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00. term sheet in simple terms (deb sahoo)
 

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    00. term sheet in simple terms (deb sahoo) 00. term sheet in simple terms (deb sahoo) Presentation Transcript

    • TERM SHEET IN SIMPLE TERMS | Deb Sahoo | MBA, Finance, University of Michigan | MS, EE, University of Southern California | B-Tech, EE, IIT |
    • 1. Company Information Company name: Delaware California Other 2. Securities to be Issued A B C D E F Other VC FINANCING TRENDS TERM SHEET TERMS Term Sheet in Simple Terms | Deb Sahoo | MBA, Finance, University of Michigan | MS, EE, University of Southern California | B-Tech, EE, IIT | Jurisdiction in which the company wiil be organized: Series of preferred stock Start Up X Term Sheet in Simple Terms (Deb Sahoo)
    • Warrants Yes No Comments Warrants grant the holder of the warrant the option to purchase company shares at a particular price, called the exercise price within a set period. Warrants increase in value as the value of the underlying shares increase in relation to the exercise price. Warrants can serve as a “kicker” to increase the potential value of an investment. Warrants are common in connection with small bridge loans, and are unusual to issue warrants in connection with preferred stock financings. The warrants will be exercisable for: 3. Equity Offering Size and Valuation Maximum amount Range Minimum: Maximum: Yes No Pre-money valuation: Aggregate number of shares to be sold: Share amounts and price are important numbers. Warrants to be received by each investor (expressed as a percentage of the preferred stock to be received): Aggregate number of shares underlying all warrants to be issued: Exercise price per share: Cash Cash and cancellation of indebtedness 4. Dilutive Financing Yes No Describe: Provide a description of any changes (e.g., “All shares of preferred stock will be converted into common stock prior to the closing.”). Use an initial capital letter and end punctuation. 5. Preferred Stock Rights – Liquidation Preference Senior to common Pari passu with common (no liquidation preference) It would be unusual if the preferred stock did not have a liquidation preference over the common stock. Purchase price Multiple of purchase price The amount of the preference is typically a function of the perceived risk of the investment. Other The most common approach is to provide a preference equal to the purchase price. This provides investors with some assurance that they will receive their investment back before amounts are distributed to the common stock. It also helps to reasonably align the interests of the investors with those of the founders, management and other holders of common stock by requiring preferred investors to convert their shares into common stock to obtain returns in excess of their initial investment (depending upon the extent of any participation rights in the residual distribution—see the “Participation” section below). In rare cases, where there are significant risks associated with an investment, investors may sometimes require that the preference be a multiple of the purchase price of the preferred shares (sometimes expressed as a 2x, 3x, etc., preference). What is the liquidation preference of the preferred shares (expressed as a multiple of the purchase price)? For example, if the preference amount is two times the purchase price, enter “2”. Participation Amount: Priority Liquidation priority: Amount of Preference A basic feature of preferred stock is the preferential right to receive distributions upon certain events. These liquidation preferences apply to distributions in connection with a liquidation and dissolution of the company ( i.e., a traditional liquidation) and distributions in connection with the sale of the company ( i.e., a “deemed” liquidation). The structuring of liquidation preferences is an issue of critical importance to investors and founders. In particular, founders (who will typically be in a subordinate position by virtue of holding common stock) should take care to understand the effect of liquidation preferences in various scenarios. Founders sometimes focus on IPO scenarios (in which liquidation preferences typically do not come into play) without due regard for other, more likely liquidation scenarios where investors will have a preference. Investors should also exercise some discretion in negotiating liquidation preferences. Liquidation preferences, particularly those that provide for multiple returns or participation rights, may result in skewing management incentives toward an initial public offering where an acquisition may be a more realistic or strategically desirable outcome. When the valuation of the company has decreased significantly since earlier rounds of financing, the new investors may insist on a variety of terms that have the effect of significantly diluting the holdings and rights of existing investors. As part of this type of highly-dilutive or “wash-out” financing, the new investors may require a significant change to the capital structure of the company prior to, or in conjunction with, the new investment. Sometimes, this will be effected through a “pay-to-play” provision that penalizes investors that fail to participate in the new round. In more rare instances, investors may require a more fundamental change to the capital structure, such as requiring preferred shares to convert to common. In that type of situation, it will be helpful to outline the expectations regarding these types of changes in the term sheet. Because dilutive financings can involve complicated multi-party negotiations and a number of complex legal issues, it is important to obtain competent legal assistance. Dilutive Financing Will the financing involve a change to the existing capitalization of the company beyond the issuance of the new preferred shares (e.g., a “wash-out” or highly-dilutive financing)? % $ Payment Form of payment for securities: $ Preferred Stock Purchase price per share: $ Warrants $ $ Valuation Include pre-money valuation in the term sheet? Will the investor(s) be receiving warrants? Offering Size Expressed as: 2,000,000 2,000,000 500,000 1 25 25,000 10 1.5 Term Sheet in Simple Terms (Deb Sahoo)
    • Yes No With “non-participating” preferred stock, the preferred holders are entitled to receive only the amount of their preference (typically the amount paid for the stock), plus any accrued and unpaid dividends, upon a sale or liquidation of the company. Any remaining proceeds are distributed solely to the common holders. If the common holders would receive more per share than the preferred holders upon a sale or liquidation (typically where the company is sold at a high valuation), the preferred holders can convert their shares into common stock and give up their preference in exchange for the right to share pro rata in the full liquidation proceeds. Management and other common holders generally favor non-participating preferred stock since it requires that the preferred holders convert and stand on equal footing with the common holders to receive a gain on their investment beyond the negotiated preference amount. With “participating” preferred stock, preferred holders are entitled to receive their preference amount first in a liquidation event (plus accrued and unpaid dividends), with any remaining proceeds being divided among holders of common stock and preferred stock on an as-converted basis. Participating preferred stock provides a significant benefit to investors at the expense of the founders, whose right to any residual amount after payment of the preference is cut by investor participation in the distribution of the remaining amounts. A participation feature may be more justified where the risk associated with the investment or, in a later stage investment, the possibility of a sale shortly after the investment, may justify a premium. Preferred participates after preference is paid Common receives specified amount before preferred participation The most common approach is for the preferred to participate after the preference is paid. Other In rare cases, the liquidation preference can be structured to provide some payment to the common before the investors begin to participate. This can serve to increase the expected return to the common holders, which may be important where the liquidation preference and the participation rights of the preferred are otherwise likely to minimize the return to the common. However, it can be difficult to predict whether this type of structure will be necessary. Consequently, a more productive approach may be to instead implement a contractual “retention program” (separate from any rights in the company’s charter) at some later time when there is better visibility as to the possibility of a liquidation event for which it is important to provide a return to the founders. Yes No Where there are participation rights, the parties often agree to some cap on participation (which can range from 1.5 to 4 times the original purchase price of the preferred stock). All proceeds beyond the cap amount would be distributed solely to the common holders. This allows the preferred holders to receive a return on their investment without having to convert their holdings to common stock, but leaves the incentive to convert in place where the sale or liquidation occurs at a high valuation. Having a capped participation feature can be used, for example, to provide a mezzanine investor with some assurance that it will get a return on its investment if the company is sold shortly after the investment. Note that a capped participation feature tends to lose value over time—a 2x return after five years is less valuable than the same return after one year. What is the maximum amount that can be received pursuant to (x) the liquidation preference plus (y) the participation right (expressed as a multiple of the liquidation preference)? For example, for a 3x cap, enter “3”. Yes No The flexibility afforded by allowing a waiver of a deemed liquidation may prove beneficial to the company and investors. a majority Other 6. Preferred Stock Rights – Conversion to Common Stock In most venture financings, each share of preferred is convertible into one share of common stock (subject to anti-dilution adjustments, as discussed later in this questionnaire). In rare cases, the conversion ratio may be adjusted (from something other than 1:1) in lieu of cumulative dividends or other guaranteed minimum returns. 7. Preferred Stock Rights – Automatic Conversion All preferred stock convert upon vote of the preferred stock, voting as a single class Series A preferred stock converts upon vote of the Series A preferred stock Automatic conversion by stockholder vote provides a convenient means to simplify the company’s capitalization structure, without having to undertake to amend the charter or to get the unanimous agreement of the preferred holders to convert their shares. All preferred stock convert upon vote of the Series A preferred stock It is typical in preferred financings to include provisions for “automatic” conversion of all of the preferred stock into common stock upon the vote or written consent of holders of a defined minimum number of shares. This helps to avoid the risk of holdouts in a situation where the conversion (or a Automatic Conversion – Stockholder Vote Select method: Vote required for waiver: If something other than “a majority,” please indicate the percentage amount (e.g., “at least 67%”, “at least 75%”, etc. ). Preferred shares issued in venture financings are typically convertible at the election of the holder into common stock. Since common shares typically receive the residual amount in connection with any liquidation (after Conversion Ratio Number of common shares into which a single share of preferred converts: Waiver Permit waiver of a deemed liquidation by the preferred? Participation: Cap on Participation Is there a cap on the participation rights? Will the preferred stock have the right to participate in any distribution to the common after payment of the liquidation preference? 2.0 1 Term Sheet in Simple Terms (Deb Sahoo)
