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Hacking Term Sheets       ap
                                                      res
                                                          en
                                                               tat
                              Day 2 - Oct 1, 2010                 ion
                                                                        by
                                                                           Jam
                                                                               es
                                                                                  Ch
                                                                                     an




Friday, October 1, 2010
Just to make sure you’re in the right room...




                                     Today, we’re talking term sheets for
                                                 early-stage investments


Friday, October 1, 2010
Before we begin...here’s a little bit about myself.

                                                                   Professional VC


                                           x 20+ term sheets

                                   +           &               =
                                            x 8 investments

                                        (from 2006 - 2010)


                                                                                     Me!

                      If you’re more experienced, please join me up in front!



Friday, October 1, 2010
Pitch to friendly investors as early as possible.




                   Raise financing as late as possible; preferably only after
                  you’ve got users and/or data to support your hypothesis.




Friday, October 1, 2010
The money you raise should be just enough - with some
                    buffer - to get you to your next key milestones; faster &
                                  quicker than your competition.




                      Raise financing as late as possible, preferably only after
                           you’ve got data to support your hypothesis.


Friday, October 1, 2010
Understand how the venture capital industry works.




                           Are you a lifestyle business, or a venture business?
                              Make sure you’re barking up the right tree.



Friday, October 1, 2010
Raising $ from investors can be especially daunting and
                                 stressful for entrepreneurs.




                   VCs issue term sheets for a living. Entrepreneurs don’t,
                           and aren’t always as experienced at it.




Friday, October 1, 2010
Naughty investors use your lack of expertise with term
                                     sheets against you.


                                                                   Nice!

                          Naughty?

                                          www.displaycostume.com


                      Nice investors leave nothing to your imagination and
                       always explain their term sheets thoroughly to you.



Friday, October 1, 2010
The entire process can be really quick, but can also
                            drag on. It’s hard to find one size that fits all.
                   Investment syndicate

                                                               Definitive Documents
                           Pitch   Negotiations   Term Sheet                         Completion
                                                                  Due Diligence

                                                                 No-shop kicks in
                            Investment Committee


                    3Fs, sophisticated angels, institutional investors? Or a
                   blend? There’s trade-offs to be had. YMMV, but above
                                        all, GIWYEO.



Friday, October 1, 2010
Voting Rights
                                                      Liquidation
                                                      Preference             Board of
                           Pay-to-play
                                                                             Directors               Redemption

               Conditions                       Price        ???                                       Rights

               Precedent                                                             Protective
                               Investment                                            Provisions
                                                                                                          Right of First
                               Instrument                                                                    Refusal

                                                                                       Tag-along &
              Conversion
                                                                                       Drag-along
                                Anti-dilution
                                                                                                     Founders
                                                                                                     activities
                 Information
                                         Dividends                                ESOP
                    Rights
                                                                                              Confidentiality &
                                                                                                 No-Shop
                          Registration
                                                 Co-Sale                     Indemnification
                            Rights                          Restriction on
                                                Agreement                     & Assignment
                                                                Sales




Friday, October 1, 2010
Drown out the noise, and focus on what matters most.




                                                       Control
                               Economics



                           Investor-entrepreneur trust is paramount.



Friday, October 1, 2010
The term sheet is a preliminary, non-binding agreement.




                             Word-smiths are not welcomed.


Friday, October 1, 2010
Voting Rights
                                                      Liquidation
                                                      Preference             Board of
                           Pay-to-play
                                                                             Directors               Redemption

               Conditions                       Price        ???                                       Rights

               Precedent                                                             Protective
                               Investment                                            Provisions
                                                                                                          Right of First
                               Instrument                                                                    Refusal

                                                                                       Tag-along &
              Conversion
                                                                                       Drag-along
                                Anti-dilution
                                                                                                     Founders
                                                                                                     activities
                 Information
                                         Dividends                                ESOP
                    Rights
                                                                                              Confidentiality &
                                                                                                 No-Shop
                          Registration
                                                 Co-Sale                     Indemnification
                            Rights                          Restriction on
                                                Agreement                     & Assignment
                                                                Sales




Friday, October 1, 2010
Liquidation
                                           Preference    Board of
                                                         Directors
                                     Price        !!!
                                                             Protective
                          Investment                         Provisions
                          Instrument

                           Anti-dilution




Friday, October 1, 2010
Common
                                        Shares

                          Investment   Preference
                          Instrument     Shares

                                       Convertible
                                         Notes

                                       +Warrants



Friday, October 1, 2010
This is what matters.

