Negotiation and Valuations


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Negotiation and Valuations

  1. 1. Breakfast Roundtable: Negotiation and Valuation November 14, 2012 1
  2. 2. Panel & Agenda Panel• Tom Pincince – CEO, Digital Lumens• Jeff Arnold – Member, Boston Harbor Angels• Jeremy Halpern –Nutter McClennen and Fish• Adam Ghander –Nutter McClennen and FishModerator:• Michael Young – ConnectPay Agenda• Term Sheet Overview (Dictionary Handout)• Negotiation (Term Sheet Handout)• Valuation Thoughts• Q&A 2
  3. 3. Term Sheet• What is a term sheet? – Agree on fundamentals before legal drafting • Type of security • Economic Terms • Control Terms • Distribution upon liquidity (the “exit”) • Conditions to doing the deal • Mechanics and timing of deal – Sales document to investors – A term sheet is generally non-binding, but... • Confidentiality / No-shops / Expense provisions 3
  4. 4. Types of early-stage securities:• Common Stock (founders, sometimes F&F)• Options (employees)• Warrants (lenders, strategic investors)• Convertible Debt (solo angels, seed/Micro VC)• Preferred Stock (angel groups, VCs) 4
  5. 5. What is Preferred Stock?• Default in high growth/high risk investments• Preferences over the Common Stock (this means you!) – Liquidation preference: Last In = First Out – Dividends (maybe)• Special rights to protect investment – Board representation and blocking rights – Anti-dilution price protection – Redemption rights – ROFRs / Preemptive Rights / Drags / Tags / Registration 5
  6. 6. Overview of Economics: Equity• Price Terms – Pre-money valuation? – Option Pool: size and pre vs. post• Treatment of Dividends – Cumulative dividends• Liquidation Preferences – Participating – Non-Participating – Capped• Price Protection – Anti-Dilution – Full Ratchet vs. Weighted Average• Redemption Features – Timing and consequences 6
  7. 7. Terms to Understand• Pre-Money – What the investor believes the company is worth prior to their investment• Post Money – The pre-money valuation plus the new investment amount 7
  8. 8. Equity Pricing: Terms to• Option Pool Understand – Given to incentivize employees – Feel ownership in company – How does it impact Founder economics/ownership? – Who benefits?• Considerations – When does it get added? – How big should it be? Does it match investment duration? – What is the vesting schedule? – Is there acceleration on a liquidity event? 8
  9. 9. Equity : Liquidation Preferences• Preferred – First out in a “liquidation event” – Liquidation event: • Merger, acquisition, change of control, true liquidation – Return of investment before common stock then... – Participating Preferred or Non-Participating? • Participating Preferred - the investor gets its liquidation preference + pro rata share (the “double dip”) • Non-Participating Preferred, the investor get either liquidation preference OR pro rata share 9
  10. 10. Anti-Dilution• Allows investors to “re-price” and protect “value” not “percentage” dilution• Two types: – 1) Weighted Average • Factors (i) spread between old and new prices, multiplied by (ii) quantity of new shares – 2) Full Ratchet • Reprices old investment to new lower price 10
  11. 11. Governance• Board of Directors – Who chooses? How chosen? – Observation rights – who, how monitored – Skills needed to fill out team – Audit, Compensation Committees – Fiduciary duties• Financial and Reporting Requirements – Financial statements – monthly, quarterly, annual – audited or not? – Who gets these?• Other Information Rights? – What information and who? – Visitation rights? 11
  12. 12. Control– Voting • Ability of board, stockholders, or class holders to block certain actions • Who elects the board?– Voting on “as if” Converted Basis– Class Voting and Protective Provisions– Negative Covenants • What you can and can’t do without investor approval 12
  13. 13. Stockholders Rights• Transfer Rights – Right of First Refusal• Participation in future financings• Founder restrictions – Reverse vesting of stock – Non-competition – Founder representations in purchase agreement 13
  14. 14. Stockholders Rights• Registration Rights – Theoretical right to force public offerings• Drag Along – Right of majority to force minority to sell• Right of Co-Sale (“Tag-Alongs”) – Pro rata liquidity for all stockholders in a proposed transfer by 1 stockholder• Redemption (“Gun to the Head”) – Right to force the company to buy back the shares 14
  15. 15. Valuation Issues• Market Test• Leverage• Power of Auction• Terms vs. Price• Price less important than relationship• Positioning for future• Impact of Convertible Debt from F&F
  16. 16. Methodologies• Venture Capital Method (used also by many angels) – Future revenue x industry multiple x pro rata percentage x IRR = current value• Discounted Cash Flow / Net Present Value – Based on fiction• Chicago (DCF x probability tiers) – Same issue as above• Berkus (finger in the air) – Maximums per attribute (max $2.5m)• OTA/Payne – Comparison to average x weight – Helpful for biotech/cleantech• Risk Factor Method – Highly subjective – a more detailed version of Berkus Method• Opportunity Cost / Contribution Model – Based on sweat and lost alternative revenue• 1/3 Max rule – Treats angels like co-founders and weight cash versus sweat• Transaction Comparables – Hard to find like deals; general market trends may apply• P/E P/R Multiples – Assumes mature companies
  17. 17. Panel of Experts Tom Pincince – CEO, Digital Lumens,@DigitalLumens Jeff Arnold – Member, Boston Harbor Angels Jeremy Halpern –Nutter McClennen and Fish, @StartupBoston Adam Ghander –Nutter McClennen and Fish @AdamGhander Moderator: Michael Young – ConnectPay