    • Automatic conversion can, for example, reduce the risk that a minority of stockholders, or the holders of a particular series, will effectively have the ability to block important transactions that may be contingent upon a more simplified capital structure (e.g., a highly-dilutive (or “wash-out”) financing, an initial public offering that does not meet separate automatic conversion thresholds (as discussed below), etc. ). A new investor in a later-stage financing should exercise some care in negotiating the automatic conversion provisions, particularly if the new investor is entitled to a larger preference or has priority relative to other series. The new investor should be cognizant of the risk that the other investors may be able to effectively eliminate any preferences or priority by effecting an automatic conversion through a class vote of all of the preferred voting as a whole. To protect its liquidation preference, the new investor may want to request a higher vote threshold or a separate series vote. a majority Other Minimum price Minimum proceeds Since the conversion of all preferred stock into common stock may be a practical condition precedent to a public offering of the company’s common stock, the company will want lower thresholds. In contrast, the investors will not want to be forced to convert to common stock unless they are assured of a sufficient return on their investment and will want to ensure that there is sufficient liquidity (public float) to allow them to sell their shares. The share price requirement addresses the first concern, and the offering proceeds requirement addresses the second. This addresses the assumed rate of return necessary to force conversion. The investors will not want to be forced to convert to common stock unless they have received a sufficient return on their investment. This number will vary depending upon the stage of the company’s progress at the time of the financing. The minimum price can vary significantly but may be as high as five times the purchase price (or more) in early stage financings or as low as 1.5 times the purchase price in a mezzanine round. The minimum price may also vary depending on the nature of the liquidation and redemption rights. 8. Preferred Stock Rights – Anti-Dilution Weighted average (broad based) Weighted average (narrow based) Full Ratchet The price-based adjustment mechanisms typically effect some change to the conversion ratio of the preferred stock. In general, price-based adjustment mechanisms are divided into “weighted-average” formulas and “full ratchet” adjustments, or some combination of the two. “Weighted-average” formulas are the most common. “Weighted-average” formulas account for the number of shares issued in the new financing and the number of shares already outstanding (in addition to the respective prices at which the shares were issued) in adjusting the conversion price. The magnitude of a weighted-average adjustment depends in large part on the number of shares deemed to be outstanding for purposes of the formula. The most common approach is a “broad-based” weighted-average formula. A broad-based formula calculates the adjustment by factoring a larger number of shares into the average, which results in a smaller adjustment than under a “narrow-based” formula. A broad-based formula would typically treat all shares issuable upon exercise of outstanding options, warrants and convertible securities (in addition to stock that is actually outstanding) as “outstanding” for purposes of the adjustment formula. “Narrow-based” weighted-average formulas, which are less typical, do not normally take into account unexercised options or warrants or outstanding convertible notes, which results in more significant adjustments than under a broad-based formula. Some very narrow-based formulas include only the outstanding preferred stock in the calculation. A narrow-based weighted-average adjustment formula is more favorable to investors than broad-based weighted-average formulas In contrast, “Full-ratchet” formulas adjust the conversion ratio of the preferred to reflect the new lower price at which the new securities are issued (without accounting for the number of shares to be issued or previously outstanding). Because it does not calibrate for differences in the size of a new issuance relative to previously oustanding shares, a full-ratchet formula tends to result in more dramatic changes than weighted-average formulas. Often such a provision will be limited in duration (e.g., applicable to issuances that occur within a certain number of months or applicable through the closing of the company’s next financing of a specified size). From the company’s standpoint, if a full- ratchet formula is used, it is important to pay extra attention to ensure that the exceptions from its application are broadly crafted so as not to trigger adjustments for stock issuances that are not related to equity financing activities. Note that there can be a circular aspect to price-based anti-dilution adjustments (i.e., any new investor will need to account for any adjustment in setting the terms of the new financing). Accordingly, these provisions often serve as a basis for negotiations between existing stockholders and new investors concerning an agreed upon outcome (rather than a simple mechanical adjustment). 9. Preferred Stock Rights – Anti-Dilution Exceptions In addition to mechanical adjustments, major venture investors typically request that the company’s charter provide for adjustments to account for the dilutive effect of future stock issuances at a lower purchase price than paid by the investor. These price-based anti-dilution adjustment mechanisms are addressed below. Anti-Dilution Formula What type of anti-dilution protection applies: Minimum IPO price per share for automatic conversion: $ Investors typically request protection against possible dilution in their holdings that may occur as a result of additional issuances of securities or other changes to the company’s capital structure. At a minimum, anti-dilution protections will provide adjustments for mechanical changes resulting from stock splits and similar recapitalizations that do not effect the underlying economics. Provision for mechanical adjustments is generally not controversial and will normally be included in financing documents. What percentage of preferred holders is required to force automatic conversion of all shares of preferred stock? If selecting “Other”, use, for example, the following format: “at least 75%”. Automatic Conversion – Initial Public Offering Must an IPO meet minimum offering price per share and/or minimum gross proceeds requirements for automatic conversion of the preferred stock (select each that applies )? 15 Term Sheet in Simple Terms (Deb Sahoo)
    • All Conversion of the preferred Issuances to employees, consultants or directors Exercise/conversion of options, warrants or convertible securities Dividends or distributions on preferred or issuances for which adjustments are otherwise made under the certificate of incorporation Public offerings Acquisitions of other corporations or joint venture agreements approved by the board Debt financing or commercial transactions approved by the board Settlements approved by the board Sponsored research, collaboration, technology license, development, OEM, marketing or other similar arrangements or strategic partnerships approved by the board The provision of goods and services pursuant to transactions approved by the board Other transactions approved by the board Yes No This number is typically equal to the number of shares to be included in the company’s post-closing option pool, as agreed to by the company and the investors. Yes No This provides additional flexibility to the company since it is generally easier to obtain board approval than to amend the charter, which requires stockholder approval. Yes No From the investor’s perspective, unanimous approval would help to ensure that any investor designee on the board would have the ability to block the approval. However, unanimous approval requirements can create some exposure to opportunistic behavior, which can be detrimental to the investors as well as the company Yes No Several of the exceptions are subject to board approval. This helps to ensure that any such issuance is consistent with the best interests of the company (and is not primarily designed to dilute the investors). Investors, however, may sometimes request additional protections to help ensure that their interests are protected. An efficient way to accomplish this is to require, in addition to board approval, approval by a director appointed by the investors. Note, however, that this approach may be problematic under California law. Please confer with your legal counsel to discuss. A means to achieve a similar result without incurring problems under California law would be to require supermajority or unanimous board approval. Exercise care with respect to requiring unanimous board approval where other options are available. Requiring approval of a director appointed by the preferred may sufficiently safeguard the investors’ interest while avoiding some of the “hold up” risk associated with a unanimous approval requirement. Under a unanimous approval requirement, any single director can effectively hold up a transaction that might otherwise be considered by all of the other directors to be in the company’s best interest. Another approach is to impose caps on the number of shares that can be issued under the different exceptions. Consider, however, that these caps can be cumbersome to increase in the future (since an increase would require