Obtaining funding for early stage startups can be challenging. The array of funding options available to entrepreneurs can be confusing and fraught with pitfalls. The speaker will discuss the most common funding options available to early stage startups, what financing instruments are appropriate at various stages of a company life cycle, and the latest trends relevant to early stage financing.

1. © Copyright 2017 by K&L Gates LLP. All rights reserved.
Presented by Stan Lewandowski
stan.lewandowski@klgates.com
650.798.6743
January 26, 2017
Silicon Valley Startup: Idea to IPO
Funding for Early Stage Startups

2. These materials have been prepared solely for educational purposes.
The presentation of these materials does not establish any form of
attorney-client relationship with the author or K&L Gates. Particular
legal issues should be addressed through consultation with your own
legal counsel, not by reliance on this presentation or these materials.
Attorney Advertising. Prior results do not guarantee a similar outcome.
© K&L Gates LLP 2017.
Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, please
be advised that any U.S. federal tax advice contained in this
communication (including any attachments) is not intended or written to
be used, and cannot be used, for the purpose of (i) avoiding penalties
under the Internal Revenue Code or (ii) promoting, marketing or
recommending to another party any transaction or matter addressed
within.
klgates.com 2

3. 3

4. INTRODUCTIONS
§ Stan Lewandowski, Esq., Partner (Emerging
Growth/Corporate/M&A)
§ Works primarily in the Silicon Valley and SF offices of
K&L Gates in Palo Alto
§ Advised clients (issuers and investors) in more than 100
closed angel and venture capital financings
klgates.com 4

5. OVERVIEW
§ The startup lifecycle
§ Latest VC financing data (as of 12/31/2016)
§ Latest trends relevant for early stage companies
§ Most commonly used funding vehicles available
to and used by early stage startups
5

6. THE STARTUP LIFECYCLE
§ Idea
§ Sketches, rough prototype
§ Proof of concept
§ MVP or MVVP
§ Building
§ Capital raising
§ Scaling
§ Maturity and exit
klgates.com 6

7. THE U.S. VC FUNDING SCENE
§ 2014
§ $68.9B – Aggregate Deal Value
§ 10,550 – Number of Closed Deals
§ 2015
§ $79.3B – Aggregate Deal Value
§ 10,468 – Number of Closed Deals
§ 2016
§ $69.1B – Aggregate Deal Value (second annual total after 2015
in the past 11 years)
§ 8,136 - Number of Closed Deals
Source: PitchBook 7

8. THE U.S. VC FUNDING SCENE
Source: PitchBook 8
$29.1 $35.5 $37.2 $26.5 $31.2 $44.3 $40.6 $44.8 $68.9 $79.3 $69.1
3,301
4,292
4,707 4,458
5,411
6,771
7,987
9,326
10,550 10,468
8,136
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
0
2,000
4,000
6,000
8,000
10,000
12,000
Deal value ($B)
# of deals closed
US VC activity by year
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*
Deal value ($B) 29.08 35.55 37.16 26.48 31.18 44.30 40.63 44.82 68.86 79.26 69.11
# of deals closed 3,301 4,292 4,707 4,458 5,411 6,771 7,987 9,326 10,550 10,468 8,136
Company count 3,067 3,953 4,328 4,136 4,966 6,233 7,365 8,548 9,656 9,742 7,751
*As of 12/31/2016

9. THE U.S. VC FUNDING SCENE
Source: PitchBook 9
US VC activity (#) by round size
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*
Under $500K 259 430 559 768 1,090 1,409 1,875 2,258 2,404 2,198 1,544
$500K-$1M 219 304 382 434 558 765 918 1,042 1,109 1,079 806
$1M-$5M 1,013 1,333 1,464 1,449 1,744 1,995 2,302 2,785 3,063 3,197 2,716
$5M-$10M 686 779 823 659 654 737 800 888 969 988 927
$10M-$25M 639 781 817 577 630 728 734 769 897 975 866
$25M+ 248 336 318 205 260 354 373 404 636 709 606
*As of 12/31/2016
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016*
0%
20%
40%
60%
80%
100%
$25M+
$10M-$25M
$5M-$10M
$1M-$5M
$500K-$1M
Under $500K

10. THE U.S. VC FUNDING SCENE
Source: PitchBook 10
0.75
0.95
4.50
5.28
10.25 10.00
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*
$0
$2
$4
$6
$8
$10
$12
Angel/Seed Early VC
Later VC

11. THE U.S. VC FUNDING SCENE
Source: PitchBook 11
1.67 1.74
9.43
10.75
28.28
26.92
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*
$0
$5
$10
$15
$20
$25
$30
Angel/Seed Early VC
Later VC

12. MOST ACTIVE ANGEL/SEED/EARLY STAGE
INVESTORS IN Q4 2016
Source: Pitchbook 12

13. TRENDS
§ Pre-Seed - new Seed
§ Seed – new Series A
§ Series A - new B
§ Where does the capital for early stage startups
come from?
klgates.com 13

14. U.S. FINANCING ECOSYSTEM
§ Incubation – up to ~$150K
§ Pre-Seed – up to ~$500K
§ Seed - $1M to $5M
§ Series A – $4-5M to $15M
§ Series B – over $15M
klgates.com 14

15. TERM SHEET AND ITS ROLE
§ AKA LETTER OF INTENT (LOI),
MEMORANDUM OF UNDERSTANDING (MOU)
§ Sets out the key terms of a transaction agreed on in
principle by the parties
§ Outlines the timetable and obligations of the parties
during negotiations
§ Contains some legally binding terms (confidentiality,
exclusivity, transaction expenses and more)
klgates.com 15

