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From PLI’s Course Handbook
Venture Capital 2009: Nuts and Bolts
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INTRODUCTION TO VENTURE
CAPITAL DEAL TERMS
Ellen B. Corenswet
Covington & Burling LLP
Sarah Reed
Lowenstein Sandler PC
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Ellen B. Corenswet
Covington & Burling LLP
Ellen B. Corenswet is a corporate partner in the New York office
of Covington & Burling LLP and one of the co-leaders of the
Corporate Practice Group firmwide. Ms. Corenswet has focused on
representing private and public technology, life sciences and other
emerging growth companies, as well as the venture capital firms
that provide capital to these companies, for her entire career. Ms.
Corenswet’s practice includes: the structuring and counseling of
start-up companies, executive compensation arrangements, venture
capital financings, private placements, equity public offerings and
PIPEs, mergers & acquisitions, and corporate governance and
public company disclosure. Ms. Corenswet’s clients include public
and private companies in a wide range of industries, such as
biotechnology, software, clean technology and Internet-based
services.
Ms. Corenswet received her J.D. from Stanford University in 1975
and her B.A. from the University of Florida in 1972.
For publications/teaching:
Ms. Corenswet has been a frequent presenter at PLI conferences
and in other forums on venture capital financings and start up
companies.
Committees, etc.
Ms. Corenswet is on the Council of National Advisors of
Springboard Enterprises, a non-profit organization dedicated to the
development and support of women entrepreneurs seeking to raise
capital and to build their businesses.
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INTRODUCTION TO
VENTURE CAPITAL DEAL TERMS
ELLEN B. CORENSWET, COVINGTON & BURLING LLP
SARAH REED, LOWENSTEIN SANDLER PC
January 2009
Topics Covered
►Overview
►Principal Deal Documents
►Economic Terms
►Control Terms
►Liquidity Terms
►Management/Founder Terms
►NVCA Forms
►Key Observations
Overview
I.
What is Venture Capital?
A.
Money invested in early stage companies with the
expectation of significant growth in the value of
the investment.
1.
Venture capital funds look for overall
returns of at least 3 to 5 times their
investment over a 10-year fund period.
In order for a company to attract venture
funding, it must have a large addressable
market and/or credible sizeable revenue
projections. Quality and experience of
the management team is also a significant
factor.
2.
Venture capital funds realize the value of
their investments through a “liquidity
event”--typically, an initial public
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offering or an M&A transaction. The
average liquidity event horizon is
currently >8 years.
II.
3.
The majority of venture capitalists have
had prior experience in their careers as
entrepreneurs, scientists, or engineers: so
they are “selling” not just money, but the
value-add experience and connections
they will bring to their portfolio
company.
4.
If a company does not have large capital
needs, so-called “angel” or friends and
family funding, or even a credit card,
might be a better choice. Early stage
companies should also consider obtaining
funding through a strategic relationship
with a more established commercial
“partner” (e.g., biotech/pharma
collaborations).
Venture Capital Statistics
A.
In the last 35 years, venture capitalists invested
more than $441 billion in over 57,000 companies
in the United States.
B.
In 2007, more than 1,400 seed and early-stage
companies received venture capital investments.
C.
Among all sectors for investment, clean
technology has seen the most venture investment
growth in the last five years. Life sciences and
technology/Internet are also significant areas of
venture investment.
D.
There are approximately 800 venture capital firms
in the United States.
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E.
III.
Venture capital funds raised over $30 billion in
2007.
IPO and M&A Trends & Data
A.
B.
IPOs
1.
There were 662 IPOs in 2008 as
compared to 1,711 in 2007 worldwide.
2.
There were 33 U.S. stock exchange
listings in 2008.
3.
Only 6 of those listings were for VCbacked companies!
4.
There were two quarters in 2008 in
which no IPOs of venture-backed
companies took place--the last time this
happened was in 1975.
M&A
1.