an amendment to the certificate of incorporation) and can expose the company to the risk of inadvertently triggering an anti-dilution adjustment. Yes No a majority Other 10. Preferred Stock Rights – Redemption It is unusual for venture investors, however, to request redemption rights. In most cases, start-ups (whose expenses typically outstrip any revenues) will not have sufficient cash resources to make redemption a realistic alternative and will not otherwise have the ability to refinance its capital structure to accommodate the redemption. State corporate laws typically also include restrictions on the ability of companies to redeem shares. Consequently, investors in venture financing transactions primarily focus on an initial public offering or a sale of the company as the means to achieve liquidity. Please note that redemption features may have important accounting and tax consequences. Please confer with your tax and accounting advisors. Waiver Required vote to waive an anti-dilution adjustment: If selecting “Other”, use, for example, the following format: “at least 75%” A primary goal of venture investors is ensuring the eventual liquidity of their investment. Redemption features are intended to provide this liquidity at a fixed time in the future. Public Offering Exception Does the exception with respect to public offerings apply only to public offerings where the preferred would automatically convert (i.e., a "qualified public offering")? Is unanimous approval required? Board Approval Requirements For those exceptions subject to board approval, will there be any additional requirements with respect to the requisite approval (e.g., approval by a director elected by the preferred, unanimous board approval, supermajority board approval, etc. )? Will there be a limit on the number of shares issuable under the exception for issuances to employees, consultants or directors pursuant to stock plans, etc. ? Although answering “No” provides more flexibility to the company, the parties typically agree to some limit. Maximum number of shares issuable (without triggering an anti-dilution adjustment): Permit issuance of a greater number if approved by the board? Exceptions Anti-dilution provisions do not apply to securities issued or issuable in connection with: These specify issuances that will not result in an anti-dilution adjustment, regardless of issue price. Limits on Exception for Issuances to Employees, Directors and Consultants There are a number of standard exceptions to anti-dilution provisions. These exceptions generally encompass issuances with a primary purpose other than raising capital and issuances pursuant to conversion or exercises of outstanding securities. Term Sheet in Simple Terms (Deb Sahoo)
    • Yes No As discussed above, it is unusual for venture investors to request redemption rights. There may, however, be circumstances where redemption rights may be more appropriate. For example, a minority investor in a later-stage, profitable company may want to have some ability to exit the investment. Note also that, even if redemption rights are not formally exercised, investors can use the threat of redemption as leverage to influence the company’s decisionmaking (e.g.,forcing the company to more seriously consider a public offering or a sale). 11. Preferred Stock Rights - Dividends Dividend rates generally reflect some benchmark rate of return on the investment and typically correspond to the then-prevailing interest rates in the economy (e.g., a certain number of percentage points above the prime rate). If dividends are only paid when and if declared by the board (which is the most common approach), the percentage is not very meaningful. Senior to common Pari passu with common Please note that, in addition to any restrictions on dividends imposed by investors in connection with a financing, there are statutory restrictions that apply to the payment of dividends. Senior to other series of preferred and common Pari passu with certain series of preferred and senior to other series of preferred and common Please note that, in addition to any restrictions on dividends imposed by investors in connection with a financing, there are statutory restrictions that apply to the payment of dividends. Pari passu with other series of preferred and senior to common Pari passu with other series of preferred and common Other Yes No Technology venture-backed deals rarely provide for cumulative dividends. If dividends are cumulative, dividends accrue and accumulate whether or not declared by the board. Even with cumulative dividends, venture investors typically do not anticipate actual dividend payments. Rather, cumulative dividends are viewed as a means to boost the underlying equity investment. Upon conversion of the preferred stock, the cumulative dividends would convert into additional common stock, which would increase the investors’ percentage ownership interest in the company above their original investment. Cumulative dividends will also typically be paid upon payment of the liquidation preference and any redemption. Companies should be particularly wary of cumulative dividends that compound given the potential significant effect on total returns over time. In addition, companies should be cognizant of the fact that accumulating dividends are liabilities that generally appear on the company’s balance sheet, which may impair the company’s ability to borrow. To provide some flexibility in the event cumulative dividends pose an impediment to an important prospective transaction, the parties should agree to some method by which the board or the preferred holders may waive cumulative dividends. Please note that where dividends are paid in additional shares of stock, investors may have a tax liability without the liquidity to pay those taxes. Common receives dividends after payment of preferred dividends Common and preferred on a pro rata basis The first option is the most favorable to the common. The last option is the most favorable to the preferred. After payment of preferred dividends, common and preferred receive dividends on a pro rata basis For the company, a preference structure is preferable to cumulative dividends because these preferences do not need to be reflected in the financials as a contingent liability (as compared to cumulative dividends). Common stock All series of preferred and common (pro rata) Select series of preferred and common (pro rata) Series TSPreferredSeries Preferred and common (pro rata) Other 12. Preferred Stock Rights – Voting – General Common stock dividend rights: Who is entitled to receive dividends after the preferred receive their preferential rights? Typically, the preferred stock votes together with the common stock, subject to any rights in the charter with respect to class voting for directors or the approval of material transactions (often referred to as “protective provisions”) and state statutory requirements. Statutory requirements vary by state and may require, for example, class voting with respect to changes in authorized shares, adverse changes to the rights or restrictions of a class, reorganization transactions, etc. Common Stock - Dividends Dividend priority: Priority of dividend rights: Preferred Stock - Cumulative Dividends Are dividends cumulative? Venture-backed companies are not typically in a position to pay dividends. The most common approach to dividends is therefore to have non-mandatory, non-cumulative dividends, which means that dividends will only be paid if (and to the extent) declared by the board. Preferred Stock - Dividends What is the dividend rate as a percentage of the purchase price? % Preferred Stock – Dividend Priority Redemption Right Will the preferred shares have redemption rights? 8 Term Sheet in Simple Terms (Deb Sahoo)
    • the number of shares of common stock into which it converts Other 13. Preferred Stock Rights – Voting for Directors Yes No How many directors will the preferred have the right to elect? How many directors will the Series TSPreferredSeries preferred have the right to elect? Yes No Voting for Directors – Other Series Specify series: Use arrows to add additional series. Type the name of the series (e.g., “Series B Preferred”). Number of directors: Yes No This helps to ensure that the preferred will not continue to have a disproportionate influence in the event the number of preferred shares decreases to a minimal amount. Minimum number of shares: Refer to the overall capitalization of the company when setting this figure. Yes No How many directors will the common stock be entitled to elect? 14. Preferred Stock Rights – Protective Provisions All Amending charter to affect rights of preferred Amending bylaws to affect rights of preferred Increase/decrease authorized preferred Authorize or issue equity securities senior to preferred Authorize or issue equity securities on parity with preferred Liquidation/dissolution/winding-up (including deemed liquidation) Merger/acquisition/sale of substantially all assets Voluntary liquidation or dissolution Dividends, distributions and share repurchases (subject to customary exceptions) Increase size of board Encumber substantially all assets Occasionally, investors may request non-standard protective provisions. Some examples are listed. Acquire material assets through merger or asset purchase Increase authorized shares under option plan or adopt a new plan Exercise care with respect to additional protective provisions. There can be a tendency for some investors to be overly aggressive in implementing protective provisions. This can often result in expansive or general restrictions that subject the company to significant administrative burdens and the risk of inadvertent breach, particularly since protective provisions are strictly construed. In many cases, investors may find that board representation, common interests among stockholders and other investor rights (among other things) adequately protect their interests, without the need for additional protective provisions. Other What percentage vote threshold must be exceeded to approve any of the above specified matters? All preferred vote together as a single class Protective Provisions - Additional Additional items requiring preferred approval: Protective Provisions - Voting % How will the preferred vote? Protective provisions can serve an important role in protecting the interests of investors (particularly where the investors will have a minority position in the company), and there are a number of fairly standard protective provisions. It is in the interests of all parties, however, to exercise caution with respect to protective provisions. Care should be exercised to ensure that each protective provision is reasonable and appropriate in light of the expected benefit to the investors and the administrative burden on the company associated with having to regularly obtain stockholder approval. Protective provisions (particularly those with high vote thresholds) also have the potential to expose the company and the investors to opportunistic behavior by other investors. In addition, unnecessarily strict or vague restrictions may result in an inadvertent violation of the company’s charter, which can have a number of negative consequences. Protective Provisions – Standard Actions that will be prohibited without approval of the preferred shares: These selections are fairly standard and found in most deals. Keep in mind that these selections are presented in summary fashion. Because protective provisions are often strictly construed, care should be exercised to ensure that the language that appears in the certificate of incorporation comports with the understanding of the parties. Will the common have the right (as set forth in the certificate of incorporation) to elect a certain number of directors (i.e., a separate class vote)? Investor will often request special approval rights with respect to certain matters of particular significance to their investment (in addition to class or series voting rights that may exist under relevant state corporate laws). These special class voting rights are generally referred to as “protective provisions.” Voting for Directors – Preferred Stock – Minimum Holding Requirement Will the preferred be required to hold a minimum number of shares to retain their class rights to elect directors? Voting for Directors – Common Stock Will any other series of preferred have the right to elect directors (i.e., a separate series vote)? Voting for Directors – Preferred Stock Will this series of preferred have the right (as set forth in the certificate of incorporation) to elect a certain number of directors (i.e., a separate series vote)? This is distinct from the right to designate directors under a voting agreement, which is addressed later in the questionnaire. Each share of preferred will have the right to a number of votes equal to: Investors will typically request the right to designate a representative to serve on the company’s board of directors. This can be accomplished by providing for class voting rights for the election of directors in the company’s certificate of incorporation or by a voting agreement (addressed later in this questionnaire) in which the major stockholders agree to a particular allocation of board seats. Investors tend to prefer class voting rights over voting agreements (although they will sometimes employ both), since class voting rights tend to be more reliable than contractual voting obligations. It is typical for an early-stage company to have a board comprised of three or five members (an odd number helps to avoid voting deadlocks). This enables adequate representation of the founders and the outside investors without the administrative burdens associated with a larger board. For example, if the company has a single lead investor, the parties might agree to have a three-person board, with one designee of the Series A investor, one common designee (typically the CEO/founder) and one independent person (approved by the investor and the common holders). Similarly, with two lead investors, a common approach is to have five directors, with two Series A investor designees, two common designees (which will often include the CEO) and an independent director. Board representation rights are subject to change in connection with subsequent financings or otherwise. Board representation rights negotiated in connection with later financing rounds will vary depending upon the existing composition of the board, relative holdings among investor groups and the requirements of the new investors. Voting 50 Term Sheet in Simple Terms (Deb Sahoo)
    • Each series has a separate vote There can be some tension between the interest in having all preferred vote together as a single class (which facilitates approval and avoids potential opportunistic behavior by smaller groups of shareholders) and providing each series of preferred with a separate series vote (which enables each series to protect its rights). One compromise approach (reflected in the last option) is to have the preferred vote as a whole, but preserve a series vote on matters of particular significance to the series. All preferred vote together as a single class and certain series have a separate vote (on all matters) All preferred vote together as a single class (on all matters) and certain series have a separate vote (on select matters) Keep in mind that even though the protective provisions may call for a vote of all preferred, state corporate statutes may additionally provide for a separate series vote with respect to certain matters. Yes No a majority Other Yes No It may be prudent to provide that the protective provisions will terminate if the number of outstanding shares of preferred stock falls below ade minimus amount. In the unlikely event that a small number of preferred remain outstanding, the company and the other investors (including any preferred holders that have converted to common) will want to avoid a situation where the remaining preferred stockholders are able to exercise influence disproportionate to their holdings. The actual amount should be determined based on the capitalization of the company. 15. Preferred Stock Rights – “Pay to Play” Yes No All preferred Select series of preferred This financing only This financing and future financings Future financings only All financings Dilutive financings only the applicable conversion price of the Series TSPreferredSeries preferred stock Other Yes No Examples include: “including at least one director elected by the investors” “by 66.67% approval” “by unanimous approval” Whatever you type will be inserted directly into a parenthetical in the relevant provision in the term sheet. Loss of preferred stock rights (e.g., loss of anti- dilution protections, forced conversion to common) Loss of stockholder rights (e.g., right of first refusal, co-sale rights, registration rights, etc.) Lose anti-dilution protection for the relevant financing Lose anti-dilution protection for all financings Convert to common Rights are lost as if there was no participation Consequences for preferred stock: If the holder participates, but not to the full pro rata share: Describe: Consequences Consequence of the failure to participate (select each that applies ): To be considered a dilutive financing, the price in the financing must be less than: The board will determine whether pay-to-play provisions apply with respect to a future financing. Will any special approval standards apply (e.g., unanimous approval, approval by particular classes of directors, etc. )? Applicable Financings Applies to: The pay-to-play provisions apply to which future financings: “Pay to Play” Include a "pay-to-play" requirement: Affected Shares Shares subject to pay-to-play requirement: In general, a “pay-to-play” provision requires that investors participate in the present financing or future financings to retain anti-dilution or other rights. A “pay-to-play” is a nonstandard provision, and there can be some variation in the scope of the provision (e.g., the particular financings as to which the provisions apply, the rights affected, etc. ). A “pay-to-play” requirement is often employed to effect a significant restructuring of the company’s capital structure in connection with a highly-dilutive, or “wash-out,” financing. A “pay-to-play” requirement can also serve more generally to discourage investors from free riding on the continued financial support provided by other investors in future financings (dilutive or otherwise). Consider carefully whether “pay-to-play” provisions are appropriate. “Pay-to-play” provisions may, for example, unfairly penalize existing investors that are simply unable to invest. It is also important to note that “pay-to-play” provisions involve complex structuring issues and can add significant costs to the transaction. Termination Will the protective provisions terminate if the number of outstanding preferred shares of the class or series falls below a specified amount? Minimum number of preferred that must be outstanding for preferred to have protective provisions: Voting Thresholds Will each series have the same vote threshold? Voting threshold for each series: If selecting “Other”, use, for example, the following format: “at least 75%.” Term Sheet in Simple Terms (Deb Sahoo)
    • Rights are subject to proportional reduction 16. Registration Rights – General Yes No Limits on the transfer of registration rights are typically imposed because of the potential complexities associated with tracking and administering registration rights, particularly if the number of holders with registration rights increases significantly. When determining the minimum amount required to be transferred, consider the number of shares issued in the financing. Registration rights typically terminate a set period of time after the company’s IPO. Registration rights will also terminate at such time as the registrable shares can be sold pursuant to SEC Rule 144, which permits resales subject to certain conditions. 17. Registration Rights – “Demand” Rights The threshold should be determined in light of the number of investors, their relative holdings and the number of times a demand right may be exercised. In general, with a smaller number of demands, investors will have a stronger incentive to agree to a higher threshold. A higher threshold will minimize the likelihood that one of the few demand rights will be exercised without their consent. With a larger number of demands, this may be of a lesser concern. Because of the time and costs associated with registrations, companies will want a higher threshold. In most cases, it will be reasonable to allow the company’s board and management some period of time before becoming subject to possible demands for registration. The company’s stage of development and the investors’ time frame for a return on their investment are relevant factors to consider in setting this period. This serves to minimize the potential disruption in the market for the company’s shares that can be caused by another offering within a short time frame after the IPO. A 180-day period is standard. Care should be taken to avoid an unduly large number of demand registrations given the potential time and expense involved. Companies should also be wary of granting separate registration rights to different groups, which can lead to significant administrative complexities and a race among investors to gain control over the process. Price minimum Proceeds minimum The proceeds minimum helps to ensure that the offering is of a sufficient size to justify the time and expense of a registration and that there will be a sufficient public float following the offering. The price minimum helps to ensure that the company meets a minimum valuation threshold before it is forced to go public. This amount