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Global Innovation Labs Founders Bootcamp - Demystifying term sheets
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Global Innovation Labs Founders Bootcamp - Demystifying term sheets Global Innovation Labs Founders Bootcamp - Demystifying term sheets Presentation Transcript

  • Demystifying Term Sheets
    Alan D. Lucas
    CMC Consulting Boston, Inc.
  • Term Sheets
    It’s all about deciding control, ownership & economic power
    and
    sets the tone of your investor relationship
  • Term Sheet Definitions
    Guts of the business deal
    NOT a “legal” document
    Investors template
  • Term Sheet Definitions
    Common Stock
    Founders and Employees
    Voting rights
    Options and restricted stock
    Preferred Stock
    Investors stock
    “preferred” because of better rights and protections than common stock
    Exact definition of preferred rights (preferences) is key focus of negotiation
  • Term Sheet Definitions
    Valuation
    “Pre-money”- value before financing
    “Post-money”- pre-money plus financing
  • Term Sheet Definitions
    Participating preferred
    If the company is sold, the preferred is paid the liquidation preference, then paid again as if it had converted to common
    Non-participating preferred
    Redeemable preferred
    After 5 years, the preferred investor can demand repayment
    Cumulative dividends
    If the dividends are not paid in one year, they are added to the dividends owed in the next year.
  • Control, Ownership & Power
    Key Terms to Negotiate
    Vesting of founders shares (3-5 years)
    Upfront; Cliff; quarterly; monthly
    Quit/fired, buyback vested & loss of unvested shares
    Accelerated vesting – (change of control)
    Option Pool 15-20% (for future hires)
    common shares & dilutive to founders (keep as low as possible)
    Preferred Stock Rights
    Participation at liquidation
    Anti-Dilution Protection
    Board of Directors 4-6 members post A Round
    % Based on investor ownership
    Who will have majority 2-2-1 (who is the independent & how chosen)
  • Preferred Stock
    Investors never give up their right to participate in upside
    Investors will always have alternative forms of payout, guaranteeing them (at least) the better of:
    Astraight liquidation preference or
    Pro rata share on as-converted basis
  • Preferred Stock
    Participation Preferred Stock
    Rights that investors stock gets upon “liquidation” (M&A; sale of assets, IPO)
    “Liquidation preference”: Investor get 100% of original money back + dividend before Common
    “Participating preferred” permits investor to share the leftovers “pro rata” with Common
  • Preferred Stock
    Participation Preferred Stock – Variants
    None: Investors get no “double dip;” only their liquidation preference: “straight preferred”
    Multiple Liquidation Participating Preferred: Very nasty and coming back
    Full Participation: Investors share PRO RATA with Common, without limit
    Capped Participation: Investors share Pro Rata with Common but only UNTIL ~2-5X return received
    Irrelevant in grand slam; matters only in poor outcome
  • Multiple Preferred Liquidation
    Investors take a multiple of their liquidation preference out before Common
    Uncommon
    Devastating in middling and poor outcomes
  • Preferred Stock
    Anti-DilutionProtection
    Investors protection in event of “down round” so that A Round investors“conversion ratio” is equal to subsequent investors’
  • Preferred Stock
    Anti-Dilution Protection
    Full Ratchet: “if only one new share is issued” in B round, all A round investors entitled to B round’s conversion ratio. A round is effectively re-priced to B round’s (lower) price.
    Weighted Average: Less harsh; takes into account the true dilutive effect of the subsequent down round.
  • Valuation - Know The Pricing of Other Deals
    Consider a number of qualitative factors
    management, size of market, etc.
    Track pre-money values in series A deals
    Create competition and negotiate
    When a company is raising equity capital
    It can’t avoid ownership dilution
    It tries to avoid value dilution
  • Valuation
    Forecast a future value assuming success
    Example
    If the company hits its plan, it will be worth $60 million in 5 years based on a multiple of revenues
    Determine a required rate of return
    Figure out how much of the future value the investor needs to own in order to achieve the targeted return
  • Targeted Rates of Return
  • Valuation Determines The Return
  • Single Stage Investment
    Invest $2,500
    Required return 50%
    Target future value is $19,000
    Sell company for $60,000
    Target ownership
    $19,000 / $60,000 = 32%
    Post money value
    $2,500 / 32% = $7,900
    Pre money value
    $7,900 - $2,500 = $5,400
  • Example
    Assume 1million shares outstanding & $2.5 million is raised at $5.00 per share
    Pre-money value is $5 million
    1,000 shares x $5 = $5,000 (pre-money)
    500 shares sold x $5 = $2,500 (raised)
    Post-money value
    $5,000 + $2,500 = $7,500
  • Business Is Sold for $10,000
    Investor 33%
    1X Preferred No participation
    LP is $2,500
    Conversion value is $10,000 x 33% = $3,333
    Proceeds to remaining common shareholders $10,000 - $3,333 = $6,667
    Investor 33%
    1X Preferred Participation
    LP is $2,500
    Proceeds after payout of LP $10,000 - $2,500 = $7,500
    Participation is $7,500 x 33% $2,475 + $2,500 = $4,975
    Proceeds to remaining common shareholders $10,000 - $4,975 = $5,025
  • Business Is Sold for $10,000
    Investor 33%
    1X Limited Preferred
    No participation
    LP is $2,500
    Conversion value is $10,000 x 33% = $3,333
    Proceeds to remaining common shareholders $10,000 - $3,333 = $6,667
    Investor 33%
    2X Limited Preferred
    Participation
    LP is $5,000
    Proceeds after payout of LP $10,000 - $5,000 = $5,000
    Participation is $5,000 x 33% $1,667 + $5,000 = $,6,667
    Proceeds to remaining common shareholders $5,000 - $1,667 = $3,333
  • Convertible Debt
    The investor receives
    A note paying a stated interest rate of X%, converted at a into preferred units of membership interest at a X% discount to the Company’s future equity round pricing
  • Demystifying Term Sheets
    It’s all about the relationships
    Between investors and founders
    Investors and syndicates
    Creating competition among investors is to the company's benefit
    Trust and comfort level are surprisingly big drivers
  • Alan D. Lucas
    617-834-2829
    alan@alandlucas.com