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Conquering The Term Sheet Everything You Need To Know About Deal Terms Part 2

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Join us for the second installment of our Q&A session with OurCrowd Partners, Zack Miller (Investor Community) and David Stark (Investments), about the fundamentals of deal terms in startup investing.

Last session we focused on valuation and how different preferences in the term sheet can impact your investment. This week we're looking at pre-emptive rights, anti dilution protections and control provisions -- all things that have to do with an investor's control of his investment.

Published in: Investor Relations
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Conquering The Term Sheet Everything You Need To Know About Deal Terms Part 2

  1. 1. Conquering the Term Sheet Everything You Need to Know About Deal Terms Part 2
  2. 2. David Stark Partner, OurCrowd @starkupnation Zack Miller Partner, OurCrowd @newrulesinvest
  3. 3. OurCrowd Leading equity crowdfunding platform with 8000+ investors from over 100 countries
  4. 4. Quick Review Lesson 1 - Equity Valuation Liquidation preferences ESOP Key takeaway Need to look at the WHOLE term sheet to see the full picture
  5. 5. Mailbox: Liquidation preferences preferred shares automatically convert to common in a qualified IPO Q: What happens to liquidation preferences in the event of an IPO?
  6. 6. Mailbox: Investment amount Warrants are the rights to invest X amount at $Y for a period of Z months. Q: Can you explain how warrants work? Real life example: Currently funding company on OurCrowd.com with 15% warrant coverage at current price (for 2 years)
  7. 7. Today’s agenda Pre-emptives Anti-dilution provisions Board of Directors Information Rights Veto Rights Right of first refusal Drag along rights Registration rights
  8. 8. Pre-emptive (Pro-rata) Rights Pro-rata right is the right to invest in later rounds in order to maintain your ownership
  9. 9. –Fred Wilson, Union Square Ventures “I think pro-rata is the single most important term anyone can negotiate for in a venture capital investment.” (Source)
  10. 10. Because returns in early stage investing come from a small portion of your portfolio and therefore, you want to own as much as you can in the winners
  11. 11. Let’s illustrate
  12. 12. Ownership % in the company * new investment amount = pro-rata right Invest $100k at $10M post, you own 1% Say the company raises $5M at $20M premoney They are selling 20% of the company and you would be diluted to 0.8% (without pro-rata) Formula Example If you want to maintain 1% holding, then you would invest 1% of the $5M (or, $50k)
  13. 13. Implications for upround, downround scenarios
  14. 14. Individual angels rarely get “the most important right” (prorata) —> institutional investors (like OurCrowd and VCs) do
  15. 15. Current'' Ownership' Total'New' Investment' Post'Money' Ownership' 1%'1%' ?' 100%'of'the' company' 25%'being'sold'to' new'investor' 25%' .75%' .25%' 1%' 25%$99%$ 74%$
  16. 16. Current'' Ownership' Total'New' Investment' Post'Money' Ownership' 1%'1%' ?' 100%'of'the' company' 25%'being'sold'to' new'investor' 25%' .75%' .25%' 1%' 25%$99%$ 74%$ Current'' Ownership' Total'New' Investment' Post'Money' Ownership' 1%'1%' 1%' 100%'of'the' company' 25%'being'sold'to' new'investor' 25%' .75%' .25%' 1%' 25%$99%$ 74%$
  17. 17. Anti-dilution provision protection from dilution resulting from later issues of stock at lower price than investor originally paid Definition
  18. 18. Weighted Average Full Ratchet Broad-based Narrow-based if company issues shares at a lower price, earlier price is effectively reduced to price of new shares NCP = OCP * ((CSO + CSP) / (CSO + CSAP)) NCP = new conversion price OCP = old conversion price CSO = common stock outstanding CSP = common stock purchasable with consideration received by company (i.e. “what the buyer should have bought if it hadn’t been a ‘down round’ issuance”) CSAP = common stock actually purchased in subsequent issuance (i.e., “what the buyer actually bought”) CSO = ALL shares of stock outstanding, including options, ESOP, convertible securities CSO = Only the number of shares of the series of Preferred that is being adjusted Anti-Dilution Provision
  19. 19. Without Anti-Dilution Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
  20. 20. Full Ratchet Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
  21. 21. Broad-Based Weighted Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
  22. 22. Narrow-Based weighted Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
  23. 23. Anti-dilution Cheat Sheet Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
  24. 24. Vesting Key here is to ensure management’s commitment What’s a cliff? Typical Schedule ?
  25. 25. Board representation
  26. 26. • Liquidation preference • Right to participate pro-rata in future rounds • Right to a board seat –Fred Wilson, Union Square Ventures The 3 terms you must have in a venture investment (other than price):
  27. 27. Typical Board Composition Investors, Founders, Industry Expert
  28. 28. What does a BOD do? • corporate governance • approving annual budgets • accounting to the stakeholders for the organization's performance • selecting, appointing, supporting and reviewing the performance of the chief executive; • ensuring the availability of adequate financial resources • setting the salaries and compensation of company management
  29. 29. director vs. observer
  30. 30. Information rights Starting point: Entrepreneurs want happy investors and owe them communication. How much, though?
  31. 31. Veto rights Protective and Control
  32. 32. Right of first refusal / Co-sale If common holders want to sell stock, investors have a right of first refusal on purchasing the stock or they have the right to participate in the proposed sale
  33. 33. Bring along/ Drag along Majority shareholders can force minority to sell
  34. 34. Registration rights • an investor’s right to force a company to list shares publicly so investor can sell them • demand registration, piggyback rights, S-3
  35. 35. Next step? Join us next week for Lesson 3 Other common investment structures: Convertible Notes SAFEs OurCrowd.com Check out our real-life term sheets by accrediting on our website

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