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  • 1. INVESTOR TERM SHEETS Roger Royse Royse Law Firm, PC 1717 Embarcadero Road Palo Alto, CA 94303 rroyse@rroyselaw.com www.rroyselaw.com San Francisco, CA Skype: roger.royse August 28, 2012IRS Circular 230 Disclosure: To ensure compliance with the requirements imposed by the IRS, we inform you that any tax advice contained in this communication,including any attachment to this communication, is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding penaltiesunder the Internal Revenue Code or (2) promoting, marketing or recommending to any other person any transaction or matter addressed herein.
  • 3. • A TERM SHEET proposes the basic relationship between a venture capitalist and a company• It sets out the broad parameters of an investment• It is NOT a legal promise to invest• It is only a contract to the extent that:  It requires you to keep the negotiations confidential  It may prevent the company from looking at other suitors for a period (the “no-shop” or “exclusivity” provision) 3
  • 5. 1. ECONOMIC TERMS• Valuation  Pre-money: the value of the company before any new cash is invested  Post-money: the pre-money valuation + total new investment• Type of Security  Typically, companies issue preferred stock, which comes with a series of preferences• Liquidation Preferences  The right to receive the proceeds of a liquidation event (or exit) before the common stock holders  The term sheet will specify what constitutes a “liquidation event” 5
  • 6. • Conversion  Transform preferred into common stock, usually at a 1:1 basis  Transform the security into whatever is being issued at the IPO• Anti-Dilution  If the number of shares change, an investor’s relative ownership in the company will be adjusted so as to remain constant  Price-based anti-dilution:  Full-ratchet anti-dilution (great for investors)  Weighted average anti-dilution (more fair for company)• Pay to Play  Works to a company’s advantage  Each investor has to invest a certain amount in later financings or suffer one or more penalties, including:  Forced conversion to common, which means losing preferred rights  Stripping the investors of anti-dilution protection  Depriving them of various control rights 6
  • 7. • Warrants  The right to buy more stock at a particular price within a particular time frame  Quite common in debt financings• Cost of Counsel  Investors ask for a certain amount of legal fees to be reimbursed 7
  • 8. 2. CONTROL AND INVESTORS’ RIGHTS• Participation Rights  A company has an obligation to sell stock in future financing rounds to existing investors• Co-Sale and Right of First Refusal (ROFR)  Co-sale: whatever percentage a founder or other key holder sells of his stake, the investor gets to do the same, to the same buyer  ROFR: investor has a right to buy the stock on the same terms on which a founder or key holder proposes to sell to a 3rd party• Registration Rights  Require the company to register investor stock for sale at IPO• Board Representation  Investors will ask for board positions  Start ups put a cap on the maximum number of board members 8
  • 9. • Voting Rights  Investors will typically require an approval right over any actions that would be adverse to them  Investors may request the consent of a certain percentage of a class or series of stock• Information Rights  Requested by investors who don’t have a board seat  Require the company to “consult” with the VC (less appealing to company)• Major Holders  Company can confine rights to “major” shareholders and define the term accordingly 9
  • 10. • Drag Along  Allow the majority of shareholders to “drag along” smaller shareholders to a sale of the company  Variety of options:  Whose approval is needed to invoke the drag (A majority of the preferred? Or a majority of the common as well)  Who gets dragged (Just the common? Or the preferred as well?) 10
  • 11. 32
  • 12. PALO ALTO LOS ANGELES SAN FRANCISCO1717 Embarcadero Road 11150 Santa Monica Blvd., 135 Main Street, Palo Alto, CA 94303 Suite 1200 12th Floor Los Angeles, CA 90025 San Francisco, CA 94105 12