                                                                       Amounted
                                        Price                           raised
         Price: $______ per share (the Original
         Purchase Price). The Original Purchase
         Price represents a fully-diluted pre-                       Price per share,
         money valuation of $ __ million and a
         fully-diluted post money valuation of                       Conversion price
         $__ million. For purposes of the above
         calculation and any other reference to
         fully-diluted in this term sheet, fully-
         diluted assumes the conversion of all                       Pre-, post-money
         outstanding preferred stock of the
         Company, the exercise of all authorized
         and currently existing stock options and
         warrants of the Company, and the
                                                                  Price modifiers:
         increase of the Company’s existing
         option pool by [ ] shares prior to this
                                                                 warrants & ESOPs
         financing.                                      Not this!




Friday, October 1, 2010
Liquidation   Not so nice, no matter
                                                  Preference    regardless of the form.

                                                                 Participation
           Liquidation Preference: In the                         Participation: After the payment of
           event of any liquidation or winding                    the Liquidation Preference to the
           up of the Company, the holders of                      holders of the Series A Preferred,
           the Series A Preferred shall be                        the remaining assets shall be
           entitled to receive in preference to                   distributed ratably to the holders of
           the holders of the Common Stock a                      the Common Stock and the Series
           per share amount equal to [x] the                      A Preferred on a common
           Original Purchase Price plus any                       equivalent basis.
           declared but unpaid dividends (the
           Liquidation Preference)                                OR ;provided that the holders of
                                                                  Series A Preferred will stop
                                                                  participating once they have
                                                                  received a total liquidation amount
                                                                  per share equal to [X] times the

            ypically 1x
                                                                  Original Purchase Price, plus any
          T                                                       declared but unpaid dividends.
                                                                  Thereafter, the remaining assets
                                                                  shall be distributed ratably to the
                                                                  holders of the Common Stock.




Friday, October 1, 2010
Board of
                                          Directors
                          Founder(s)         Board Representation: The
                                             holders of Series A Preferred will
             Investor                        have the right to elect one
                                             representative to the Company’s
         “Bored” composition                 Board of Directors, based on a
                                             three member Board of Directors.
                                             The holders of the Series A will
                            Independent      have the right to have observers
                                             attend all meetings of the Board
                                             of Directors.
                    Best Practices




Friday, October 1, 2010
Veto rights that
                                                          investors have on certain
        Typically covers actions that:                    actions of the company
         (i) changes rights, preferences or
                privileges of the class of stock that
                investors are holding
         (ii) changes authorized number of shares
                                                              Protective
                of Common and/or Preferred
         (iii) fund-raising veto of any instrument
                                                              Provisions
                type, possibly with an amount cap
         (iv) changes or waivers to the company’s
                articles/by-laws                             Though some are just out of this world...
         (v) changes to board size and                        (i) investments by the company which
                composition                                       is deemed by NRF Holdings to be
         (vi) payment or declaration of dividends                 illegal, criminal or which affects the
         (vii) capital expenditures in excess of                  interests, integrity or public security
                $35,000                                           or national security of Singapore or
         (viii) issuance of debt in excess of $100,000            the Singapore Government
         (ix) mergers, corporate reorganization,
                sale of control or any transaction that
                results in sale of assets of company




Friday, October 1, 2010
Middle ground

                          Bad                                                Entrepreneur-friendly
                                               Narrow-based WA
                          Full ratchet                                 Broad-based WA
            Entrepreneur bears 100% of                            For Weighted Average, investor(s) and
            dilutive effects in a downround;                      entrepreneur share the dilutive effect.
            Investor(s)’ shareholding % is
            maintained.                                               CP2 = CP1 × (A+B) ÷ (A+C)
                                                                      where
                                                                       CP2 = New Conversion Price
                                                                       CP1 = Prior Conversion Price
                                                                       A = # of shares outstanding prior to
                           Anti-dilution                               current round
                                                                       B = ($ raised in current round ÷ CP1)
                                                                         = # of shares issued as if raised at
                                                                         Prior Conversion Price
                                                                       C = # of shares issued in current round




Friday, October 1, 2010
Good lawyers are really hard to find. If you meet one,
                      hang on as tightly as you would to your soul mate.