16. MOST COMMONLY USED FUNDING VEHICLES
§ Friends, Family and … (FFF)
§ Convertible Promissory Notes (Notes)
§ Simple Agreements For Equity (SAFEs)
§ Keep It Simple Agreements (KISSes)
§ Other Options (crowdfunding, grants, etc.)
16

17. CONVERTIBLE PROMISSORY NOTES
§ Debt instruments with a conversion into equity feature
§ Features
§ Maturity date
§ Interest
§ Mostly, automatic conversion into equity in a qualified financing
§ Conversion discount (~20%) or a valuation cap (max. pre-money
valuation), or…
§ Premium on acquisition (1X+)
17

18. CONVERTIBLE PROMISSORY NOTES
§ Conversion Options – Automatic Conversion
§ Upon Qualified Financing
§ What is a Qualified Financing?
§ Discount
§ Valuation Cap
§ Fully Diluted Capitalization
§ What if the valuation cap in the note is lower than that agreed by
the company and the investors?
18

19. CONVERTIBLE PROMISSORY NOTES
§ Conversion Options – Automatic Conversion
§ If No Qualified Financing or Acquisition Before Maturity Date
§ Conversion into Common Stock at a Pre-Agreed Valuation Cap
on a Fully Diluted Basis
19

20. SAFE (CONVERTIBLE EQUITY)
§ Convertible equity instrument
§ No debt features
§ Interest
§ Maturity
20

21. SAFE (CONVERTIBLE EQUITY)
§ Four available versions
§ Price cap, no discount (no minimum amount for conversion)
§ Discount, no price cap (no minimum amount for conversion)
§ Price cap and discount
§ Most favored nation (MFN) provision (no price cap or
discount but MFN treatment, minimum amount for
conversion)
21

22. SAFE (CONVERTIBLE EQUITY)
§ Price Cap, no Discount (no minimum for conversion)
§ Price cap = valuation cap
§ Conversion into Standard Preferred Stock or Safe Preferred
Stock
§ Same or different price per share
22

23. SAFE (CONVERTIBLE EQUITY)
§ Discount, no Price Cap (no minimum for conversion)
§ Discount rate = [100 - the discount]%
§ Conversion into shares of Standard Preferred Stock based
on principal amount divided by price of Standard Preferred
Stock sold in Equity Financing
23

24. SAFE (CONVERTIBLE EQUITY)
§ Price Cap and Discount
§ Conversion into number of shares of Preferred Stock equal
to:
§ The principal amount divided either by:
§ Safe Price (valuation cap/capitalization of company), or
§ Discount Price (standard price of stock sold in Equity
Financing x discount rate), whichever results in a greater
number of shares
24

25. SAFE (CONVERTIBLE EQUITY)
§ Most Favored Nation (MFN) provision
§ (no price cap or discount but MFN treatment, minimum
amount for conversion)
§ What’s the benefit?
§ Amendment of existing documents to reflect better terms
offered to investors purchasing issuer’s convertible securities
in the future
25

26. SAFE (CONVERTIBLE EQUITY)
§ Now, what if:
§ Company is acquired by another person before conversion of
your principal amount into preferred stock?
§ You can elect to:
§ Receive your money back, or
§ Automatically receive shares of common stock equal to the
principal amount divided by FMV of company’s common
stock, if you fail to elect receipt of cash
26

27. SAFE (CONVERTIBLE EQUITY)
§ Now, what if:
§ Company terminates its operations, liquidates, dissolves or
winds up before conversion of your principal amount into
preferred stock?
§ You will:
§ It depends
27

28. SAFE (CONVERTIBLE EQUITY)
§ Now, what if:
§ Your investor asks for participation rights as part of its
investment?
§ Few options are available
28

29. KISS DOCUMENTS
§ Two versions
§ Debt
§ Equity (more favorable to the issuer)
29

30. KISS DOCUMENTS
§ Comparison of Debt and Equity Versions
(substantially similar, except for interest and maturity)
§ Treatment in financing
§ Conversion into preferred stock in a qualified financing round
(~$1M, for instance) at a price that’s lesser of cap or discount
30

31. KISS DOCUMENTS
§ Comparison of Debt and Equity Versions
(substantially similar, except for interest and maturity)
§ Treatment in acquisition
§ You elect to either convert principal into shares of common stock
at a valuation cap or multiple of investment plus interest (2X)
31

32. KISS DOCUMENTS
§ Comparison of Debt and Equity Versions
(substantially similar, except for interest and maturity)
§ Treatment at maturity
§ If not converted in equity financing or part of an acquisition, then,
on or after maturity, the majority in interest will elect to either
convert into Series Seed Preferred Stock at a cap OR demand
repayment from issuer
32

33. KISS DOCUMENTS
§ Comparison of Debt and Equity Versions
(substantially similar, except for interest and maturity)
§ Most favored nation treatment
§ Right to exchange the existing instrument for one issued
subsequently to other investors on terms more favorable than
the terms of the instruments issued to existing investors if such
subsequent issuance occurs before conversion or repayment of
the existing instrument
33

34. KISS DOCUMENTS
§ Comparison of Debt and Equity Versions
(substantially similar, except for interest and maturity)
§ Information and participation rights
§ Rights for “Major” Investors? Who is Major Investor?
§ What are the rights?
§ Information
§ Participation (pro rata, 1X+ investment amount)
34

35. OTHER OPTIONS TO SECURE CAPITAL
§ AngelList (https://angel.co)
§ Crowdfunding (www.kickstarter.com)
§ Factoring (selling AR)
§ Customer financing
§ Grants
35

36. THANK YOU
For Further Questions Please Contact:
Stan Lewandowski
Partner, K&L Gates LLP
(650) 798-6743
E-mail: stan.lewandowski@klgates.com
klgates.com 36