should be sufficiently large to justify the time and expense associated with registering the shares and to ensure sufficient public float following the offering. Although lower thresholds may facilitate the exercise of a demand right by investors, note that the company and the investors have a similar interest in avoiding an offering whose small size risks its success. The minimum price is often set in relation to the purchase price of the preferred and valuation targets for going public. Yes No It is in the company’s interest to require use of an underwriter. The use of an underwriter helps to ensure the success of the offering and an orderly market for the company’s shares after the offering. There may also be significant additional administrative burdens on the company if it is forced to register shares for resale outside of the underwritten offering context. Include a limitation on demand rights where the investors do not request a firm underwriting? Demand Rights - Deferral How many times in a one-year period may the company defer demand registration based on a determination that the registration Include a limitation on the exercise of demand rights for offerings below certain price and/or proceed thresholds? What are the minimum aggregate offering proceeds necessary for the exercise of demand rights? $ What is the minimum IPO price (net of underwriters' discounts) required to effect a demand registration? $ The questions below relate to standard exceptions from demand registration rights for which there can be some variation in scope. How many years after the date of the Investor Rights Agreement until demand rights may be exercised? How many days after an IPO until demand rights may be exercised? Maximum number of demand registrations: A “demand” right enables investors to require that the company register the investors’ shares for resale, subject to standard limitations and exceptions. There are typically limits on the number of permissible demands and the time frame for exercising a demand. In addition, it is typical to require that investors making a demand satisfy certain minimum thresholds with respect to overall shareholdings as well as the number of shares to be registered. Companies will normally agree to demand registration rights for significant investors. Demand Rights To effect a demand registration, the initiating holders must hold at least what percentage of registrable securities? % Demand Rights - Limitations Transfers Minimum number of shares that must be transferred to transfer registration rights: Termination How many years following the closing of the IPO until the registration rights terminate? To help ensure their ability to resell the shares, investors will often request registration rights. Registration rights, which typically include “demand,” “piggyback” and “S-3” rights, enable investors to require that the company register the investors’ shares for resale under certain circumstances. Although it is somewhat unusual for registration rights to be exercised, the availability of registration rights can serve as leverage in affecting the timing of an IPO or other liquidity event and the extent to which investors’ shares are included in any registered offering. In general, companies will want to limit the scope of any registration rights due to the time, expense and liability associated with registrations. However, it is important to keep in mind that, because registration rights have been rarely exercised historically, there is at least some question as to the value of expending significant effort trying to negotiate the specific aspects of registration rights. There are fairly standard conventions with respect to registration rights, and we have tried to reflect those conventions as default selections in the questionnaire. Registration Rights Will the investors have registration rights? It is important for investors to have a means to eventually liquidate their investments. Securities sold in private financings are typically subject to restrictions on resale under securities laws. Although there are limited exemptions from these resale restrictions, these exemptions subject the investors to holding periods and other potentially applicable conditions that may limit the ability of investors to resell their shares. 3 50 5 180 2 20,000,00 10 2 Term Sheet in Simple Terms (Deb Sahoo)
    • It is typical to provide the company with some flexibility in the event registration at a particular time might compromise the company’s interests in the face of other business developments (e.g., if the company is engaged in acquisition talks). The number of times the company may exercise this right (and, sometimes, the deferral period) can be subject to negotiation. What is the maximum number of days that a demand may be deferred? 18. Registration Rights — “Piggyback” Rights Yes No For the company, it is preferable to have a full cutback to avoid any marketing issues associated with selling stockholders and to limit administrative hassles. It is fairly standard for investors to agree to a full cutback with respect to IPOs given the marketing sensitivities associated with having selling stockholders in an IPO. Minimum percentage amount to which the registration rights of investors may be cut back: 19. Registration Rights — “S-3” Rights This amount typically ranges from $500,000 to $5,000,000, with $1,000,000 being the most common. Enter a number (e.g., “1”, “2”). Investors are typically given the right to one or two S-3 registrations in a given twelve-month period. 20. Market Stand-Off How many days is the lock-up? 180 days is typical. IPO only All offerings Yes No Before agreeing to a lock-up, investors will typically want assurances that insiders and other significant shareholders will also be subject to a lock-up. Investors will not want to be locked out of the market while other shareholders are free to sell. A company should be careful in agreeing to this type of all-or-nothing condition given the risk of hold-outs and opportunistic behaviour. Directors and officers only 1% stockholders only A company should be comfortable that it can obtain the required lock-ups. Ideally, the company’s standard stockholder documentation will incorporate lock-up language. Directors, officers and 1% stockholders 21. Information Rights Annual financials Quarterly financials It is common for companies to agree to provide annual and quarterly information. Before instituting more extensive information requirements, the parties should consider whether the company is equipped to comply with those requirements in a timely manner and the relative value of that information. Monthly balance sheet and statement of income and cash flows Annual operating plan Variances from plan (monthly) (select only if an annual operating plan is otherwise required) To limit potential burdens associated with administering certain rights, it is typical to limit certain rights to significant investors. Information Rights The company will be required to provide the following financial information on an on-going basis: Minimum number of shares that must be held by an investor to have information rights: Annual Financials Is the lock-up conditioned upon directors, officers and/or 1% stockholders also agreeing to a similar lock-up? Who else must be subject to a lock-up for the lock-up to apply to investors? Companies will typically agree to provide investors with periodic financial information and rights to inspect corporate records. These rights provide investors with important ongoing information concerning their investment and can also serve to address certain technical legal requirements that can be relevant to venture funds. It is typical for investors to agree to a standard market stand-off agreement (sometimes referred to as a “lock-up”) in which the investors agree not to sell company securities for a certain period of time after a public offering. Underwriters for the company’s IPO will normally require that all company stockholders be subject to market stand-off agreements as a condition to the offering. This helps to ensure an orderly market for the company’s shares following the offering. Since potential disagreements at the time of the offering may delay or threaten the offering, it is ideal for the company to obtain these lock-up agreements at the time of each securities issuance rather than to wait until the IPO. Market Stand-Off The lock-up applies to what offerings: It is typical to limit the lock-up to the IPO. % S-3 rights are a form of demand registration that applies to registrations on Form S-3. Form S-3 is a “short form” registration available to companies that are already public reporting companies and that meet other requirements. Because use of Form S-3 enables companies to incorporate by reference to the company’s public filings with the SEC, the time and expense associated with a Form S-3 registration tends to be significantly less than that associated with an IPO or another offering that requires use of Form S-1 (which is a much longer form). Consequently, as compared to standard demand registration rights, the thresholds associated with S-3 registration rights tend to be lower and the rights tend to be more regularly exercisable. However, because S-3 registrations involve time, cost and risk, S-3 rights are nevertheless subject to many of the restrictions applicable to demand registration rights generally. S-3 Rights Minimum required offering size for an S-3 registration: $ Maximum number of Form S-3 registrations that may be requested in a given twelve-month period: “Piggyback” registration rights enable investors to include their shares in registered offerings by the company. “Piggyback” registration rights typically do not apply to the company’s IPO and are subject to being cut back in the event the inclusion of selling shareholders in the offering may harm the marketing of the offering. “Piggyback” registration rights may be of more practical significance to investors than demand rights, which are less likely to be used. “Piggyback” Rights Investors are typically prohibited from “piggybacking” on an IPO with no other selling stockholders. In other offerings, will there be a limit on the amount the investors can be cut back? would be detrimental to the company? 2 90 25 1,000,000 2 180 Term Sheet in Simple Terms (Deb Sahoo)