There were only 260 M&A deals in 2008
for VC-backed companies and over 220
of those were done in the first three
quarters of 2008--there were only 37
M&A deals for VC-backed companies in
Q4 ’08.
2.
The Q4 ’08 U.S. M&A deal value
dropped over 50% from the deal value in
Q4 ’07.
3.
The Boards of Directors of operating
companies with cash are hesitant to use it
for M&A transactions, fearing that the
economic situation could get worse and
that they will need to conserve their cash
for their own operations.
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4.
IV.
V.
Acquisitions by private equity buyers (as
opposed to strategic buyers) accounted
for 15% of the M&A transactions in
2007, but declined in 2008 due to the
tightening of the debt markets.
Possible Trends in 2009
A.
Shake-out in VC firms: some will not be able to
raise subsequent funds.
B.
Fewer “me too”/copycat companies.
C.
Lower pre-money valuations.
D.
Business plans with plausible revenue models.
E.
More M&A activity on a number of fronts:
potential “roll-up” transactions of multiple private
VC-backed companies in the same space;
acquisition of distressed companies by both public
and private VC-backed companies in order to
acquire intellectual property rights, customers or
for other reasons; acquisition of public VC-backed
companies with depressed valuations (e.g., biotech
acquisitions) by pharmaceutical and larger biotech
companies due to bargain prices of small biotechs
and drug “pipeline” needs of larger companies.
Preferred Stock as the Investment Vehicle of Choice by
Venture Capital Investors
A.
The most common form of security issued in a VC
financing is convertible preferred stock
(“Preferred Stock”).
B.
Preferred Stock provides for certain economic and
control rights and protections not given to holders
of Common Stock (who are typically founders,
employees, possibly angel investors).
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C.
VI.
Certain special rights of Preferred Stock (e.g.,
liquidation preference) enable a company to value
its Common Stock at a lower price and, therefore,
to grant options to its employees at a price lower
than the price paid by investors who purchase
Preferred Stock.
Typical Timeline for a Preferred Stock Investment
A.
B.
Term Sheet:
1.
Negotiations can take several weeks.
2.
The term sheet should be as detailed as
possible – the draftsperson should never
assume that “jargon-y” VC terms have a
defined meaning (e.g., “narrow-based”
anti-dilution adjustments). Make sure
that the terms sheet clearly defines what
the parties mean.
3.
Term sheets are almost always nonbinding except for the provisions relating
to confidentiality, payment of expenses
and, if applicable, any “no shop”
provision (an agreement by the company
not to discuss or negotiate a competing
transaction of any type during a certain
period following signing of the term
sheet--typically 30 to 60 days.
4.
Legal input is very important at the term
sheet stage, particularly in representing
the potential portfolio company, where
management may not be sophisticated (or
as sophisticated as they think!).
Due Diligence:
1.
Venture Capitalists may conduct
preliminary market, financial and
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management diligence before the term
sheet is signed.
2.
Legal/IP diligence typically begins after
the term sheet is signed.
3.
The due diligence process typically takes
3 to 4 weeks following the signing of a
term sheet and is conducted
contemporaneously with drafting;
however, diligence can take much longer
(up to several months) and sometimes
outside consultants are engaged by a
Venture Capitalist to evaluate a market
size and competition or IP rights.
C.
Document drafting typically takes 2 to 5 weeks
following execution of the term sheet.
D.
Formation of a syndicate – The lead investor(s)
will typically invest 20% to 50%, and possibly
more, of the round of funding and will work with
the company to attract additional investors for the
balance. This may raise issues of multiple counsel
and multiple due diligence efforts. Wherever
possible, it should be clear that only the lead
investor’s counsel will “run” the documents and
the diligence process on the investor side).
E.
There are a number of approvals needed for a
venture capital financing transaction (typically,
Board approval, stockholder approval,
amendments to existing stockholder and other
agreements, potentially third party consents, and
in some cases the need to convert the entity from
an LLC to a C corporation).
F.