                     For the rest of us, manage your lawyer well, lest he or
                          she manages you. Your investor is watching.



Friday, October 1, 2010
Questions? I’ll do my best with them.




                                      Thank you!


Friday, October 1, 2010
Voting Rights
                                                      Liquidation
                                                      Preference             Board of
                           Pay-to-play
                                                                             Directors               Redemption

               Conditions                       Price          !!!                                     Rights

               Precedent                                                             Protective
                               Investment                                            Provisions
                                                                                                          Right of First
                               Instrument                                                                    Refusal

                                                                                       Tag-along &
              Conversion
                                                                                       Drag-along
                                Anti-dilution
                                                                                                     Founders
                                                                                                     activities
                 Information
                                         Dividends                                ESOP
                    Rights
                                                                                              Confidentiality &
                                                                                                 No-Shop
                          Registration
                                                 Co-Sale                     Indemnification
                            Rights                          Restriction on
                                                Agreement                     & Assignment
                                                                Sales




Friday, October 1, 2010

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Hacking Term Sheets

  • 1. Hacking Term Sheets ap res en tat Day 2 - Oct 1, 2010 ion by Jam es Ch an Friday, October 1, 2010
  • 2. Just to make sure you’re in the right room... Today, we’re talking term sheets for early-stage investments Friday, October 1, 2010
  • 3. Before we begin...here’s a little bit about myself. Professional VC x 20+ term sheets + & = x 8 investments (from 2006 - 2010) Me! If you’re more experienced, please join me up in front! Friday, October 1, 2010
  • 4. Pitch to friendly investors as early as possible. Raise financing as late as possible; preferably only after you’ve got users and/or data to support your hypothesis. Friday, October 1, 2010
  • 5. The money you raise should be just enough - with some buffer - to get you to your next key milestones; faster & quicker than your competition. Raise financing as late as possible, preferably only after you’ve got data to support your hypothesis. Friday, October 1, 2010
  • 6. Understand how the venture capital industry works. Are you a lifestyle business, or a venture business? Make sure you’re barking up the right tree. Friday, October 1, 2010
  • 7. Raising $ from investors can be especially daunting and stressful for entrepreneurs. VCs issue term sheets for a living. Entrepreneurs don’t, and aren’t always as experienced at it. Friday, October 1, 2010
  • 8. Naughty investors use your lack of expertise with term sheets against you. Nice! Naughty? www.displaycostume.com Nice investors leave nothing to your imagination and always explain their term sheets thoroughly to you. Friday, October 1, 2010
  • 9. The entire process can be really quick, but can also drag on. It’s hard to find one size that fits all. Investment syndicate Definitive Documents Pitch Negotiations Term Sheet Completion Due Diligence No-shop kicks in Investment Committee 3Fs, sophisticated angels, institutional investors? Or a blend? There’s trade-offs to be had. YMMV, but above all, GIWYEO. Friday, October 1, 2010
  • 10. Voting Rights Liquidation Preference Board of Pay-to-play Directors Redemption Conditions Price ??? Rights Precedent Protective Investment Provisions Right of First Instrument Refusal Tag-along & Conversion Drag-along Anti-dilution Founders activities Information Dividends ESOP Rights Confidentiality & No-Shop Registration Co-Sale Indemnification Rights Restriction on Agreement & Assignment Sales Friday, October 1, 2010
  • 11. Drown out the noise, and focus on what matters most. Control Economics Investor-entrepreneur trust is paramount. Friday, October 1, 2010
  • 12. The term sheet is a preliminary, non-binding agreement. Word-smiths are not welcomed. Friday, October 1, 2010
