Lecture 9: Term Sheets | Adv. Venture Capital-FINAN 6310 | Chad Jardine, University of Utah, 2008–

5. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. (1+IRR)X (Investment) The Valuation Formula Valuation Formula: Should be very familiar by now (Multiple) (Exit Value) Hurdle Rate =

6. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Convert % ownership to # of shares new shares old shares + new shares % Ownership = % ownership Determine new shares to be issued 1 - % ownership New shares = X old shares Advanced Valuation Formula

7. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Reverse Engineer total # of shares .35 e.g., If there are 1M shares premoney and VC must own 35% 1 - .35 538,462 shares = X 1M Total shares 1 1 - % ownership = X old shares Advanced Valuation Formula

8. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Derive price per share $3.5 M e.g., If $3.5M is invested in 538,462 shares 538,462 $6.59 per share = Share price investment new shares = Advanced Valuation Formula

9. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Infer total value (post-money) based on VC stake $3.5 M e.g., If VC invests $3.5M for 35% .35 $10 M = post-money valuation = investment % ownership acquired Advanced Valuation Formula

10. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Infer total value (post-money) based on VC stake $3.5 M e.g., If post-money is $10M and investment is $3.5M $6.5 M pre-money = $10 M - pre-money valuation = (post-money valuation) - (new investment) Advanced Valuation Formula

11. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Advanced Valuation Formula What if you have multiple rounds? (1+0.5)5 ($1.5 Million) (15) ($2.5 Million) 30.4% = Round 1 (1+0.4)3 ($1.5 Million) (15) ($2.5 Million) 7.3% = Round 2 (1+0.25)2 ($1.5 Million) (15) ($2.5 Million) 3.3% = Round 3 This is the equity required post-dilution

12. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Advanced Valuation Formula Retention is the equity percentage you keep. retention % = 1 - (total of future final % ownership) 89.3 % = 1 - (7.3% + 3.3%) How much equity do I want in the end?

13. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Advanced Valuation Formula Keep the end in mind from the beginning. How much equity do I want in the end? current % ownership final % ownership retention % =

14. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. FINANCING ROUND Price per Share (PPS) Bootstrap Angel Seed Series A Series B IPO EOPP $203,450,000 ITY VALUATION 15,650,000 How much is each investor worth now? • 35.1% Public $71,500,000 • 22.4% B-VC $45,500,000 (17,500,000) • 16.0% A-VC $32,500,000 (5,000,000) • 5.1% Seed $10,400,000 (1,000,000) • 2.2% Employees $4,550,000 • 0.6% Angel $1,300,000 (100,000) • 18.5% Entrepreneur $37,700,000 (10,000)

15. Venture Capital: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Advanced Valuation Formula Keep the end in mind from the beginning. 26.5 % = 1 - (35.1% + 22.4% + 16.0%) Seed Round 19.3 % 5.1% 26.5 % =

16. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. “In founding a startup, you throw yourself off a cliff, and build an airplane on the way down.” —Reid Hoffman Cofounder of LinkedIn

20. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Why Use Term Sheets? • Get the essence of the deal down before you pay attorneys • Not binding—expression of good faith, testing the waters. • Leverage negotiating with other investors. (First guy in creates social proof AND anchors the terms.)

22. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Term Sheet Sections •Preamble/Opening Info (Mini PPM) •New Securities Offered •Total Raised, Number of Shares, Price per Share •Post-financing Capitalization •Dividend Provisions: Rights, Preferences & Privileges of Series [X] Preferred •Liquidation Preference •Redemption •Conversion/Automatic Conversion •Dilution Clauses •Voting Rights •Protective Provisions •Board Composition •Special Board Approval Items •Information Rights •Registration Rights •Right of First Refusal/Pro Rata Rights (Pay to Play) •Conditions Precedent •Purchase Agreement •Employee Matters •Closing Date, Legal Counsel, Expenses/Fees and Finders

23. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. •Preamble/Opening Info (Mini PPM) •New Securities Offered •Total Raised, Number of Shares, Price per Share •Post-financing Capitalization •Dividend Provisions: Rights, Preferences & Privileges of Series [X] Preferred •Liquidation Preference •Redemption •Conversion/Automatic Conversion •Dilution Clauses •Voting Rights •Protective Provisions •Board Composition •Special Board Approval Items •Information Rights •Registration Rights •Right of First Refusal/Pro Rata Rights (Pay to Play) •Conditions Precedent •Purchase Agreement •Employee Matters •Closing Date, Legal Counsel, Expenses/Fees and Finders Term Sheet Sections

24. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Preamble/Opening Optional Basic length of time to put a deal together Exclusivity “No-Shop” clause

26. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. New Securities What class and series of equity? How will this impact the cap stack?

28. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Keys of valuation. How much is your company worth?

30. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. “There are only two things that VCs really care about when making investments: economics and control.” —Brad Feld Managing Director, Foundry Group Co-founder, Techstars

32. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Yes or no? Cumulative or Regular? Preferred or non?

34. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Liquidation Preference = Front of the line at liquidity events.

36. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Redemption Protects VCs against cash cow exits. Forces a return of capital if the deal hasn’t progressed sufficiently.

38. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Conversion Preferred 1 : 1 Common Automatic Conversion: Terms under which preferred automatically converts to common (i.e., Qualified IPO, value of common in relation to original investment, and company valuation). Should be the same for all preferred. At option of preferred. Is value of common worth more than the liquidation pref of preferred? Standard Conversion:

40. Common Shares   (post conversion) A-Round 35% Founder 65%

41. Common Shares   (post conversion) B-Round 35% A-Round 23% Founder 42%

42. Common Shares   (post conversion) B-Round 35% A-Round 35% Founder 30%

45. Forget your Financial Accounting text. Preferred is typically given the right to vote “as-if converted”

47. Protective Provisions Veto rights on major decisions (like issuing shares)

49. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Board of Directors Senior Management Shareholders

54. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Right of First Refusal, Pro-rata Rights, Pay to Play ROFR = Previous investors HAVE THE RIGHT to buy stock in subsequent rounds ahead of new investors. Pro-rata = Previous investors MAY purchase enough stock to retain their percentage ownership in subsequent rounds. Pay to Play = Previous investors MUST buy their pro-rata shares in subsequent financings or have their shares converted to common stock.

56. Venture Capital: Financing New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Conditions Precedent What if due diligence uncovers a material problem?

59. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. Employee Matters Consider preparing an Options Budget 10–20% of the company is a ballpark. Look at your starting point, who you need to hire, and consider growth of 4–5% per year in the number of options you will need to offer. How many of those will need to be granted before the next financing? Typical equity (after vesting): 5–10% CEO 1.5–3% VPs 0.3–0.7% Senior Engineers (Software Co.) 0.2–0.4% Mid-level Engineers (Software Co.)

60. Venture Capital: Financing for New Ventures: FINAN 6300 Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners. •Preamble/Opening Info (Mini PPM) •New Securities Offered •Total Raised, Number of Shares, Price per Share •Post-financing Capitalization •Dividend Provisions: Rights, Preferences & Privileges of Series [X] Preferred •Liquidation Preference •Redemption •Conversion/Automatic Conversion •Dilution Clauses •Voting Rights •Protective Provisions •Board Composition •Special Board Approval Items •Information Rights •Registration Rights •Right of First Refusal/Pro Rata Rights (Pay to Play) •Conditions Precedent •Purchase Agreement •Employee Matters •Closing Date, Legal Counsel, Expenses/ Fees and Finders Term Sheet Sections

Lecture 9: Term Sheets | Adv. Venture Capital-FINAN 6310 | Chad Jardine, University of Utah, 2008–

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Lecture 9: Term Sheets | Adv. Venture Capital-FINAN 6310 | Chad Jardine, University of Utah, 2008–