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Conquering The Term Sheet Everything You Need To Know About Deal Terms Part 3
This document provides an overview of key concepts related to term sheets in equity crowdfunding, focusing on aspects such as liquidation preferences, pro rata rights, and convertible notes. It outlines the benefits and considerations for both investors and entrepreneurs regarding convertible loans, detailing mechanisms for automatic conversion, interest rates, and conversion pricing strategies. The importance of terms like discount caps and maintaining control during fundraising is emphasized to secure favorable outcomes for investors.
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Conquering The Term Sheet Everything You Need To Know About Deal Terms Part 3
- 1. Conquering the Term Sheet EverythingYou Need to Know About Deal Terms Part 3
- 2. David Stark Partner, OurCrowd @starkupnation ZackMiller Partner, OurCrowd @newrulesinvest
- 3. OurCrowd Leading equity crowdfunding platform with8000+ investors from over 100 countries
- 4. Mailbox: Liquidation preferences Itdepends. Pro rata rights are a right, not an obligation. Things to remember: Lean on your winners. Avoid being crushed. Important note: If you have the opportunity to buy up, why not? Q: Should I exercise my pro rata rights?
- 5. Quick Review Lesson 1- Equity Valuation Liquidation preferences ESOP Key takeaway Need to look at the WHOLE term sheet to see the full picture Lesson 2 - Equity Pro rata rights Anti-dilution protection Control provisions Key takeaway Need to have opportunity to continue backing your winners
- 6. Today’s agenda Convertible notes Prosand cons (investor/entrepreneur) Amount/maturity Interest Conversion Discount Cap Auto/voluntary conversion Repayment SAFE
- 7. Convertible Notes Structured asa loan, converts to equity if certain events occur (generally upon a future financing)
- 8. Why use aconvertible loan? • Increases STM (Speed to Money) • Can be a “bridge” to next round, maximizing value creation and reducing dilution • Increased flexibility with size of investment, equity stake sold • Often no control provisions, board representation The entrepreneur’s Perspective
- 9. Why use aconvertible loan? • Faster, easier, cheaper • Enables securing of deal • Get some built-in upside • Downside protection The Investor’s Perspective • First investment: displaces valuation discussion onto larger institutional entity • Follow on: provide company with bridge to next round Use Cases
- 10. Keeping the faith Eventualrights and preferences are unknown at the time of investment…
- 11. Loan Amount How muchmoney is going to be invested by you + How much money will be invested by others (What is the timeframe for others to join)
- 12. Maturity Length of theloan period Typically 12-24 months
- 13. Interest Convertibles are loansand have interest rate associated with them
- 14. Secured vs. Non-secured Underlying assetsto seize or personal guarantee
- 15. Prepayment Note may notbe prepaid without the consent of the lender
- 16. Interest Interest accrues ratherthan being paid out Simple vs Compound Interest 8% interest per annum Invest $1M, converts to equity in exactly one year Equivalent of having invested $1.08M Example After 2 years: $1.16M vs. $1.1664 M
- 17. Conversion Move from debtto equity
- 18. Automatic vs. Voluntary Conversion Exactlyas it sounds, some conversions are forced when certain conditions are met Others are optional
- 19. Automatic Conversion “Prior tothe Maturity Date, upon receiving notice from the Company that the Company has raised more than $X million in funds in which it has issued preferred shares (“Qualified Financing”), then the Note will automatically convert all principal, together with all accrued and unpaid interest under the Note, into the shares issued in such Qualified Financing. The conversion price will be a price per share equal to…”
- 20. Automatic Conversion “Prior tothe Maturity Date, upon receiving notice from the Company that the Company has raised more than $X million in funds in which it has issued preferred shares (“Qualified Financing”), then the Note will automatically convert all principal, together with all accrued and unpaid interest under the Note, into the shares issued in such Qualified Financing. The conversion price will be a price per share equal to…” Threshold ensures balance between institutional lead investor and pragmatic fundraising plans