Closing--this is the last step in the transaction. At
the closing, the funds are delivered by the
investors and the stock certificates are delivered
by the company. There may be a single closing but
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there may also be multiple closings over a period
of weeks or months.
Principal Deal Documents
VII.
Summary of Principal Deal Documents: These are more
fully discussed in the succeeding sections of this outline.
A.
Stock Purchase Agreement: A contract between
the company and the purchasers (and sometimes
the founders as well), that provides for the type
and amount of securities to be sold, the purchase
price, representations by the company (and
possibly the founders) and investment
representations by the purchasers, and conditions
to closing. The stock purchase agreement
typically does not contain continuing obligations
on the part of any of the parties after the closing(s)
have occurred.
B.
Restated Certificate of Incorporation or Certificate
of Designation (“charter documents”): These
documents contain the terms of the Preferred
Stock (dividends, liquidation preference,
conversion rights/obligations and anti-dilution
adjustments, voting and protective provisions,
redemption rights). Please note that the charter
document is not a contract. It is a public record
that is filed in the office of the secretary of state in
the state of the issuer’s incorporation. Because it
is not a contract, charter violations result in acts
that are void ab initio or voidable. Breaches of
contract, by contrast, give rise only to claims for
damages or equitable relief. Also, a charter
document can only be amended by a subsequent
filing with the secretary of state. Charter
documents require approval of the Board and
stockholders.
C.
Investor Rights Agreement: A contract between
the company and the purchasers that typically
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contains registration rights, covenants regarding
rights to financial and other information, other
affirmative and negative covenants, and right of
first refusal on new issuances of securities.
VIII.
D.
Voting Agreement: A contract between the
company, the purchasers and the “key common
stockholders” (founders and management) that
contains details on size and composition of Board
and may contain “drag along” rights -- rights that
allow stockholders holding a specified percentage
of outstanding shares to require all stockholders to
approve and participate in a sale of the company.
E.
Right of First Refusal and Co-Sale Agreement: A
contract between the company, the purchasers and
the “key common stockholders” (founders and
management), the primary purpose of which is to
impose restrictions on founder/management
stock. This agreement covers the circumstances
where founders or management propose to sell any
of their shares to a third party. The agreement
typically requires that management and the
founders give the company first, and then the
investors second, notice of such proposed sale and
grants the company/investors a right of first
refusal to purchase these shares or, alternatively,
allows the investors to sell a pro-rata portion of
their shares alongside the management/founder
stockholders.
Structure of Venture Capital Financing
A.
An example of the capitalization of a company
immediately following the closing of its first
venture round is attached to this outline as
Schedule A.
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Economic Terms
IX.
Economic Terms
A.
B.
Dividends
1.
Dividends are typically not mandatory
but are paid "if, as and when" declared by
the Board of Directors -- the assumption
being that dividends will not ever be
declared so that cash can be preserved for
the growth of the business.
2.
One variation is a “dividend” that accrues
and is paid only upon liquidation or
acquisition of the issuer or redemption of
the preferred stock (or, rarely, upon an
IPO).
Liquidation Preference
1.
A liquidation preference provides the
preferred stock investors with a preferred
return in the case of a liquidation of the
issuer. "Liquidation Event" is typically
defined to include mergers and sales of
substantially all assets and may be
defined to include a change of ownership
of >50% of the shares unless a specified
percentage of the preferred determines
not to treat such a transaction as a
Liquidation Event.
2.
Under the typical liquidation preference,
the preferred investors are entitled to
receive in a Liquidation Event an amount
equal to their investment, or some
multiple of their investment (e.g., 2x to
4x), before the Common Stock holders
receive any proceeds. Alternatively,
investors may be entitled to a preference
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equal to their investment plus a
“dividend” that is payable only upon a
Liquidation Event.
3.
C.
The balance of proceeds, after payment
of the liquidation preference, can be
distributed either:
a)
all to the Common Stock holders
(referred to as “non-participating
preferred”) or
b)
to the Common and Preferred
holders on a pro rata, as converted
basis (referred to as“participating
preferred”), either with no limit
on the Preferred’s maximum
return or with a limit equal to a
multiple of their investment.
