© 2014 Valla & Associates, Inc., P.C.
www.vallalaw.com 1
Majda Barazzutti
July 23, 2014
THE VENTURE CAPITAL
FINANCING PROCESS:
TERM SHEET NEGOTIATION
© 2014 Valla & Associates, Inc., P.C.
www.vallalaw.com 2
ENT...
Financing is a Staged Process
 Common Stock
 Bootstrapping
 Friends and Family
 Angels: Equity, Warrants, Convertible ...
Convertible Debt
 Bridge loan before financings
 Useful when the company does not have a
satisfactory valuation
 Risks ...
 Warrants: option to purchase company shares
at a price within a set period
 “Kicker” to increase the potential investme...
Alternatives: Strategic Investors
 Aims Differ
 Not Interested in Helping the Company Grow
 Conflict of Interest: great...
Venture Capital
 Identify the Right VC
 Due Diligence
 The Risk of “Finders”
© 2014 Valla & Associates, Inc., P.C.
www....
 Prior to Investing:
 Document Employees
 Founders Relationships
 Securities filings
 Confidentiality and Invention A...
Preferred Stock (Series)
 Why Preferred?
 Liquidation Preference
 Preserve a low common stock value for option grants
(...
Sample Term Sheet
 Binding Provisions:
 No Shop
 Confidentiality
 Applicable law
 ALL other provisions are not bindin...
A Typical Term Sheet
 Valuation/Number of Shares/Price
 Liquidation Preference
 Redemption
 Conversion
 Vesting of fo...
Valuation/Price
 Pre-money/Post-money valuation: Option pool shuffle
 How are your shares valued?
 8M pre-money valuati...
Liquidation Preferences
 Liquidation Preference: 1x or more – 2x, 2x
 Participating Preferred:
 Straight/Non-participat...
Dividends
 No expectation of dividends, but:
 Cumulative Dividends: __ % cumulative dividend accrues over
time, whether ...
Redemption
 Optional (Company call):
 Company can repurchase stock at original price (plus
dividends) if Investors don’t...
Conversion
 Preferred always has a conversion to Common feature,
but loses all preferred privileges
 Optional Conversion...
Anti-Dilution
 Protect investors if company issues equity at a lower
valuation than preferred
 Full Ratchet 3%
 Weighte...
Exclusions from Dilution
 Carve-outs from anti-dilution:
 Options grants to employees, consultants (negotiate
all or onl...
Other Terms:
 Vesting of founders’ stock, acceleration
 Right of first refusal: new issuance and
transfers by founders
...
Other Terms:
 No-shop agreement
 Information rights
 Confidentiality
 Indemnification
 Counsel expenses up to ___
 L...
Bottom Line
 (Almost) anything can be negotiated
 Pick your battles: Liquidation Preferences,
Protective Provisions, Boa...
Thank you
IN BOCCA AL LUPO!
Valla & Associates, Inc., P.C.
1990 N. California Blvd., Suite 1060
Walnut Creek, CA 94596
USA...
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Term Sheet Negotiations

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The Venture Capital Financing Process: Term Sheet Negotiation. Presentation for entrepreneurs on the legal process of term sheet negotiation with Venture Capitalists.

