at less than 1:1), thereby losing protective provisions of preferred stock. • “Pay to Play” minimizes fears of major investors that small investors will benefit by having major investors continue providing needed equity, particularly in troubled economic times.© 2010 Haynes and Boone, LLP
  27. 27. Antidilution Adjustments Example 1: With Pay to Play “Conversion ratio for Series ___ Preferred Stock adjusted on [ratchet/ [broad or narrow] weighted average] basis in the event of a dilutive issuance [so long as investor purchases full pro rata share of dilutive issuance (“pay to play”).]”© 2010 Haynes and Boone, LLP
  28. 28. Antidilution Adjustments Example 2: Pay to Play with Cram Down “Any Existing Holder that does not fund its Pro Rata Amount by the Initial Closing shall have its Equity Securities automatically converted at a ratio of 10 to 1 to a new series of Common Stock that retains no voting rights; provided however, that to the extent an Existing Holder partially meets its Pro Rata Amount, such holder shall retain a corresponding portion of its Equity Securities, and may choose the respective portion to retain.”© 2010 Haynes and Boone, LLP
  29. 29. Antidilution Adjustments Example 3: Specified Exceptions “Dilutive issuance” shall not include: (i) up to ______ shares of Common Stock issued pursuant to a stock option plan approved [unanimously/by a majority] of the Board of Directors; (ii) Common Stock issued upon conversion of the Preferred Stock; (iii) stock issued in any IPO in which the Preferred Stock is converted into Common Stock; or (iv) stock issued in connection with mergers or acquisitions approved [unanimously/by a majority] of the Board of Directors.”© 2010 Haynes and Boone, LLP
  30. 30. Protective Provisions Considerations • Control Provisions • Board Seats • Voting Agreements • Other Protections© 2010 Haynes and Boone, LLP
  31. 31. Protective Provisions • Investor approval of: senior securities, Pre- sale of company, payment of dividends, Bubble liquidation, change of rights • Investor approval of senior or pari passu securities, sale of company, payment of Post- dividends, change of rights, change of business, incurrence of debt over Bubble specified limit, annual budgets and variances, acquisitions of other businesses, grant of exclusive rights in technology, appointment or termination of CEO© 2010 Haynes and Boone, LLP
  32. 32. Protective Provisions Example “Votes on an as-converted basis, but also has [class/series] vote as provided by law and on (i) the creation of any senior [or pari passu] security, [(ii) payment of dividends on [Common Stock/on any class of Stock]],[(iii) any redemptions or repurchases of Common Stock or Preferred Stock [except for purchases at cost upon termination of employment], (iv) any liquidation, dissolution or winding up of the Company; (v) any merger, acquisition, recapitalization, reorganization or sale of all or substantially all of the assets of the Company, (vi) an© 2010 Haynes and Boone, LLP
  33. 33. Protective Provisions Example (cont.) increase or decrease in the number of authorized shares of Series [ _ ] Preferred Stock or Common Stock, (vii) any [adverse] change to the rights, preferences and privileges of the Series [ _ ] Preferred, [(viii) an increase or decrease in the size of the Board], [(ix) [material] amendments or repeal of any provision of the Company’s Charter or Bylaws]; [(x) the issuance of any additional shares of capital stock (or options) to the Company’s founders,] and [(xi)] authorization of any amount of indebtedness in excess of $____.]”© 2010 Haynes and Boone, LLP
  34. 34. Defining the Terms of the Stock Purchase Agreement© 2010 Haynes and Boone, LLP
  35. 35. Representation and Warranties Considerations • Scope/Coverage • By the Company • By the Founders (e.g., technology)© 2010 Haynes and Boone, LLP
  36. 36. Closings Considerations • When will the Investors go “at-risk”? • Lump Sum at Closing • Staging of Investment • Passage of Time • Milestones© 2010 Haynes and Boone, LLP
  37. 37. Closings Pre- • Single Tranche Investment Bubble Post- • Single Tranche Investment Bubble • More Extreme: Milestone-Based Tranches© 2010 Haynes and Boone, LLP
  38. 38. Conditions to Closing Considerations • Satisfactory Completion of Due Diligence • Exemption or Qualification of Shares under Applicable Securities Laws • Filing of Amendment to Charter to Establish Rights and Preferences of the Preferred Stock • Opinion of Counsel to the Company© 2010 Haynes and Boone, LLP
  39. 39. Employee Matters Considerations • Employment Agreements with Founders • Obligation for All Employees/Consultants to Enter into Company’s Standard Inventions and Proprietary Information Agreement© 2010 Haynes and Boone, LLP
  40. 40. Expenses Considerations • Company Typically Pays Reasonable Fees and Expenses of Investors’ Counsel • Consider Cap on Obligation© 2010 Haynes and Boone, LLP
  41. 41. Defining the Terms of the Investors’ Rights Agreement© 2010 Haynes and Boone, LLP