Conversion
1.
Optional Conversion: Preferred Stock is
typically convertible, at the holder’s
option, into Common Stock at any time.
As a practical matter, investors have
virtually no incentive to give up their
preferred status and convert into
Common Stock earlier than is required
by the mandatory conversion provisions.
2.
Mandatory Conversion: Preferred Stock
typically converts automatically into
Common Stock upon consummation of a
“Qualified IPO.” A Qualified IPO is
typically an IPO of a minimum specified
size and a minimum per share price
(typically 2x to 5x the preferred
investors’ original purchase price per
share). Preferred Stock may also
automatically convert into Common
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Stock if a certain percentage of the
holders of Preferred Stock agree.
D.
Anti-dilution Protection
1.
General: The conversion ratio or price of
Preferred Stock is typically established as
being on a one-for-one basis, subject to
adjustment upon certain events.
2.
Structural Anti-Dilution Adjustments: In
all cases, the terms of the Preferred Stock
should provide that the conversion ratio
or price will be adjusted for any stock
splits, stock dividends and similar events
with respect to the Common Stock. This
ensures that, for example, if a share of
Preferred Stock converts into one share
of Common Stock initially and, later, the
company effects a two-for-one split of
the Common Stock (thereby doubling the
number of shares of Common Stock held
by Common Stock holders), then
thereafter, each share of Preferred Stock
will convert into two shares of Common
Stock. Without such a provision, the
Preferred Stock would immediately lose
half of its value.
3.
Price Anti-Dilution Adjustments: The
terms of the Preferred Stock can also
include an adjustment provision that is
triggered if the company later issues
equity securities at a price less than the
price paid by the Preferred investors
(comparing both securities on a
“converted-to-common basis). This is
referred to as price anti-dilution
protection. There is generally an
exception to price anti-dilution
adjustments for shares issued under the
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company's stock incentive plan. Other
typical exceptions include securities
issued to acquire other companies, and
securities issued to strategic partners,
lenders and lessors. In a difficult
economic environment, price antidilution provisions are common.
4.
Price anti-dilution protection takes one of
two basic forms:
a)
Weighted average price
protection: This formulation
adjusts the conversion ratio based
on a comparison of (1) the
number of shares issued at the
lower price, relative to (2) the
number of shares of the issuer
already outstanding. “Broadbased” v. “narrow-based”
formulas refers to what securities
are considered “outstanding” for
purposes of calculating a
weighted average adjustment.
The broadest formulation (leading
to the smallest adjustment)
includes all outstanding common
and preferred, on an as-converted
basis, plus shares issuable upon
the exercise of all outstanding
options and warrants. The
narrower formulation typically
includes outstanding Preferred
Stock and Common Stock, on an
as converted basis (but the
narrowest formula includes only
Preferred Stock).
b)
Full ratchet anti-dilution
protection: This formulation
provides that if the issuer issues
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any shares in a lower-priced round
("down round"), the conversion
price of the existing preferred will
be reduced to the price in the
down round, without regard to the
number of shares issued. The
Preferred Stock terms may
provide that the ratchet formula is
replaced with a weighted average
formula when the company has
raised a specified amount of
money at an equal or higher
valuation than the current round
or after a fixed time period.
E.
Additional Economic Issues in Venture Capital
Investment Transactions
1.
Staggered financings: This refers to
multiple tranches, or closings, at the
same valuation, but where the obligation
of investors to fund the later tranches is
conditioned on the company’s meeting
certain specified milestones. There are
several reasons that it might be
preferable, from either (or both) the
company’s and/or the investors’
perspectives, to structure a financing this
way. It locks in the terms of financing
for a greater amount of funding for the
company but protects the investors if the
company does not accomplish what it
promises. Staggered financings work
best where the funding amount needed is
large and where there are easily defined
milestones, such as the completion of a
clinical trial or the signing of a particular
customer contract.