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  • Term Sheet Negotiations

    1. 1. © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 1 Majda Barazzutti July 23, 2014
    2. 2. THE VENTURE CAPITAL FINANCING PROCESS: TERM SHEET NEGOTIATION © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 2 ENTREPRENEURIAL JOURNEY
    3. 3. Financing is a Staged Process  Common Stock  Bootstrapping  Friends and Family  Angels: Equity, Warrants, Convertible Notes  Series seed financing  Series A Preferred (B, C, etc.)  Liquidity Event © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 3
    4. 4. Convertible Debt  Bridge loan before financings  Useful when the company does not have a satisfactory valuation  Risks of repayment feature  No minimum capital but insolvency changes the rules  Better include a provision to force conversion © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 4
    5. 5.  Warrants: option to purchase company shares at a price within a set period  “Kicker” to increase the potential investment value  Warrants increase in value as the value of the underlying shares increase in relation to the exercise price  Usually issued with bridge financing © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 5 Warrants
    6. 6. Alternatives: Strategic Investors  Aims Differ  Not Interested in Helping the Company Grow  Conflict of Interest: greater returns from commercial rights than growth  Expertise  Could affect future VC financings © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 6
    7. 7. Venture Capital  Identify the Right VC  Due Diligence  The Risk of “Finders” © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 7
    8. 8.  Prior to Investing:  Document Employees  Founders Relationships  Securities filings  Confidentiality and Invention Agreements  Prepare for VC’s due diligence © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 8 “Clean Up”
    9. 9. Preferred Stock (Series)  Why Preferred?  Liquidation Preference  Preserve a low common stock value for option grants (ratio 1:4 to 1:8):  Common Stock was bought at cheap price, $0.10 to founders.  If Common were sold at same time at $5.00 to VC, tax consequences for founders.  No limits to Preferred/Common ratio © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 9
    10. 10. Sample Term Sheet  Binding Provisions:  No Shop  Confidentiality  Applicable law  ALL other provisions are not binding  See examples: NVCA (http://www.nvca.org) © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 10
    11. 11. A Typical Term Sheet  Valuation/Number of Shares/Price  Liquidation Preference  Redemption  Conversion  Vesting of founders’ stock  Antidilution  Voting Rights  Protective Provisions © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 11
    12. 12. Valuation/Price  Pre-money/Post-money valuation: Option pool shuffle  How are your shares valued?  8M pre-money valuation, 6M shares outstanding  $8M pre-money ÷ 6M existing shares = $1.33/share, right?  WRONG: The share price is $1.00  WHY? Read the term sheet: “The $8 million pre-money valuation includes an option pool equal to 20% of the post- financing fully diluted capitalization.”  $8M pre-money ÷ (6M existing shares+2M options )= $1/share.  Pre-money valuation includes an unallocated option pool for new employees -- lowering pre-money valuation © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 12
    13. 13. Liquidation Preferences  Liquidation Preference: 1x or more – 2x, 2x  Participating Preferred:  Straight/Non-participating 67%  Full participating (double-dip) 19%  Capped participating 14%  Preferred has the option to convert into Common  Interaction of various series: First pay B, then A, then all; all participate equally, etc.  “Deemed Liquidation”: good times and bad times  Not an IPO © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 13
    14. 14. Dividends  No expectation of dividends, but:  Cumulative Dividends: __ % cumulative dividend accrues over time, whether or not the company declares it - PLUS participation with Common Stock on an as-converted basis.  Non-cumulative Dividends: “An amount equal to $[_____] per share of Series A Preferred when, as and if declared by the Board”  PIK (payment-in-kind) dividends. Company option to pay accrued and unpaid dividends in cash or in common shares valued at fair market value.  Usually payable on liquidation or redemption, not conversion © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 14
    15. 15. Redemption  Optional (Company call):  Company can repurchase stock at original price (plus dividends) if Investors don’t convert to Common after x years  Mandatory (Investors Put)  Investor can force Company to repurchase shares after x years – beware of redemption premium  Guaranteed exit path for VC if Company is “successful enough”  But, Company must have legally available funds  22% of all VC financings in 2012, 35% in down rounds © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 15
    16. 16. Conversion  Preferred always has a conversion to Common feature, but loses all preferred privileges  Optional Conversion  Automatic Conversion: IPO  Conversion Ratio is initially 1:1, modified based on anti-dilution provisions © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 16
    17. 17. Anti-Dilution  Protect investors if company issues equity at a lower valuation than preferred  Full Ratchet 3%  Weighted Average: Broad Base: more favorable 92%  Weighted Average: Narrow Base: less favorable to company 4% © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 17
    18. 18. Exclusions from Dilution  Carve-outs from anti-dilution:  Options grants to employees, consultants (negotiate all or only authorized pool)  Warrants to lenders (approved by majority vs. unanimous board approval)  Warrants to service providers, strategic partners  Shares issued in mergers / acquisitions  Exercises or conversions of current stock or grants © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 18
    19. 19. Other Terms:  Vesting of founders’ stock, acceleration  Right of first refusal: new issuance and transfers by founders  Employee pool  Co-sale agreement (drag along, tag along) : force a sale  Registration rights  Board Control © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 19
    20. 20. Other Terms:  No-shop agreement  Information rights  Confidentiality  Indemnification  Counsel expenses up to ___  Lock-up provisions © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 20
    21. 21. Bottom Line  (Almost) anything can be negotiated  Pick your battles: Liquidation Preferences, Protective Provisions, Board Control  Make sure you understand what you’re signing © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 21
    22. 22. Thank you IN BOCCA AL LUPO! Valla & Associates, Inc., P.C. 1990 N. California Blvd., Suite 1060 Walnut Creek, CA 94596 USA E-mail: majda.barazzutti@vallalaw.com Phone: +1 925 705 7623 Fax: +1 925 705 7629 www.vallalaw.com © 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 22

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