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10.3 venture capital term sheets.pptx


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Term sheets and review of some of the details that founders should worry about.

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10.3 venture capital term sheets.pptx

  1. 1. This presentation is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this presentation are the sole responsibility of Rick Rasmussen and do not necessarily reflect the views of USAID or the United States Government. Venture Capital Financing Term Sheets
  2. 2. Selecting your V.C. Firm •  Funds Available for Investment •  Stature of the Firm •  Chemistry – philosophy match •  Syndicating the round •  Valuation –  Market Driven –  Competition for the Deal
  3. 3. Negotiating Term Sheet •  Work with an experienced lawyer •  Work out a list of top half dozen things you want to negotiate •  Agree on the rest and work on bigger issues •  Valuation is NOT the most important – You ownership at exit will vary only a “little” •  “Win-Win” is best for all 3
  4. 4. GENERAL TERMS OF THE FINANCING Security: Series A Preferred Stock (“Series A”) Amount of Offering: $4,000,000 Number of Shares: 8,000,000 Purchase Price: $0.50 per share Capitalization: Immediately following the sale and issuance of the Series A, the Company’s capitalization will be as follows: Shares Outstanding Percentage Common Stock $8,000,000 44.45% Incentive Stock Plan(1) 2,000,000 11.10% Series A Preferred Stock 8,000,000 44.45% Totals: 18,000,000 100.00% (1) The Company’s board of directors has adopted a stock option plan to be administered by the board authorizing the Company to grant options and stock purchase rights to employees and consultants. The Company plans to grant options to new employees. At the current time 850,000 shares are subject to outstanding options and 1,150,000 shares remain available for future issuance.
  5. 5. Terms of the financing •  You’re offering Preferred Stock •  A special class of shares with features not possessed by common stock –  Preference in assets, in the event of liquidation •  Dissolution of company •  Exit via M&A –  Convertible to common stock. –  Callable, at the option of the corporation –  Preference in dividends –  Special voting rights  
  6. 6. Price/Valuation •  Valuation is often a highly contested issue •  In the end, the value of a company is the price at which a willing buyer and seller can complete a transaction.
  7. 7. Preferred Stock •  Investors typically receive convertible preferred stock •  Convertible preferred stock has priority over common stock if the company is acquired or liquidated and assets are distributed •  The higher priority of the preferred stock justifies a higher price, compared to common stock. •  "Convertible" means that the shares may be exchanged for a fixed number of common shares.
  8. 8. Liquidation preference options •  When the company is sold or liquidated, preferred stockholders receive a certain fixed amount before any assets are distributed to the common stockholders •  Non-participating: –  Preferred Stock gets investment back first, –  Then convert to Common and share in proceeds •  Participating: –  Preferred Stock gets investment back (sometimes 2x or 3x investment back) –  Then Preferred Stock and Common Stock share equally •  Priority of one series over another –  e.g. Series C has liquidation preference over Series A and B
  9. 9. Liquidation Preference: In the event of any liquidation or, winding up of the Company, the holders of the Series A shall be entitled to receive in preference to the holders of Common an amount equal to $0.50 per share plus any declared and unpaid dividends. All remaining assets available for distribution shall be distributed ratably to the holders of Common Stock. A merger or sale of substantially all of the assets of the Company shall be treated as a liquidation or winding up for purposes of the liquidation preference.
  10. 10. Priority of Claims under Liquidation 1.  Liquidators costs 2.  Creditors with fixed charge over assets 3.  Costs incurred by an administrator 4.  Amounts owing to employees for wages/superannuation 5.  Payments owing in respect of workers’ injuries 6.  Amounts owing to employees for leave 7.  Retrenchment payments owing to employees 8.  Creditors with floating charge over assets 9.  Creditors without security over assets 10. Shareholders (Liquidating Distribution)
  11. 11. Conversion Rights •  Optional Conversion: –  Preferred stock may be converted into common stock at a certain conversion price, generally whenever the stockholder chooses •  Automatic Conversion: –  Conversion may happen in response to certain events such as when the company goes public
  12. 12. Conversion: Optional Conversion: The holders of the Series A shall have the right to convert their shares of Series A, at their option, at any time into shares of Common Stock, at the rate of one share of Series A for one share of Common Stock, subject to adjustment as described below.