2.
Pay to play provisions: These provisions
are designed to punish existing investors
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who do not participate in a later round of
financing and/or to reward those
investors who do participate. Typical
repercussions, if an investor subject to a
pay-to-play does not invest its pro rata
portion of a later round, include
converting the non-participants' Preferred
Stock to Common Stock, converting the
Preferred Stock of those who do
participate pro rata to new Preferred
Stock with better economic rights, or
eliminating non-participants' anti-dilution
protection for that round as well as later
rounds.
Control Terms
X.
Control Terms
A.
Voting
1.
The company’s charter typically provides
that, except as otherwise specified in the
charter or under the Delaware General
Corporation Law, Preferred Stock votes
with the Common Stock as one class,
with the Preferred Stock voting on an asconverted basis.
2.
Preferred Stock typically has separate
class or series voting rights, which are
essentially veto rights (typically referred
to as “protective provisions”) with
respect to certain matters such as:
a)
the issuance of equity securities
senior to or pari passu with the
Preferred Stock
b)
the liquidation or “deemed
liquidation” of the company
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c)
the entering into of an exclusive
license with a third party or the
sale of a material amount of the
company’s assets
d)
the repurchase or redemption of
outstanding shares
e)
the declaration or payment of
dividends
f)
incurring any debt over a
specified dollar amount
g)
any increase in the number of
shares of Common Stock reserved
for issuance under the company’s
stock incentive plans and
agreements
h)
any amendment to the company’s
charter
i)
creating any subsidiaries that are
not wholly-owned and/or taking
any of the foregoing actions with
respect to any such subsidiaries.
3.
Certain of these “protective provisions”
may be more appropriately implemented
at the Board level (requiring the approval
of the Board members designated by the
investors) than at the stockholder level
(e.g., the incurrence of debt over a
specified level, any change in senior
management or the company’s auditors).
4.
One of the most important aspects of the
protective provisions is to determine
what the appropriate percentage voting
thresholds should be (e.g., majority, 60%,
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66⅔%, 80% of all Preferred Stock).
There may even be multiple sets of
protective provisions, with all Preferred
Stock voting on some actions and certain
series of Preferred being entitled to veto
the same or other actions. To determine
appropriate thresholds, it is important to
analyze the post-financing pro forma cap
table. Where the ownership percentages
among the investors have not yet been
determined, these threshold amounts are
often bracketed in draft documents to
flag the issue as open until the
capitalization is finally determined.
5.
Issues under Delaware General
Corporation Law – Section 242(b)(2):
Notwithstanding the protective
provisions of the charter, under certain
circumstances, the holders of Common
Stock or of a particular series of
Preferred Stock may have a separate
class or series vote.
a)
Unless the Certificate of
Incorporation provides otherwise,
the holders of outstanding shares
of each class (including common)
are entitled to vote separately on
any amendment to change the
rights of that class or increase
authorized shares.
b)
Unless the Certificate of
Incorporation provides otherwise,
if any proposed amendment
would change the rights of one or
more series of any class so as to
adversely affect such series but
not the entire class, then such
series has a separate vote.
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B.
Board of Directors
1.
The charter may contain a provision
designating the right to elect directors by
class or series, with more detailed
requirements as to Board size and
composition contained in the Voting
Agreement.
2.
Voting Agreement: This agreement
specifies the size of the Board and how
particular Board positions will be filled.
3.
a)
For example, if the Series A
Preferred is entitled to two
directors, the Voting Agreement
may say that ABC Venture Firm
is entitled to designate one
director and XYZ Venture Firm is
entitled to designate one director,
each so long as it owns a specified
number of shares. Removal and
replacement of these directors is
subject to same procedure.
b)
Other designated “slots” for
positions as directors might
include the individual serving as
CEO, one or more "common
stock" directors (typically,
founders or angel investors),
and/or a designated number of
outside directors with relevant
industry experience.
