The document discusses the venture capital financing process, outlining key elements such as term sheet negotiation, types of financing, and the importance of convertible debt and warrants. It provides insights on preparing for due diligence, valuation methodologies, and structuring preferred stock agreements, including liquidation preferences and anti-dilution protections. Additionally, it emphasizes the negotiable nature of terms and the need for entrepreneurs to understand the implications of their agreements.

1. © 2014 Valla & Associates, Inc., P.C.
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Majda Barazzutti
July 23, 2014

2. THE VENTURE CAPITAL
FINANCING PROCESS:
TERM SHEET NEGOTIATION
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ENTREPRENEURIAL JOURNEY

3. Financing is a Staged Process
 Common Stock
 Bootstrapping
 Friends and Family
 Angels: Equity, Warrants, Convertible Notes
 Series seed financing
 Series A Preferred (B, C, etc.)
 Liquidity Event
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4. Convertible Debt
 Bridge loan before financings
 Useful when the company does not have a
satisfactory valuation
 Risks of repayment feature
 No minimum capital but insolvency changes the
rules
 Better include a provision to force conversion
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5.  Warrants: option to purchase company shares
at a price within a set period
 “Kicker” to increase the potential investment
value
 Warrants increase in value as the value of the
underlying shares increase in relation to the
exercise price
 Usually issued with bridge financing
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Warrants

6. Alternatives: Strategic Investors
 Aims Differ
 Not Interested in Helping the Company Grow
 Conflict of Interest: greater returns from
commercial rights than growth
 Expertise
 Could affect future VC financings
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7. Venture Capital
 Identify the Right VC
 Due Diligence
 The Risk of “Finders”
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8.  Prior to Investing:
 Document Employees
 Founders Relationships
 Securities filings
 Confidentiality and Invention Agreements
 Prepare for VC’s due diligence
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“Clean Up”

9. Preferred Stock (Series)
 Why Preferred?
 Liquidation Preference
 Preserve a low common stock value for option grants
(ratio 1:4 to 1:8):
 Common Stock was bought at cheap price, $0.10
to founders.
 If Common were sold at same time at $5.00 to
VC, tax consequences for founders.
 No limits to Preferred/Common ratio
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10. Sample Term Sheet
 Binding Provisions:
 No Shop
 Confidentiality
 Applicable law
 ALL other provisions are not binding
 See examples: NVCA (http://www.nvca.org)
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11. A Typical Term Sheet
 Valuation/Number of Shares/Price
 Liquidation Preference
 Redemption
 Conversion
 Vesting of founders’ stock
 Antidilution
 Voting Rights
 Protective Provisions
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12. Valuation/Price
 Pre-money/Post-money valuation: Option pool shuffle
 How are your shares valued?
 8M pre-money valuation, 6M shares outstanding
 $8M pre-money ÷ 6M existing shares = $1.33/share, right?
 WRONG: The share price is $1.00
 WHY? Read the term sheet: “The $8 million pre-money
valuation includes an option pool equal to 20% of the post-
financing fully diluted capitalization.”
 $8M pre-money ÷ (6M existing shares+2M options )= $1/share.
 Pre-money valuation includes an unallocated option
pool for new employees -- lowering pre-money valuation
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13. Liquidation Preferences
 Liquidation Preference: 1x or more – 2x, 2x
 Participating Preferred:
 Straight/Non-participating 67%
 Full participating (double-dip) 19%
 Capped participating 14%
 Preferred has the option to convert into Common
 Interaction of various series: First pay B, then A, then
all; all participate equally, etc.
 “Deemed Liquidation”: good times and bad times
 Not an IPO
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14. Dividends
 No expectation of dividends, but:
 Cumulative Dividends: __ % cumulative dividend accrues over
time, whether or not the company declares it - PLUS participation
with Common Stock on an as-converted basis.
 Non-cumulative Dividends: “An amount equal to $[_____] per
share of Series A Preferred when, as and if declared by the
Board”
 PIK (payment-in-kind) dividends. Company option to pay
accrued and unpaid dividends in cash or in common shares
valued at fair market value.
 Usually payable on liquidation or redemption, not conversion
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15. Redemption
 Optional (Company call):
 Company can repurchase stock at original price (plus
dividends) if Investors don’t convert to Common after x years
 Mandatory (Investors Put)
 Investor can force Company to repurchase shares after x
years – beware of redemption premium
 Guaranteed exit path for VC if Company is “successful
enough”
 But, Company must have legally available funds
 22% of all VC financings in 2012, 35% in down rounds
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16. Conversion
 Preferred always has a conversion to Common feature,
but loses all preferred privileges
 Optional Conversion
 Automatic Conversion: IPO
 Conversion Ratio is initially 1:1, modified based on
anti-dilution provisions
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17. Anti-Dilution
 Protect investors if company issues equity at a lower
valuation than preferred
 Full Ratchet 3%
 Weighted Average: Broad Base: more favorable 92%
 Weighted Average: Narrow Base: less favorable to
company 4%
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18. Exclusions from Dilution
 Carve-outs from anti-dilution:
 Options grants to employees, consultants (negotiate
all or only authorized pool)
 Warrants to lenders (approved by majority vs.
unanimous board approval)
 Warrants to service providers, strategic partners
 Shares issued in mergers / acquisitions
 Exercises or conversions of current stock or grants
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19. Other Terms:
 Vesting of founders’ stock, acceleration
 Right of first refusal: new issuance and
transfers by founders
 Employee pool
 Co-sale agreement (drag along, tag along) :
force a sale
 Registration rights
 Board Control
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20. Other Terms:
 No-shop agreement
 Information rights
 Confidentiality
 Indemnification
 Counsel expenses up to ___
 Lock-up provisions
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21. Bottom Line
 (Almost) anything can be negotiated
 Pick your battles: Liquidation Preferences,
Protective Provisions, Board Control
 Make sure you understand what you’re signing
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22. Thank you
IN BOCCA AL LUPO!
Valla & Associates, Inc., P.C.
1990 N. California Blvd., Suite 1060
Walnut Creek, CA 94596
USA
E-mail: majda.barazzutti@vallalaw.com
Phone: +1 925 705 7623 Fax: +1 925 705 7629
www.vallalaw.com
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