THE LANGUAGE AND STRUCTURE OF ANGEL AND VENTURE DEALS

JULY 28TH, 2015

©MCCARTHY LAW, LLC 2015

LEGAL ISSUES FOR STARTUPS AND ENTREPRENEURS

FOUR SECTIONS OF THIS PRESENTATION

• Types of Deals

• Common Structure of Deals

• Critical Deal Terms

• Other Key Concepts

SECTION I: TYPES OF DEALS

• Common Equity

• Preferred Equity

• Convertible Notes

• Less Common Deals

COMMON EQUITY

• Common Among Less Sophisticated Investors/Startups

• Simple

• Implies a Valuation

• Pre/Post-Dilution Issues

PREFERRED EQUITY

• Most Common Venture Vehicle/Most Sophisticated Investors

• Varying Levels of Complexity

• Liquidation Preferences

• Huge Variation in Fairness/Characteristics of How Startups Treated

CONVERTIBLE NOTE

• An Investment Vehicle that Has Characteristics of Debt and Equity

• Initially Debt. Upon Triggering Event, Converts into Equity.

• Delays Valuation Question

• Originally Used in Bridge Financing, Now Super Common in Early-Stage Startups

LESS COMMON INVESTMENT VEHICLES

• FACE

• KISS

• Convertible Equity

• ROBS

• Revenue-Based Financing

SECTION II: COMMON STRUCTURE OF DEALS

• Term Sheet

• Disclosure Documents

• Investor Due Diligence

• Accredited Investor Certs

• Final Deal Agreements

• Federal Filings

TERM SHEETS

• Broad Strokes

• Agreement to Agree

• Where You Learn Exactly About Seriousness Level of Your Investors’ Interest

• Not a Binding Document

DISCLOSURE DOCUMENTS

• Securities Laws

• Material Misstatement or Omission

• CYA

• Forward-Looking Statements

INVESTOR DUE DILIGENCE

• You’re Responsible for Having the Documents in Place

• Investors Do the Legwork Here

ACCREDITED INVESTOR CERTIFICATION FORMS

• For Most Startups, Only Let Accredited Investors Invest

• 200k/year Individual, 300k/year Married Couple

• $1,000,000 in Assets Excluding Primary Residence

FINAL DEAL AGREEMENTS

• Stock Purchase Agreement

• Preferred Stock Purchase Agreement

• Convertible Note Agreement

• Fully Fleshed Out, All Legal Concepts

FEDERAL FILINGS

• Form D

• Associated State Filings

• Additional Filings May Be Required – Depends on the Size of the Round

SECTION III: CRITICAL DEAL TERMS

• Liquidation Preference

• Anti-Dilution Provisions

• Representations and Warranties

• Qualified Financing

• Conversion Price

• Valuation Cap

LIQUIDATION PREFERENCES

• Investor Gets Money Back First

• Participating vs. Non-Participating

• Usually a Multiple

• 1x Considered Standard

DILUTION, ANTI-DILUTION PROVISIONS

• Issued vs. Authorized Stock

• Option Pool

• Pro Rata Participation Rights

• Automatic Grant to Maintain Ownership %= Crazy!

REPS & WARRANTIES

• Company Has to Certify It Has Its Excrement Together

• If You Didn’t Set Your Company Up Correctly, Probably In Violation of This

• IP, Authority, Compliance with Laws, Full Information

KEY CONCEPTS, CONVERTIBLE NOTES

Coming Slides

QUALIFIED FINANCING

• Typically, Threshold for Automatic Conversion for a Convertible Note

• Point at Which Investors Convert to Preferred Equity

• $1,000,000 Standard Size

CONVERSION PRICE

• Size of Discount Convertible Note Investors Receive to Later Investors

• 20% Discount Standard

VALUATION CAP

• Provides a Reasonable Estimate of What Convertible Note Investors Think Company Should be Worth Next Round

• $5 MM Cap, $10 MM Raise

SECTION IV: OTHER KEY CONCEPTS

• Regulation D Offering

• Rule 504 vs. 506 Offerings

• Tag-Along/Drag-Along/Co-Sale

• Right of First Refusal

ADDITIONAL READING

• Venture Deals by Brad Feld and Jason Mendelson

• Deal Terms by Alex Wilmerding

THAT’S IT!

• Kieran@ColoradoStartupLawyer.com

• @CoStartupLawyer• www.coloradostartuplawyer.com

Thanks for Coming!