In addition to Preferred Stock holders,
key common holders are required to
become parties to the Voting Agreement
to ensure sufficient votes to effect the
requirements of the Voting Agreement.
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4.
C.
Observer Rights: One or more investors
may have the right to appoint an observer
who, although not a Board member, will
be entitled to attend all Board meetings
and receive all materials, notices, etc.
sent to the Board. Note that these
individuals do not have fiduciary
obligations to the company and, absent
contractual terms, do not have
confidentiality obligations with respect to
the information they receive. In addition,
observers should be excused from any
portion of a Board meeting at which
privileged information is discussed.
Other Rights Provided to Preferred Stock
Investors
1.
Contractual Pre-emptive Rights: This is
the right of existing Preferred Stock
investors to purchase their pro rata
portion of any new securities issued by
the company (excluding options, and
possibly excluding shares issued in an
acquisition or a Qualified IPO, and
shares issued to strategic partners,
lenders and lessors).
2.
Information Rights (some of which may
apply to all investors and some only to
major investors): monthly, quarterly and
annual financial statements, budget,
special notice of certain events.
3.
Other Covenants: These may include
requirements, among others, that, without
the consent of the Board including the
investors’ representatives or without the
consent of a majority-in-interest of the
investors, all employee stock options
must vest in accordance with a certain
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schedule, and the company must carry
D&O insurance of at least a specified
amount and key man insurance in
specified amounts on specified
individuals.
4.
All special rights, other than registration
rights, typically terminate upon a
Qualified IPO or a Liquidation Event.
Liquidity Terms
XI.
Liquidity Terms
A.
Registration Rights
1.
Demand rights: Typically, investors are
granted one or two “demands,” entitling
a specified percentage-in-interest of the
investors to require the company to
register the Common Stock underlying
their Preferred Stock, at any time
beginning six months after the company's
IPO (or by a certain date if an IPO has
not occurred). This right applies to the
underlying Common Stock, not the
Preferred Stock (the Preferred Stock
would be required to convert into
Common Stock before an underwriter
would complete an IPO).
2.
Piggyback rights: This refers to the right
of an investor to include its shares of
Common Stock obtained upon
conversion of the Preferred Stock in a
company-initiated offering. Typical
issues are whether piggyback rights
apply to an IPO (they usually do not) and
what are the priorities of various
stockholders to include their shares in the
offering in the event that the underwriters
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say that all of the shares requested to be
included cannot be included (known as
an “underwriter cutback”).
3.
B.
Unlimited S-3 rights: This refers to the
right of the investors to request the
company to register their shares of
underlying Common Stock, multiple
times, on a short-form registration
statement if the company is eligible to
use the form and if they intend to sell at
least a minimum specified amount. With
certain changes to Rule 144 in February
2008, this right will not likely be
important to any stockholders other than
affiliates of the issuer.
Control Provisions with Respect to M&A
Transactions
1.
Protective Provisions in the Charter:
Preferred Stock holders have a veto over
"Liquidation Events" but the charter
provisions do not give the Preferred
Stock holders the right to force a
Liquidation Event to occur.
2.
Drag Along in Voting Agreement: If
there is a drag along right, and a certain
percentage of stockholders (typically a
supermajority) agrees to the terms of a
transaction constituting a Liquidation
Event or a sale of all of the outstanding
stock, then all stockholders who sign the
Voting Agreement are required to vote in
favor of the transaction, enter into the
requisite agreements, and sell their
shares.
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C.
Redemption
1.
Preferred stock may be subject to
mandatory redemption by the issuer if the
issuer has not been sold or gone public
within a specified number of years,
typically five years, after the financing.
This serves as investors' leverage to
pressure management to sell the
company or otherwise realize liquidity
after a significant investment period.
2.
Typical terms are redemption payments
made at the end of years 5, 6 and 7, in
three equal installments, at the price
originally paid by the investors plus an
amount equal to accrued "dividends."
Management/Founder Terms
XII.
Management/Founder Terms
A.
Equity Participation by Founders/Management
1.