    • Within how many days after the end of each fiscal year must the annual financials be delivered? Independent public accountants of recognized national standing The CFO of the company For many early-stage companies, it may not be appropriate to require audited financials. Within how many days after the end of each of the first three quarters must the company provide the quarterly financial information? Yes No It is customary for companies to provide significant investors with rights to inspect corporate records. What is the minimum number of shares that an investor must hold to have inspection rights? Any IPO A qualified public offering (i.e., a public offering that would trigger the automatic conversion of the preferred) Information rights should generally terminate upon an IPO (regardless of whether it is a qualified public offering) since investors will have access to the company’s public reports and should not therefore need information rights. 22. Right of First Refusal on Future Issuances by the Company Yes No All preferred Only this series of preferred Yes No It is typical to limit certain investor rights to significant investors. This helps to limit potential burdens associated with administering these rights. It is helpful to have a uniform approach with respect to who constitutes a significant investor (for purposes of granting different shareholder rights). Unless there is a particular rationale for doing otherwise, you should use the same share threshold for different rights. Any new offering of securities Up to a certain percentage of any new offering of securities All outstanding securities (on an as-exercised and as-converted basis) The company's fully-diluted capitalization (including full option pool) The first two options are focused on providing investors with the right to maintain their ownership interest in the company or simply to participate in future financings. The third option, which is more investor-favorable, provides investors with the right to acquire all shares offered in any future issuances by the company. Shares held by all investors with the right of first refusal Yes No There is a risk that the purchase of only some of the offered securities by existing investors may undermine the company’s ability to sell the remaining shares (since prospective investors may not be interested in a smaller investment), which might deprive the company of needed funds. Yes No An over-allotment right (which is sometimes called a “gobble-up”) would enable investors that fully exercise their rights of first refusal to have a second chance to purchase any of the offered shares not otherwise purchased by the other investors. An over-allotment right is an investor-favorable term. Any IPO A qualified public offering (i.e., a public offering that would trigger the automatic conversion of the preferred) A “qualified public offering” is one that meets the price/proceeds thresholds required to cause the automatic conversion of the preferred stock into common. Use of the “qualified public offering” definition protects investors from the loss of their rights prior to the time that they can secure a certain minimum return on their investment. Although termination of investor rights is often tied to the “qualified public offering” standard, it may be prudent to have the right of first refusal terminate upon any public offering. It can be problematic under securities laws for companies to grant rights of first refusal with respect to public offerings. 23. Voting Agreement – General Yes No A B C Which series of preferred will have board representation rights under the voting agreement (select each that applies)? Shareholders (typically, the preferred holders and the major common holders) will sometimes enter a voting agreement to allocate board seats to particular groups of shareholders. Even if the company’s charter provides for class voting for directors, a voting agreement can serve to specify how seats within a particular class will be allocated among holders of that class. For example, if a particular class has the ability to elect two directors, a voting agreement can serve to further specify which shareholders in the class have the right to designate one of the directors and which shareholders have the right to designate the other. Use of voting agreements may also help venture capital funds to qualify for the venture capital operating company exception under the plan asset regulations of ERISA. Voting Will the parties be entering a voting agreement with respect to the election of directors? Will the investors have an over-allotment right with respect to the right of first refusal? Termination The right of first refusal will terminate upon: The right of first refusal on future company issuances will be allocated pro rata among investors based on: Will holders exercising the right of first refusal be required to purchase all of the securities being offered? Over-Allotment Option Minimum number of shares that must be held for an investor to have a right of first refusal: Allocation The right of first refusal will apply (subject to customary exceptions) to: Who will have the right of first refusal? Will the right of first refusal be limited to stockholders with significant holdings? Investors will often request a right to participate in future financings. Because first refusal rights can add time, expense and complexity to future financing efforts, it is important to ensure that appropriate limitations and exceptions are included in the final documentation. Right of First Refusal Will the investors have a right of first refusal on future company issuances? Will the investors have inspection rights? Termination The information rights will terminate upon: The annual financials must be certified by: Quarterly Financials Inspection Rights 120 45 200000 Term Sheet in Simple Terms (Deb Sahoo)
    • D E F Other How many directors will this series have the right to designate? How many directors will this series have the right to designate? How many directors will this series have the right to designate? How many directors will the investors have the right to designate? Enter “0” if none. How many directors will the founders have the right to designate? Enter “0” if none. How many directors will the founders and the investors have the right to jointly designate? Enter “0” if none. 24. Voting Agreement – Common Designees Yes No The parties will often agree that one of the designees will be an officer of the company, such as the Chief Executive Officer or President. What position? 25. Voting Agreement – Mutual Designees a majority at least 66 2/3% Other a majority at least 66 2/3% Other 26. Board Observer Rights Yes No [1] Investor with Board Observer Rights Name: [2] Investor with Board Observer Rights Name: [3] Investor with Board Observer Rights Name: 27. “Drag-Along” Rights Yes No Persons subject to the "drag-along" requirement: List the relevant individuals using the following format: “[Name], [Name] and [Name]”. All preferred Only this series of preferred Other a majority at least 66 2/3% Other 28. Right of First Refusal on Sales by Other Shareholders Yes No The company first, then the investorsThe right of first refusal will be granted to: Investors will often require that any founder that intends to sell his or her shares offer those shares first to the company and the investors. The primary purpose of the right of first refusal is to provide the company and the investors with the ability to keep the company’s capital stock within the existing ownership group. If the founders or other major stockholders elect to exit the company, the investors will want the ability to purchase their shares so that the investors may either obtain greater control over the company or prevent the transfer of control to non-strategic or hostile parties. Rights of first refusal are typically granted to the investors and applied against the founders (although, occasionally, these rights may also be granted to founders or applied against other major stockholders). Right of First Refusal Will sales by founders or other stockholders be subject to a right of first refusal? The "drag-along" will be triggered if a sale is approved by: What is the minimum percentage vote of the investors required (in addition to the approval of the board) to trigger the "drag- along" rights? If you select “Other” and enter another amount, include the words “at least” (e.g., “at least 75%”). A “drag-along” provision obligates stockholders that are subject to the “drag along” to vote to approve a transaction that is otherwise approved by a specified percentage of the stockholders. Common holders may sometimes have different interests than preferred holders, particularly where liquidation preferences will have the effect of minimizing the return to the common holders. “Drag-along” rights provide the investors with some assurance that the founders and other major common holders (who are typically the focus of “drag along” provisions), and, in some cases, other shareholders, will not attempt to block a sale of the company through the exercise of class voting rights or otherwise. Shareholders should exercise caution in agreeing to be subject to “drag-along” provisions. Shareholders should understand the implications of being subject to the “drag along” and should carefully assess any associated obligations. In addition, those subject to the “drag along” should ensure that there are appropriate limitations and exceptions. “Drag-Along” Rights Will the founders be subject to "drag-along" rights? (#1 of 3) (#2 of 3) (#3 of 3) Minority investors (that do not otherwise have the right to appoint a director) may ask for the right to have a non-voting observer attend board meetings. In addition, an investor forced to relinquish a board seat as board seats get allocated to new investors will sometimes be given board observer rights. There are important qualifications and limitations that should apply to board observer rights, and it is important that the rights and limitations are carefully documented. Board Observer Rights Will any investors require board observer rights? Mutual Designee Investor approval required for a mutual designee: If entering another amount, include the words “at least” (e.g., “at least 75%”). Founder approval required for a mutual designee: If entering another amount, include the words “at least” (e.g., “at least 75%”). Mutual Designee(s) Officer as Common Designee Is one of the common designees required to be an officer? Series C Designee(s) Preferred Designee(s) Common Designee(s) Series A Designee(s) Series B Designee(s) X Y Term Sheet in Simple Terms (Deb Sahoo)