- 21. Automatic Conversion “Prior tothe Maturity Date, upon receiving notice from the Company that the Company has raised more than $X million in funds in which it has issued preferred shares (“Qualified Financing”), then the Note will automatically convert all principal, together with all accrued and unpaid interest under the Note, into the shares issued in such Qualified Financing. The conversion price will be a price per share equal to…” Important because don’t want common stock
- 22. Automatic Conversion “Prior tothe Maturity Date, upon receiving notice from the Company that the Company has raised more than $X million in funds in which it has issued preferred shares (“Qualified Financing”), then the Note will automatically convert all principal, together with all accrued and unpaid interest under the Note, into the shares issued in such Qualified Financing. The conversion price will be a price per share equal to…” Well, it’s just automatic
- 23. Automatic Conversion “Prior tothe Maturity Date, upon receiving notice from the Company that the Company has raised more than $X million in funds in which it has issued preferred shares (“Qualified Financing”), then the Note will automatically convert all principal, together with all accrued and unpaid interest under the Note, into the shares issued in such Qualified Financing. The conversion price will be a price per share equal to…” See Lesson 1,2 of our lecture series Get rights and preferences of equity round
- 24. So, now youknow which shares you’ll receive. But what are you paying for them??
- 25. Conversion Price The conversionprice will be a price per share equal to the lower of: (i) y% of the price paid in the Qualified Financing (ii) a price per share reflecting a company pre- money valuation of $X Discount Cap
- 26. Conversion Price Discount tothe price/share paid in the next equity round Typically 10%-30% (most often 20%) Discount Cap “(i) y% of the price paid in the Qualified Financing”
- 27. Conversion Price Discount Cap “(i) y%of the price paid in the Qualified Financing” Time-triggered discount: no discount if next round w/in 90 days from closing Escalating discount: 15% within 90 days, 25% after 90 days but prior to 180 days, 35% after 180 days Examples of variations
- 28. Real Life Example ConversionPrice 20% discount: next round = $1.00 per share, then the note will convert into the same shares at a 20% discount, or $0.80 per share. $500,000 convertible note —> 625,000 shares ($500,000 / $0.80) New $500,000 equity investor —> 500,000 shares ($500,000 / $1.00) Discount Cap
- 29. Conversion Price Discount Cap (ii) aprice per share reflecting a company pre-money valuation of $X Maximum conversion valuation (regardless of valuation of next round)
- 30. Conversion Price Discount Cap (ii) aprice per share reflecting a company pre-money valuation of $X breakeven point is $X/Y% eg. lower of 80% of pps or $20M cap —> $20M/8% = $25M <$25M 20% discount >$25M $20M cap (discount > 20%) Next round valuation
- 31. Conversion Price Discount Cap Importance ofa cap for investors • Protect upside on risk-adj basis • Align interests • Protection vs. tail risk Balance with management not wanting cap to set next round’s valuation
- 32. Non Qualified Financing Financing roundthat doesn’t meet the criteria Can voluntarily convert
- 33. M&A prior toconversion Don’t want to just get repaid 1. Receive multiple of investment (e.g. 2x or 3x) 2. Convert at a discount to purchase price 3. Convert at predetermined price (e.g. last round’s post money) 3 options
- 34. What happens atmaturity?
- 35. What happens atmaturity? Repayment or Conversion at Predetermined Price Repayment (w/ option to convert): • entrepreneur can view as ticking time bomb • investor unlikely to get repaid anyways • inability to repay = insolvency Automatic Conversion @ Predetermined Price: • valuation signal when trying to raise equity round?
- 36. Issues with Convertibles •have more downside protection than full ratchet (Lesson 2!) • can result in >1x liquidation preference (Lesson 1!) • have features of debt even though intention is equity
- 37.
- 38. Priced Convertible Debt Floor to gowith the ceiling
- 39. SAFEs: Simple Agreement forFuture Equity
- 40.
- 41. Next step? Thanks forjoining us for our Term Sheet series OurCrowd.com Check out our real-life term sheets by accrediting on our website