  13. 13. TERMS OF INVESTORS RIGHTS AGREEMENT Information Rights: So long as an Investor continues to hold at least 500,000 shares of Series A, the Company shall deliver audited annual and unaudited quarterly financial statements. The obligation of the Company to furnish such information shall terminate upon the Company’s first underwritten public offering.
  14. 14. Anti-dilution Protection •  Preferred stock is typically protected against certain diluting events, such as stock splits or stock dividends •  Preferred stock is typically subject to "price protection,” –  an adjustment based on sales of stock at prices below the conversion price (a down round) •  Antidilution possibilities: –  (a) Stock splits only, no price based anti-dilution –  (b) Weighted average price based anti-dilution –  (c) Ratchet based anti-dilution –  (d) Pay to play provisions
  15. 15. Anti-dilution: typical types •  Weighted Average (most fair and most common): –  Broad-based: Adjusts the conversion price according to a formula that incorporates the number and price of new shares being issued –  Narrow-based: Excludes options not outstanding, entire option pool and Common Stock •  “Ratchet" protection (common during dot-com) –  lowers the conversion price to the price at which any new stock is sold no matter the number of shares •  Often some shares are exempted from this protection to cover key employees, consultants, and directors –  i.e. they are “kept whole”
  16. 16. Weighted average anti-dilution formula •  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”)
  17. 17. Full Ratchet •  Original price of $0.50 •  Sell 2,000,000 Shares at $0.25 •  Conversion Price “Rachets” to $0.25 •  New Conversion Ratio: 1 share Series A converts into 2 shares of Common Stock •  Thereafter 8,000,000 Shares of Series A Preferred Stock Converts into 16,000,000 Shares of Common Stock
  18. 18. Conversion: Anti-dilution Provisions: Proportional adjustments will be made for capital reorganizations, stock splits, reclassifications, etc. In the event the Company issues additional shares (other than shares issued to employees, consultants, directors, officers and licensors of technology pursuant to arrangements approved by the board of directors, and other customary exclusions) at a purchase price below the Series A conversion price then in effect, adjustments will be made on a broad-based weighted average basis. The initial conversion price for the Series A shall be $0.50 per share.
  19. 19. Weighted Average Antidilution (Broad Based) •  Sell 2,000,000 Shares at $0.25 = $500,000 ■  18,000,000 Shares x $0.50 = $9,000,000 + $500,000 = 9,500,000 20,000,000 shares = $.475 ■  New Conversion Ratio: 1 share Series A converts in 1.05 shares of Common Stock ■  Thereafter 8,000,000 shares of Series A Preferred Stock converts into 8,421,053 shares of Common Stock
  20. 20. Conversion: Automatic Conversion: The Series A shall be automatically converted into Common Stock, at the then applicable conversion rate, (i) in the event of the closing of an underwritten public offering of the Company’s securities in which the aggregate gross proceeds to the Company equals or exceeds $10,000,000, at a per share offering price equal to or exceeding $2.50 per share (subject to proportionate adjustment for future stock splits, dividends, or combinations), or (ii) upon the election of the holders of a majority of the shares of Preferred Stock then outstanding.
  21. 21. Voting Rights •  Preferred stock has a number of votes equal to the number of shares of common stock into which it is convertible •  Plus Preferred stock usually has special voting rights, such as –  the right to elect one or more of the company’s directors, or –  to approve certain types of corporate actions, such as amending the articles of incorporation, or –  creating a new series of preferred stock.
  22. 22. Voting: A holder of Series A shall have the right to that number of votes equal to the aggregate number of shares of Common Stock issuable upon conversion of such holder's shares of Series A. The Series A shall vote together with the Common Stock on all matters except as otherwise provided herein.
  23. 23. RIGHTS, PREFERENCES AND PRIVILEGES Dividends: The holders of the Series A shall be entitled to receive noncumulative dividends of $0.04 per share per annum (8%) in preference to the common Stock (“Common”) when and if declared by the board of directors.