    • The company only The investors only Yes No The most common approach is to provide the company and the eligible investors with the right to purchase all or any portion of the offered shares. This approach provides the most flexibility to the company and the eligible investors. Founders may prefer that the company and/or the eligible investors purchase all or none of the offered shares (on a cumulative basis) since a partial purchase may undermine a founder’s ability to sell all of the shares (i.e., prospective purchasers may be unwilling to purchase a smaller stake). All preferred Only this series of preferred All outstanding securities (on an as-exercised and as-converted basis) The company's fully-diluted capitalization (including full option pool) Shares held by all investors with the right of first refusal Yes No An over-allotment right (which is sometimes called a “gobble-up”) would enable investors that fully exercise their rights of first refusal to have a second chance to purchase any of the offered shares not otherwise purchased by the company or the investors. This investor-favorable provision is not uncommon. From the investor’s perspective, an over-allotment option provides additional protection against outside parties becoming stockholders in the company. Founders may object since an over-allotment option can serve to more effectively block any transfer to a third party. There is a stronger basis for the over-allotment right if the investors are required to purchase all or nothing in connection with the exercise of their rights of first refusal. A qualified public offering (i.e., a public offering that would trigger the automatic conversion of the preferred) Any IPO A “qualified public offering” is one that meets the price/proceeds thresholds required to cause the automatic conversion of the preferred stock into common. Use of the “qualified public offering” definition protects investors from the loss of their rights prior to the time that they can secure a certain minimum return on their investment. While it is not contemplated that investors would continue to have a right of first refusal on sales by founders after the company is public (whether or not the company’s IPO is a “qualified public offering”), the “qualified public offering” requirement provides the investors with an additional means to influence the decision as to whether to go public. 29. “Co-Sale” Rights Yes No All preferred Only this series of preferred Yes No It is uncommon to give co-sale rights to other founders. Yes No An over-allotment right would enable investors that fully exercise their co-sale rights to sell additional shares to the extent other investors do not fully exercise their co-sale rights. This is an investor- favorable right. A qualified public offering (i.e., a public offering that would trigger the automatic conversion of the preferred) Any IPO A “qualified public offering” is one that meets the price/proceeds thresholds required to cause the automatic conversion of the preferred stock into common. Use of the “qualified public offering” definition protects investors from the loss of their rights prior to the time that they can secure a certain minimum return on their investment. While it is not contemplated that investors would continue to have co-sale rights after the company is public (whether or not the company’s IPO is a “qualified public offering”), the “qualified public offering” requirement provides the investors with an additional means to influence the decision as to whether to go public. 30. First Refusal/Co-Sale Restrictions - Founders [1] Founder Name of founder to be subject to first refusal/co-sale obligations: Use arrows to add names. [2] Founder Name of founder to be subject to first refusal/co-sale obligations: Use arrows to add names. Termination The co-sale rights will terminate upon: (#1 of 2) (#2 of 2) Will the founders also have co-sale rights? Over-Allotment Rights Will the investors have an over-allotment option with respect to the co-sale rights? Will sales by founders or other stockholders be subject to co-sale rights? Who will have co-sale rights on sales by founders? Termination The right of first refusal will terminate upon: “Co-sale” rights enable investors to participate in any sales of the company’s capital stock by founders or other large stockholders. Co-sale rights are principally designed to protect investors’ interests in a situation where founders or others attempt to sell a significant block of common stock. Investors may want the option to participate in the sale since the sale of a controlling interest may involve a control premium and may have the effect of foreclosing other avenues to liquidity. In addition, investors may generally want an opportunity to liquidate their investment if the founders are seeking to exit the enterprise. Co-Sale Rights Will participating investors have an over-allotment right with respect to unsubscribed shares? Investors Who will have the right of first refusal on proposed transfers by founders? The right will be allocated pro rata among investors based on: Company Will the company be required to purchase all the shares proposed to be transferred if it exercises its right of first refusal? Deb Sahoo Term Sheet in Simple Terms (Deb Sahoo)
    • Common stock only All shares (including any preferred shares held by the founder) Founders may request that only the common stock received as a founder be restricted, on the rationale that they should have the same rights as other preferred holders with respect to any preferred holdings. Investor will prefer that all shares held by founders be subject to restriction since the rationale for imposing restrictions on sales of common shares applies similarly to sales of preferred. This issue may vary in significance depending upon the number of preferred shares held or expected to be held by the founders. 31. First Refusal/Co-Sale Restrictions – Major Investors Yes No Although these restrictions typically apply only to sales by founders, they can also apply to sales by other significant stockholders such as other major common holders, seed investors and strategic investors (it is uncommon for these restrictions to apply to venture investors). Relevant factors include the company’s capitalization structure and the relative holdings of different stockholders, the interests and relationships of the different holders and relative negotiating leverage. Major Investor Name: Use arrows to add names. Common stock only All shares (including any preferred shares held by the major investor) 32. First Refusal/Co-Sale Rights – Investors Yes No To lessen potential administrative burdens, first refusal/co-sale rights will often be limited to investors with a significant interest in the company. Significant investors also benefit under this approach since there are fewer investors with which to compete. Minimum number of shares that must be held to have first refusal/co-sale rights: 33. Management Rights Yes No Investor with Management Rights Name: 34. Stock Vesting for Founders Yes No Investors will want founders’ shares to be subject to vesting (even where shares may have been purchased for value or have previously vested) to create an incentive for the founders to remain committed to the company, particularly where a significant portion of the value of the enterprise lies in the “human capital” of the founders. Vesting also helps to mitigate the potential dilutive effect associated with filling a management position vacated by a departing founder (i.e., any unvested shares can be allocated to the new hire). Founders may object to any vesting requirements, particularly with respect to stock purchased for value or where vesting does not appropriately account for the time and effort already contributed by the founder. Some of the key issues with respect to vesting will include the persons and shares subject to vesting, the vesting schedule, events triggering accelerated vesting and credit for prior service. Founders will typically be provided some level of accelerated vesting in the event of termination following a change of control. Specify founders subject to vesting: If vesting will apply to someone other than the founding group (or if it is otherwise helpful to identify those subject to vesting by name in the term sheet), list the persons subject to vesting (using the following format: “Person A, Person B and Person C”). Standard four-year vesting (with 25% vesting after one-year cliff followed by month-to-month vesting) To be determined upon later mutual agreement Vesting schedule: Will the term sheet include a discussion of the investors’ expectations regarding the vesting of founders’ shares? Term sheets often include a discussion of the investors’ expectations regarding the vesting of founders’ shares. Vesting of founders’ shares can be a contentious issue, particularly if the founders’ shares are not presently subject to vesting or are subject to a different vesting schedule than contemplated by the investors. Vesting of Founders' Shares An investor may ask for “management rights” to qualify for the venture capital operating company exception to the ERISA plan asset regulations. Please consult with an expert for advice in this area. Management Rights Will any investors require management rights? Major Investor Shares to be Restricted What shares held by major investors will be subject to first refusal/co-sale rights? Investors with Rights Will first refusal/co-sale rights be limited to stockholders with significant holdings? Major Investors Will shareholders other than the founders (“major investors”) be subject to right of first refusal/co-sale restrictions? Founder Shares to be Restricted What shares held by the founders will be subject to first refusal/co-sale rights? all founders Term Sheet in Simple Terms (Deb Sahoo)
    • Other the commencement of services the initial closing of the financing Other 35. Stock Vesting for Employees Yes No Standard four-year vesting (with 25% vesting after one-year cliff followed by month-to-month vesting) Other 36. Insurance Issues Yes No “Key person” to be covered Name: Amount of coverage: Yes No It may be more appropriate for the investors to defer to the board’s discretion on this matter, rather than mandating it in connection with the financing. 