Venture capital investors may insist that
vesting be retroactively imposed on some
of founders’ shares.
2.
VCs will negotiate the size of the equity
incentive plan reserve, whether founders
will be entitled to participate in the plan
and the vesting terms of options. A
typical reserve is 10% to 20% of fullydiluted shares post-financing.
3.
One of the key vesting issues regarding
stock options is whether vesting will be
accelerated, partially or in full, upon a
change in control. Accelerated vesting
may apply upon the closing of an
acquisition (known as a “single trigger”)
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or may apply only if there is an
acquisition and the executive or
employee is terminated within a specified
period of time after the acquisition
(known as a “double trigger”).
B.
Agreements with Founders/Management
1.
Employment Agreements: These are not
typically favored by VCs for founders in
early stage companies. They are more
common for executives brought in at
later stages.
2.
Non-competes: These are typically
included in executive employment
agreements (if there are such
agreements), but note that there are
enforceability issues – scope, length of
time, compensation for the non-compete
obligation. The laws regarding
enforceability of non-competes vary from
state to state. Non-competes are
generally not enforceable in California,
for example.
3.
Confidentiality and Assignment of
Invention Agreements: It is critical that
all employees and consultants sign these
agreements.
NVCA Forms
XIII.
NATIONAL VENTURE CAPITAL ASSOCIATION
(“NVCA”) FORMS
A.
The NVCA has created Venture Capital Financing
Model Legal Documents which are available on
the NVCA website (www.nvca.org):
1.
Term Sheet
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B.
2.
Stock Purchase Agreement
3.
Certificate of Incorporation
4.
Investor Rights Agreement
5.
Voting Agreement
6.
Right of First Refusal and Co-Sale
Agreement
7.
Management Rights Letter
8.
Opinions
9.
Indemnification Agreement
Model Legal Documents
1.
These documents are a best practices set
of documents that have been drafted,
reviewed and endorsed by an expert
working group.
2.
These documents are “balanced” as
between concerns of VCs and
entrepreneurs.
3.
Where appropriate, the forms provide
alternatives for key provisions that can be
reviewed and selected (e.g., broad-based
anti-dilution, narrow-based anti-dilution,
full-ratchet).
4.
The forms also contain explanatory
commentary where necessary or helpful.
5.
Each document is constantly reviewed,
updated, and refined (through e-mails to
the working group, and through periodic
working group review).
25
Key Observations
XIV.
Keeping Terms in Perspective
A.
B.
Company beware!
1.
Don't just focus on pre-money valuation
and percentage ownership.
2.
Other terms matter such as: liquidation
preferences and veto provisions.
3.
Other factors are critical: managements’
chemistry with theVCs, the VCs’ ability
to fund additional rounds and bring in
additional investors, and the VCs’
“network” of management candidates,
collaboration partners and other
commercial partners, banks and
underwriters.
4.
Raise more money now, not later.
VCs beware!
1.
What's good for the goose….. tough
terms in one round may show up from
new investor in the next round.
2.
Make sure management has strong
incentives and is aligned with the
investors.
3.
Pay attention to approval thresholds and
maintain alliances to achieve approvals.
4.
Plan for feasible exits.
26
Exhibit A
Structure of Venture Capital Financing
Example of capitalization of company immediately following first venture round (assumes purchase price of
$1.00/share and 1:1 conversion ratio):
No. of Shares of
Common Stock
No. of Shares of
Preferred Stock
No. of Shares
Fully Diluted
5M
-
5M
-
4M*
4M
Stock Option Plan
(reserved)
1M
-
1M
16.67%
10%
Total (fully diluted)
6M
4M
10M
100.00%
100.00%
Founders and Early
Stage Investors
VC Investors
*
Convertible into 4,000,000 shares of Common Stock on a one-for-one basis.
Valuation
- Pre-Money Valuation = $6M
- Post-Money Valuation = $10M
27
% of Total
Outstanding
83.33%
-
% of Total Fully
Diluted
50%
40%
28