  24. 24. Dividend Preference •  Dividends are typically a fixed amount (i.e. cents per share and/or a %) owed to holders of Stock •  Dividends are paid first to preferred stock, and then common stock. •  Dividends may be –  Cumulative – accrue from year to year until paid in full, or –  Non-cumulative and discretionary to be awarded by the board
  25. 25. Election of Directors: The Company’s Board will consist of five (5) directors. The holders of Series A, voting as a separate class, shall be entitled to elect two (2) members of the Company’s Board. The holders of Common Stock, voting as a separate class, shall be entitled to elect two members of the Company’s Board. All remaining members of the Board shall be elected by the Common Stock and Preferred Stock, voting together as a single class.
  26. 26. Vesting on Founders’ Stock •  Founders often vest 100% with a repurchase clause •  If a founder leaves the company a percentage of founders’ stock, which decreases over time, can be repurchased by the company at cost •  This is a protection for the investors against founders leaving the company after it gets funded.
  27. 27. Other Financing Issues •  Details for the attorneys to work through •  Use industry standard boilerplate. If someone tries hard to negotiate these terms, it’s a bad sign –  Stock Purchase Agreement –  Registration Rights –  Lockup Agreement –  Termination –  Co-sale Agreement –  Redemption –  Right of First Refusal
  28. 28. Stages in a Venture Round •  Introduction •  Offering (the pitch) •  Private placement memorandum (optional) •  Negotiation of terms. •  Non-binding term sheets, letters of intent, etc. •  Signed term sheet. (non-binding, may be exclusive) •  Definitive transaction document()s –  Stock purchase agreement –  Buy-sell agreement –  Co-sale agreement –  Right of first refusal, etc. –  Investor rights agreement –  board seats –  covenants not to obtain additional financing or sell company –  inspection rights –  information rights
  29. 29. Venture Round… •  Fix any company issues –  New employment contracts –  Stock vesting schedules for key executives •  Representations and warranties regarding disclosures •  Final agreement •  Closing –  Investors provide the funding –  Company provides stock certificates –  May be "rolling closings" or "tranched,” •  Post-closing –  Conversion of outstanding convertible notes. –  State securities filing –  Filing of amended Articles of Incorporation
  30. 30. Term Sheet Summary •  Probably the most important documents you’ll ever sign as CEO •  May seem arcane at first •  Try to understand as best you can •  Hire a great attorney to help explain and negotiate
  31. 31. This presentation is made possible by the support of the American People through the United States Agency for International Development (USAID). The contents of this presentation are the sole responsibility of Rick Rasmussen and do not necessarily reflect the views of USAID or the United States Government. Supplemental Details Items for the Lawyers to handle
  32. 32. Registration Rights •  Registration rights are generally given to preferred investors as part of their investment. •  These rights provide investors liquidity by allowing them to require the company to register their shares for sale to the public –  either as part of an offering already planned by the company (called piggyback rights), or –  in a separate offering initiated at the investors’ request (called demand rights).
  33. 33. Protective Provisions: A majority of the Preferred Stock must approve (i) any amendment of the Articles of Incorporation which would change the authorized number of Series A or the rights, preferences and privileges of the Series A, (ii) creation of shares having dividend or liquidation rights equal or superior to the Series A or (iii) any merger, reorganization or sale of substantially all assets of the Company.
  34. 34. Right of First Refusal •  Holders of preferred stock typically have the right to purchase additional shares when issued by the company, up to their current aggregate ownership percentage •  Also known as “peri passu”
  35. 35. RIGHT OF FIRST REFUSALAND CO-SALE AGREEMENT Right of First Refusal: The Company will be entitled to a right of first refusal on any proposed transfer by Jane Founder and Joe Founder (the “Founders”), subject to customary exceptions for transfers in connection with estate planning, bona fide loan transactions and sales of up to 15% of the total number of shares of capital stock held by a Founder. To the extent not exercised by the Company, the right of first refusal will be transferred to the holders of Series A on a pro rata basis.
  36. 36. Redemption •  Preferred stock may be redeemed or retired –  At the option of the company or the investors, –  Or on a mandatory basis –  Frequently at some premium over the initial purchase price of the stock. •  Venture firms want this right due to the finite life of each a fund managed by the firm.
  37. 37. Co-Sale Right •  A co-sale right gives investors some protection for investors against founders selling their interest to a third party •  Gives investors the right to sell part of their stock as part of such a sale.