  42. 42. Registration Rights Considerations • Types of Registration Rights • Demand Rights • Piggyback Rights • S3 Rights • Termination of Rights • Limitation on Subsequent Rights • Absolute prohibition • Permitted if Subordinate • Allocation of Expenses© 2010 Haynes and Boone, LLP
  43. 43. Registration Rights Example 1: Demand Rights “Beginning on the earlier of [3-5] years from Closing, or [three/six] months after the Company’s IPO, [1-2] demand registrations [for underwritten public offerings] upon initiation by holders of at least [30]% of outstanding Series ___ Preferred Stock (or Common Stock issuable upon conversion of the Series ___ Preferred Stock or any combination thereof) for aggregate proceeds in excess of $_______.”© 2010 Haynes and Boone, LLP
  44. 44. Registration Rights Example 2: Piggyback Rights “Investors in Series __ Preferred Stock will have [unlimited] piggyback registration rights subject to pro rata cutback at the underwriter’s discretion. Full cutback upon the IPO; [30% minimum inclusion thereafter]. Investors will not be subject to cutback unless all other selling shareholders are excluded from registration.”© 2010 Haynes and Boone, LLP
  45. 45. Registration Rights Example 3: S3 Rights “[Unlimited] S-3 Registrations of at least $500,000 each [upon initiation by holders of at least [20%] of the outstanding Series ___ Preferred Stock (or Common Stock issuable upon conversion of the Series ___ Preferred Stock or any combination thereof)]. [No more than two S-3 Registrations in any 12 month period.]”© 2010 Haynes and Boone, LLP
  46. 46. Registration Rights Example 4: Termination “Registration rights terminate [(i) [3-7] years after the IPO;] or (ii) when [the Company is publicly traded and] all shares can be sold [in any 90-day period] under Rule 144, whichever occurs first.][, provided that this clause (ii) shall not apply to any 5% holder deemed to be an affiliate of the Company.]”© 2010 Haynes and Boone, LLP
  47. 47. Market Stand-Off Considerations • Time of Lock-Up • Who Controls Decision • Investors • Underwriter • Equal Application • Obligation to Execute Underwriter’s Form of Lock-Up Agreement© 2010 Haynes and Boone, LLP
  48. 48. Market Stand-Off Example “Prior to the Closing, all shareholders shall agree that in connection with the IPO not to sell any shares of Preferred Stock or Common Stock issuable upon conversion thereof for a period of up to [180] days following the IPO [(provided directors and officers of the Company and [5]% shareholders agree to the same lock-up. Such shareholders also shall agree to sign the underwriter’s standard lock-up agreement reflecting the foregoing.”© 2010 Haynes and Boone, LLP
  49. 49. Right of First Offer Considerations • Who Owns the Right? • All holders of preferred stock • Holders of at least [____] percentage of preferred stock • Determination of Percentage© 2010 Haynes and Boone, LLP
  50. 50. Right of First Offer Pre- • Right to maintain pro-rata ownership in Bubble later financings Post- • Right to maintain pro-rata ownership in Bubble later financings • More Extreme: right to invest 2X pro- rata ownership in later financings© 2010 Haynes and Boone, LLP
  51. 51. Right of First Offer Example “The Investors shall have a pro rata right, based on their percentage equity ownership of [Preferred Stock] [Common Stock, on a fully diluted basis], to participate in subsequent financings of the Company (excluding [See List of Specified Exceptions to Antidilution Adjustments]. Such right will terminate immediately prior to a Qualified Public Offering.”© 2010 Haynes and Boone, LLP
  52. 52. Financial Information Considerations • Financial Statements • [Audited] annual statements • Unaudited monthly/quarterly statements • [1-5] Year Projections • Other Material Information© 2010 Haynes and Boone, LLP
  53. 53. Board of Directors Considerations • Determination of Authorized Number of Directors • Voting Agreement Among Shareholders • Class Votes • Specific Identification • Independent Members of Board • Use of an Advisory Board • Board Observation Rights© 2010 Haynes and Boone, LLP
  54. 54. Board of Directors Example “[The Company’s Articles of Incorporation shall provide that the] Board shall consist of ____ members, with the holders of a majority of Series ___ Preferred Stock entitled to elect ____ member(s) [and the holders of a majority of the Common Stock entitled to elect ____ member(s)]. [The Company and the Investors intend to select ____ outside director(s) with relevant industry experience as soon as possible after Closing.] Board composition at Closing shall be _______, [with vacancy].”© 2010 Haynes and Boone, LLP
  55. 55. Defining the Terms of Other Agreements© 2010 Haynes and Boone, LLP
  56. 56. Restrictions on Transferability • Rights of First Refusal • Co-Sale Rights • Drag-Along Rights© 2010 Haynes and Boone, LLP