  • 13. Voting Rights Liquidation Preference Board of Pay-to-play Directors Redemption Conditions Price ??? Rights Precedent Protective Investment Provisions Right of First Instrument Refusal Tag-along & Conversion Drag-along Anti-dilution Founders activities Information Dividends ESOP Rights Confidentiality & No-Shop Registration Co-Sale Indemnification Rights Restriction on Agreement & Assignment Sales Friday, October 1, 2010
  • 14. Liquidation Preference Board of Directors Price !!! Protective Investment Provisions Instrument Anti-dilution Friday, October 1, 2010
  • 15. Common Shares Investment Preference Instrument Shares Convertible Notes +Warrants Friday, October 1, 2010
  • 16. This is what matters. Amounted Price raised Price: $______ per share (the Original Purchase Price). The Original Purchase Price represents a fully-diluted pre- Price per share, money valuation of $ __ million and a fully-diluted post money valuation of Conversion price $__ million. For purposes of the above calculation and any other reference to fully-diluted in this term sheet, fully- diluted assumes the conversion of all Pre-, post-money outstanding preferred stock of the Company, the exercise of all authorized and currently existing stock options and warrants of the Company, and the Price modifiers: increase of the Company’s existing option pool by [ ] shares prior to this warrants & ESOPs financing. Not this! Friday, October 1, 2010
  • 17. Liquidation Not so nice, no matter Preference regardless of the form. Participation Liquidation Preference: In the Participation: After the payment of event of any liquidation or winding the Liquidation Preference to the up of the Company, the holders of holders of the Series A Preferred, the Series A Preferred shall be the remaining assets shall be entitled to receive in preference to distributed ratably to the holders of the holders of the Common Stock a the Common Stock and the Series per share amount equal to [x] the A Preferred on a common Original Purchase Price plus any equivalent basis. declared but unpaid dividends (the Liquidation Preference) OR ;provided that the holders of Series A Preferred will stop participating once they have received a total liquidation amount per share equal to [X] times the ypically 1x Original Purchase Price, plus any T declared but unpaid dividends. Thereafter, the remaining assets shall be distributed ratably to the holders of the Common Stock. Friday, October 1, 2010
  • 18. Board of Directors Founder(s) Board Representation: The holders of Series A Preferred will Investor have the right to elect one representative to the Company’s “Bored” composition Board of Directors, based on a three member Board of Directors. The holders of the Series A will Independent have the right to have observers attend all meetings of the Board of Directors. Best Practices Friday, October 1, 2010
  • 19. Veto rights that investors have on certain Typically covers actions that: actions of the company (i) changes rights, preferences or privileges of the class of stock that investors are holding (ii) changes authorized number of shares Protective of Common and/or Preferred (iii) fund-raising veto of any instrument Provisions type, possibly with an amount cap (iv) changes or waivers to the company’s articles/by-laws Though some are just out of this world... (v) changes to board size and (i) investments by the company which composition is deemed by NRF Holdings to be (vi) payment or declaration of dividends illegal, criminal or which affects the (vii) capital expenditures in excess of interests, integrity or public security $35,000 or national security of Singapore or (viii) issuance of debt in excess of $100,000 the Singapore Government (ix) mergers, corporate reorganization, sale of control or any transaction that results in sale of assets of company Friday, October 1, 2010
  • 20. Middle ground Bad Entrepreneur-friendly Narrow-based WA Full ratchet Broad-based WA Entrepreneur bears 100% of For Weighted Average, investor(s) and dilutive effects in a downround; entrepreneur share the dilutive effect. Investor(s)’ shareholding % is maintained. CP2 = CP1 × (A+B) ÷ (A+C) where CP2 = New Conversion Price CP1 = Prior Conversion Price A = # of shares outstanding prior to Anti-dilution current round B = ($ raised in current round ÷ CP1) = # of shares issued as if raised at Prior Conversion Price C = # of shares issued in current round Friday, October 1, 2010
  • 21. Good lawyers are really hard to find. If you meet one, hang on as tightly as you would to your soul mate. For the rest of us, manage your lawyer well, lest he or she manages you. Your investor is watching. Friday, October 1, 2010
  • 22. Questions? I’ll do my best with them. Thank you! Friday, October 1, 2010
  • 23. Voting Rights Liquidation Preference Board of Pay-to-play Directors Redemption Conditions Price !!! Rights Precedent Protective Investment Provisions Right of First Instrument Refusal Tag-along & Conversion Drag-along Anti-dilution Founders activities Information Dividends ESOP Rights Confidentiality & No-Shop Registration Co-Sale Indemnification Rights Restriction on Agreement & Assignment Sales Friday, October 1, 2010