Silicon Valley Term Sheets [SVNewTech]

Silicon Valley Term Sheets Brad Rock DLA Piper LLP (US) 650-833-2111 brad.rock@dlapiper.com PA10488825.2

Structure of Typical Start Up •  Founders: Partly vested common stock •  Employees: Common stock options with vesting over 4 years •  Investors: Convertible preferred stock •  C corporation: DE or CA •  In practice, no variation permitted PA10488825.2 2

Framework of Analysis •  Like a Prenuptial Agreement? •  Which terms matter •  Which don’t matter •  Attributes of Ownership Rights •  Economic •  Political PA10488825.2 3

Which Terms Don’t Matter - Economics •  Dividends (that are not automatic or cumulative) •  Conversion rights (always starts 1:1) •  IPO •  By choice •  Antidilution (if “broad based” not “ratchet”) •  Registration rights •  Demand •  S-3 •  “Piggy-back” •  Lock up (180 days) PA10488825.2 4

Which Terms Don’t Matter – Economics (cont.) •  Information Rights •  Indemnification •  D&O Insurance •  Management Rights Letter •  Proprietary Rights Agreements •  Deal expenses (within range) •  Right of Co-sale and First Refusal (as to founders and their stock) •  Redemption PA10488825.2 5

Terms that Matter - Economics •  Valuation (and which shares are “pre-money”) •  Liquidation Preferences •  Participating/Non-participating •  “Deemed liquidation” – mergers •  Founder vesting •  Up-front vesting? •  Acceleration if terminated without cause? PA10488825.2 6

Key Political Terms •  Raw Percentage Ownership •  “Protective” provisions •  Always part of deal – boundaries •  Class versus Series rights – veto powers •  Board Composition •  Determines strategic direction; termination of management •  “Drag along” terms •  Who decides to sell company? •  CA vs. Delaware •  Contractual provisions PA10488825.2 7

Terms Mostly About the Investors •  Right of First Refusal on future financing •  “Pay to Play” PA10488825.2 8

“Cap Table” for Valuation of High Tech, Inc. Pre-Money % Post-Money % Outstanding 3,000,000 shares 75.00% 3,000,000 shares 50.0% Common Stock Outstanding 0 shares -- 2,000,000 shares 33.33% Preferred Stock Outstanding Stock 200,000 shares 5.00% 200,000 shares 3.33% Options Reserved Options 800,000 shares 20.00% 800,000 shares 13.33% 100.00% 100.00% 4,000,000 shares 6,000,000 shares Valuation: (Series A $8.0 million $12.0 million Preferred Purchase Price = $2.00 per share) PA10488825.2 9

Anti-Dilution Protection •  Antidilution •  Weighted Average: Most common •  Ratchet: decreasing •  None: rare (generally, investor policy) •  Exclusions •  Option pool •  Warrants for banks/leasing companies •  Pay to Play provisions •  Lose future investment rights and preferences •  Harsher terms: Convert to common rather than a “shadow” series of preferred stock PA10488825.2 10

Basic Protective Provisions •  Authorize more of that series •  Authorize series with more senior rights •  Change rights of that series •  Merger / sale of assets •  Limits on changes to number of members of Board of Directors •  Many others possible •  Limits on borrowing, exclusive licenses, dividends, redemption of shares PA10488825.2 11

Documents for Funding •  Stock Purchase Agreement •  Schedule of Exceptions •  Due Diligence •  Articles (Certificate) of Incorporation •  Investor Rights Agreement •  Registration Rights Agreement (often combined with Investor Rights Agreement) •  Voting Agreement (with “drag along”?) •  Co-sale and rights of first refusal PA10488825.2 12

Due Diligence: Common Start-Up IP Problems •  Hidden founder •  Missing IP assignments to company •  Prior employer rights •  Trademark issues •  Exclusive licenses •  Tradeshow display before the patent is filed •  Unplanned use of Open Source software PA10488825.2 13

Effect of Liquidation Preference in Merger Assumed Total Liquidation or Sale Amount (options expire or assumed): $9.0 million $15.0 million $20.0 million $25.0 million Example A: Non-Participating Preferred (per share): $0.80 $1.25 $1.67 $2.08 Preferred Common (per share): $0.725 $1.25 $1.67 $2.08 Example B: Fully Participating Preferred (per share): $1.28 $1.78 $2.20 $2.62 Preferred (assuming Common (per share): $0.48 $0.98 $1.40 $1.82 1 times preferred) Example C: Participating Preferred (per share): $1.28 $1.78 $2.00 $2.08 Preferred up to $2.00 Common (per share): $0.48 $0.98 $1.50 $2.08 per share PA10488825.2 14

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Silicon Valley Term Sheets [SVNewTech]

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