  57. 57. Rights of First Refusal Pre- • Right to purchase any shares proposed Bubble to be sold by employees • Right to purchase any shares proposed Post- to be sold by employees Bubble • More extreme: right to purchase any shares proposed to be sold by any shareholder© 2010 Haynes and Boone, LLP
  58. 58. Rights of First Refusal Example “Any [vested] Common Stock acquired by [employees] [founders] [shareholders] shall be subject to a right of first refusal of [the Company] [the Investors] to repurchase any stock, at the bona fide offer price.”© 2010 Haynes and Boone, LLP
  59. 59. Co-Sale Rights Pre- • Right to sell alongside any founder that Bubble sells shares • Right to sell alongside any founder Post- that sells shares Bubble • More extreme: Right to sell alongside any shareholder that sells shares© 2010 Haynes and Boone, LLP
  60. 60. Co-Sale Rights Example “Until the IPO, the Investors also shall have the right to participate on a pro rata basis in transfers of any shares of [Preferred Stock or] Common Stock [held by the Founders or any [major] shareholder], [and a right of first refusal on such transfers, [subordinate to] [prior to] the Company’s right of first refusal. [Any shares not subscribed for by an Investor may be reallocated among the other eligible Investors.]”© 2010 Haynes and Boone, LLP
  61. 61. Drag-Along Rights Pre- • None Bubble • None Post- • More extreme: Right to force Bubble • shareholders to sell company upon board and majority shareholder vote© 2010 Haynes and Boone, LLP
  62. 62. Drag-Along Rights Example “So long as the Investors own shares of Series ___ Preferred Stock representing at least [25]% of the Company’s Common Stock on a fully-diluted basis (as determined by ]), the Investors shall have drag-along rights with respect to securities of any of the Founders or principal Common Stock holders in the event of a proposed sale of the Company to a third party (whether structured as a merger, reorganization, asset sale or otherwise).”© 2010 Haynes and Boone, LLP
  63. 63. Founder Vesting Pre- • 3- or 4-year vesting with some up-front Bubble vesting • 4-year vesting with no-up front vesting Post- • More extreme: 5-year vesting and/or Bubble performance standards© 2010 Haynes and Boone, LLP
  64. 64. Founder Vesting Example 1: Single Trigger “If a Founder voluntarily terminates his or her employment with the Company or is terminated for cause, then the [Company/the Investors] will have the right to repurchase 100% of the Founders’ shares less [1/48]th of those shares for each complete month of service the employee served with the Company.”© 2010 Haynes and Boone, LLP
  65. 65. Founder Vesting Example 2: Double Trigger “Upon termination of the employment of the shareholder, with or without cause, the Company may repurchase at cost any shares subject to the repurchase option. The Company’s repurchase option shall lapse by [___ percent (__%)] of the unvested portion in the event such Founder is terminated without Cause or Constructively Terminated as a result of and within six (6) months prior to or twelve (12) months following a Change in Control.”© 2010 Haynes and Boone, LLP
  66. 66. Certain Term Sheet Terms© 2010 Haynes and Boone, LLP
  67. 67. Capitalization Example “The Company’s capital structure before and after the Closing is set forth below [including founder’s shares to be issued prior to the Closing]:” Pre-Financing Post-Financing Security # of Shares % # of Shares % Common – Founders 4,077,670 73.7 4,077,670 40.5 Common – Employee Stock Pool Issued -- -- -- -- Unissued 1,456,311 26.3 1,456,311 14.5 Common – Warrants to Debt Holders -- -- 75,000 0.7 Series A Preferred -- -- 4,466,019 44.3 Total 5,533,981 100.0 10,075,000 100.0© 2010 Haynes and Boone, LLP
  68. 68. Publicity Example • “The Company will not discuss the terms of this Term Sheet with any person other than key officers, members of the Board of Directors of the Company or the Company’s accountants or attorneys without the written consent of Investor, except as required by law. In addition, the Company shall not use the Investor’s name in any manner, context or format (including, reference on or links to websites, press releases, etc.) without the prior review and approval of Investor.”© 2010 Haynes and Boone, LLP
  69. 69. No Shop Example • “From the signing date hereof until 5:00 P.M. Pacific Standard Time on __________, the Company and the Founders agree that they shall not solicit, encourage others to solicit, encourage or accept any offers for the purchase or acquisition of any capital stock of the Company, of all or any substantial part of the assets of the Company, or proposals for any merger or consolidation involving the Company, and they shall not negotiate with or enter into any agreement or understanding with any other person with respect to any such transaction.”© 2010 Haynes and Boone, LLP
  70. 70. Questions? Bart Greenberg Partner 18100 Von Karman Avenue, Suite 750 Irvine, California 92612 bart.greenberg@haynesboone.com 949.202.3037 70© 2010 Haynes and Boone, LLP

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