36. Qualified Small Business Stock – Compliance Issues Yes No It is more common for investors to request representations regarding “qualified small business stock” matters than an undertaking from the company to comply with “qualified small business stock” requirements. It is important that you consult with a qualified tax advisor on issues related to “qualified small business stock.” Comply with applicable filing and reporting requirements Cause the shares to qualify as qualified small business stock A company should exercise caution in agreeing to any covenant relating to “qualified small business stock” status. In particular, a company should exercise caution in agreeing to cause the shares to qualify as “qualified small business stock,” which may have a number of negative implications for the company. It is important that you consult with a qualified tax advisor on issues related to “qualified small business stock.” Not applicable 37. Closing Matters Expected closing date: Yes No It is typical in venture financings to provide some flexibility to conduct subsequent closings within a reasonable period after the initial closing. This enables the company to collect money from investors that are ready to invest without foreclosing the possibility of subsequent investments by other investors that may have become involved later in the process or are otherwise delayed in investing. This flexibility is particularly important for start-ups since they are often thinly capitalized and may need at least some funds prior to the time that all investors would otherwise be ready to close. This period typically ranges from 30 to 90 days. It is appropriate to have some reasonable limit on the period during which subsequent closings may occur. After some period of time, the valuation of the company may change, which would necessitate new pricing terms. Yes No There can be instances where investors agree to provide an initial investment followed by a possible additional investment upon the achievement of specified milestones. Use of these “milestone” closings is not common. They can involve complex drafting issues that can significantly increase the time and costs associated with the financing, with uncertain benefit. It can be difficult to establish milestones that are objectively verifiable and not subject to interpretive disputes. Moreover, reliance on milestones may not adequately account for other events or developments that may affect the company’s valuation. There are also a number of other issues that must be addressed. For example, the parties must determine whether achievement of the milestone automatically triggers the investment or whether it gives the company the right to call the investment. Provide for additional closings upon achievement of specified “milestones”? Subsequent Closings Allow subsequent closings after the initial closing: Within how many days after the initial closing may subsequent closings occur? “Milestone” Closings The company will agree to use reasonable efforts to (select each that applies ): In most venture financings, the parties sign the definitive financing documents and close the transaction (i.e., issue the securities on payment of the purchase price) at the same time. Because there is typically no gap between signing and closing, closing matters tend to be relatively straightforward. Closing Investors interested in the potential tax benefits associated with an investment in “qualified small business stock” will sometimes ask for related representations or undertakings from the company. It is important that you consult with a qualified tax advisor on issues related to “qualified small business stock.” Compliance with “Qualified Small Business Stock” Requirements Will the company give a representation as to qualified small business stock status? $ Insurance for Directors and Officers Will the company be required to obtain liability insurance for directors and officers? Vesting schedule: "Key Person" Life Insurance Will the investors require that the company obtain "key person" life insurance covering specified individuals? This provision is most typical in early rounds where the loss of one or more key persons can cause the company to lose significant value. Term sheets sometimes include a statement regarding the vesting of employee shares. Keep in mind, however, that any standard set forth in the term sheet will be subject to the discretion of the board in approving the grants. Consequently, this mainly serves to express the expectations of investors with respect to future issuances of options. Vesting of Employees' Shares Will the term sheet include a discussion of the investors’ expectations regarding the vesting of options granted to employees? Vesting commencement date: If you select “Other,” the text will be inserted exactly as typed into the term sheet following the words “vesting on the first anniversary of . . . .” Therefore, do not use an initial capital. 60 Term Sheet in Simple Terms (Deb Sahoo)
    • If you answer “Yes,” you will need to separately prepare an exhibit detailing the milestone closing requirements. Payment upon initial closing: Mandatory Voluntary (at the election of the investor) Certificate as to accuracy of representations and compliance with covenants as of the closing Good standing certificate It is typical to require delivery of a certificate as to the accuracy of the representations and compliance with the covenants in the stock purchase agreement as of the closing date. It is also typical to require that the company furnish a certificate from relevant state authorities indicating that the company is in good standing with those authorities. Secretary's certificate Legal opinion Investors will sometimes request delivery of a certificate from the company’s corporate secretary certifying as to corporate documentation and approvals. This is relatively straightforward and should not be objectionable to the company. Legal opinions from company counsel involve more cost and effort and are therefore typically only requested in significant financings involving venture funds. The company should confer with its counsel regarding opinion issues. Yes No Special Closing Condition Describe: 38. Legal Fees Yes No Yes No Although there are general industry conventions regarding the amount of the cap, the cap should also account for the complexity of the transaction. Yes No 39. Capitalization Information Yes No Yes No It can be helpful to provide pro forma capitalization information that reflects the financing and related changes (e.g., any increase to the option pool). This can help to ensure that the parties are operating on the same understanding with respect to pricing and ownership issues. 40. Confidentiality Yes No The existence and terms of the Term Sheet The fact that negotiations may be ongoing with the investors Yes No Yes No 41. Exclusive Negotiations Require that any person receiving confidential information (as reasonably necessary to complete the transaction) is otherwise subject to confidentiality obligations? Please keep in mind that this level of assurance may not be appropriate for venture financing term sheets and may subject the parties to undue burdens. Investors will sometimes require companies to agree to an exclusive negotiation period (sometimes referred to as a “no-shop” period). Given that it may have expended significant time and effort in conducting due diligence and negotiating deal terms, an investor will not want the company to immediately turn around and use the term sheet to leverage better deal terms from other investors. Companies, however, should exercise caution in agreeing to a “no shop.” Agreeing to a “no shop” too early in the process may foreclose better opportunities. In addition, a “no shop” can be increasingly coercive where the company is close to running out of money. Ultimately, from the company’s perspective, a “no shop” is problematic because investors do not have an obligation to proceed with the investment. With no guarantee of a deal, the company may be left with no options or bad options at the end of the “no shop” period. The confidentiality requirement will cover (select each that applies ): Exceptions Include standard exceptions for disclosures reasonably required to consummate the financing and disclosures required by law? Exceptions are also permitted with the consent of the company and the lead investor. The confidentiality requirements terminate upon the initial closing of the financing. Investors will often request that any term sheet be confidential to decrease the likelihood that the company will attempt to leverage the term sheet to obtain better terms from another investor. A company may not want to be so restricted, particularly where there may be significant interest in the company or if the company is in the early stages of soliciting interest. Confidentiality Requirement Include binding confidentiality obligations with respect to the term sheet or the negotiations? Capitalization Table Will the term sheet include a capitalization table? If you answer “Yes,” you will need to separately prepare a capitalization table to attach to the term sheet. Include pro forma , post-financing capitalization information in the table? Payment Require that legal fees be payable at closing? Term sheets typically include a table detailing the existing capitalization of the company. An effective table would include, among other things, information about outstanding common stock, preferred stock, stock options and restricted stock, warrants, convertible securities, shares reserved for issuance under company option plans, conversion ratios, etc. Cap on Legal Fees Will there be a cap on attorneys' fees? It is typical to have some cap on attorneys fees. Cap amount: $ Investors typically require that the company pay the fees of one counsel for the investors, subject to some cap. Reimbursement of Legal Fees of Investors’ Counsel Will the company be required to pay the legal fees of one counsel to the investors if the financing closes? Closing Conditions Will there be any special closing conditions (beyond the standard closing conditions for venture financings)? $ Upon completion of the performance milestones, additional investment is: Closing Deliverables The company must deliver the following at closing: Term Sheet in Simple Terms (Deb Sahoo)
    • Yes No The exclusivity period will also terminate upon notice of termination of negotiations by the lead investors or the initial closing of the financing contemplated by the term sheet. Soliciting Participating in negotiations or discussions Providing non-public information Other investments in the company Acquisitions of the company Similar transactions Yes No Prior consent Prior written consent Yes No 42. Governing Law California Delaware New York Texas Washington Other 42. Signatures Name of investor that is signing the term sheet: Source : Brad Feld and Others Governing Law Select: Unless the parties intend to include limited binding provisions (such as those relating to confidentiality or exclusive negotiations, for example), it is generally recommended that the term sheet not be signed. Signing the term sheet may open the possibility that the term sheet would be construed as a contract when, in fact, the commitment by either the company or the investors may remain subject to a number of conditions not adequately reflected in the term sheet. Exceptions The "no shop" restriction will not apply if the lead investor provides: Allow the company to have discussions with specified parties identified in the term sheet? Often, an exception is made for prospective investors specifically identified by the company (e.g., prospective investors with which the company is already in contact or expects to be in contact). The prohibition applies to (select each that applies ): Will the company be required to notify the lead investors of any investment or acquisition proposal? Exclusivity Period The exclusivity period ends: Restrictions The company is prohibited from (select each that applies ): Whether a company should ultimately agree to a “no shop” period will depend on a number of factors, including the company’s financial condition, the negotiating leverage of the parties, market conditions, etc. “No-Shop” Restriction Provide for an exclusive negotiation period (i.e., a "no shop" period): Term Sheet in Simple Terms (Deb Sahoo)