Date post: | 12-Jul-2015 |
Category: |
Small Business & Entrepreneurship |
Upload: | malaysian-global-innovation-and-creativity-centre-magic |
View: | 155 times |
Download: | 0 times |
Venture FinancingHow to negotiate a term sheet
C. Jeffrey Char
J-Seed Ventures, Inc.
2
My Name is
Jeff Char
3
From Hawaii
4
10 years
5
23 years
6
Securities research analyst
Corporate finance attorney
Serial entrepreneur
Venture capitalist
7
J-Seed Ventures Inc.
Venture incubator
Founded in 2000
Self-funded
9 portfolio companies currently
8
We start businesses that
address real market needs
with innovative business
models and technologies.
8
9
9
My ventures
10
Before we begin…
11
Advice for Raising Capital
Mistakes are costly – plan ahead
Don’t raise too early – OPM is for scaling
Binding vs. non-binding
Valuations – higher is not always better
Find an experienced lawyer
12
13
Common Stock vs. Preferred Stock
Common Stock
Statutory definition
Founders
Preferred Stock
Articles of Incorporation
Investors
14
Negotiating A Term Sheet
Preferred Stock Rights
Preferred Stock Restrictions
Contractual Rights
Liquidation Preference
Anti-Dilution Protection
Protective Provisions
Investor Redemption Rights
Conversion Rights
Voting Rights
Automatic Conversion
Company Redemption Rights
Board Representation
Maintain Ownership
Information Rights
Registration Rights
Employee Equity
15
Negotiating A Term Sheet
Preferred Stock Rights
Preferred Stock Restrictions
Contractual Rights
Liquidation Preference
Anti-Dilution Protection
Protective Provisions
Investor Redemption Rights
Conversion Rights
Voting Rights
Automatic Conversion
Company Redemption Rights
Board Representation
Maintain Ownership
Information Rights
Registration Rights
Employee Equity
16
Preferred Stock RightsLiquidation Preference
Only investment returned, or
participate with common after
investment returned
Occurs on true liquidation
or on sale of company
Liquidation preference increases
over time
Senior liquidation right, or in
proportion to invested capital
(“pari passu”)
Issue Normal Provision
Participate with common unless
fully diluted payout is 3x to 5x
investment price
Merger deemed liquidation
Not unusual
In proportion to invested capital
Preferred Stock RightsLiquidation Preferences Compared
Mobile Tech, Inc. Capital Structure
Class Price Per Share Shares $ Paid In
Common $0.01 6,000,000 $ 60,000
Preferred $1.00 4,000,000 $ 4,000,000
No Liquidation Money Back and Money Back and
Company Sale Price Preference Money Back Only Participate to 3x Cap Fully Participating
$5 Million Common
Preferred
$10 Million Common
Preferred
$20 Million Common
Preferred
$40 Million Common
Preferred
$ Million
Total $ Per
Layout Share
$ 3 $ 0.50
$ 2 $ 0.50
$ 6 $ 1.00
$ 4 $ 1.00
$ 12 $ 2.00
$ 8 $ 2.00
$ 24 $ 4.00
$ 16 $ 4.00
$ Million
Total $ Per
Layout Share
$ 1 $ 0.16
$ 4 $ 1.00
$ 6 $ 1.00
$ 4 $ 1.00
$ 16 $12 $ 2.00
$ 4 $ 8 $ 2.00
$ 36 $ 24 $ 4.00
$ 4 $ 16 $ 4.00*
*
* Preferred converts to maximize returns
** Preferred receives less due to cap.
$ Million
Total $ Per
Layout Share
$ 0.6 $ 0.10
$ 4.4 $ 1.10
$ 3.6 $ 0.60
$ 6.4 $ 1.60
$ 9.6 $ 1.60
$10.4 $ 2.60
$ 24 $ 21 $ 4.00
$ 16 $ 19 $ 4.00
$ Million
Total $ Per
Layout Share
$ 0.6 $ 0.10
$ 4.4 $ 1.10
$ 3.6 $ 0.60
$ 6.4 $ 1.60
$ 9.6 $ 1.60
$ 10.4 $ 2.60
$ 21 $ 3.50
$ 19 $ 4.75**
18
Issue Normal Provision
Preferred Stock RightsAnti-Dilution Protection
”Ratchet” (full, narrow or
broad base)
Size of employee incentive
pool
Broad base
15-25% of company
(including shares subject to
options and shares reserved
for future options)
19
Preferred Stock RightsAnti-Dilution Protection
Pre-Money
Number of Shares Original Purchase Valuation at Time
Type of Security Outstanding Price Per Share of Purchase
Capitalization of JS Tech, Inc.
Common Stock 1,000,000 $0.10 $ 100,000
Options to Purchase Common 100,000 $0.10 N/A
Series A Preferred Stock 500,000 $1.00 $1,100,000
Series B Preferred Stock 400,000 $2.00 $3,200,000
New Issue:
Series C Preferred Stock 500,000 $1.50 $3,000,000
Preferred Stock RightsAnti-Dilution Protection
Anti-dilution operates by adjusting the
“Conversion Rate” of a series of preferred stock
Conversion Rate = Original Purchase Price (always the same)
Adjusted Conversion Price
• A decrease in the “Conversion Price” increases the Conversion Rate.
• The Conversion Price never exceeds the Original Purchase Price.
Formulas for Determining Adjusted Conversion Price of Series B
Full Ratchet: Narrow Base Broad Base
Weighted Average Weighted Average
BPP A + B + ( ) A + B + CS + O + ( )
CPP A + B + C A + B + CS + O + C
BPP = Series B Purchase Price B = Series B shares outstanding
CPP = Series C Purchase Price C = Series C shares to be issued
C$ = Total amount paid for Series CS = Common Stock shares
A = Series A shares outstanding O = Option shares outstanding
C$
BPP
C$
BPP
Preferred Stock RightsAnti-Dilution Protection
Example of Anti-Dilution(3)
Application of formulas to JS Tech, Inc. Series B Preferred Stock
JS Tech, Inc. Issues 500,000 Shares of Series C Preferred Stock at $1.50/Share
Full Ratchet: Narrow Base: Broad Base: $750 $750
500 + 400 + $2.00 500 + 400 + 1,000 + 100 + $2.00
500 + 400 + 500 500 + 400 + 1,000 + 100 + 500
1,275,000 = .9107 2,375,000 = .95
1,400,000 2,500,000
$2.00 X .9107 = $1.82 (new CP) $2.00 x .95 = $1.90 (new CP)
$2.00 $2.00 $2.00
$1.50 $1.82 $1.90
400,000 Series B @ $1.33 400,000 Series B @ 1.0989 400,000 Series B @ 1.0526
convert to 532,000 Common convert to 439,560 Common convert to 421,040 Common
= 1.33 (new rate) = 1.0989 (new rate) = 1.0526 (new rate)
22
Issue Normal Provision
Preferred Stock RightsProtective Provisions
Actions which require consent
Who must consent
All investors or only new
investors
Percentage required
Preferred Series vote vs. Preferred
Class vote
Sale of Company
Senior securities
Equivalent securities
Change in rights
Repurchases except on termination
All investors
3 of 5, or 4 of 7, largest investors
Sale of Company and Repurchases -
Preferred as a class
Others - Vote by series
23
Issue Normal Provision
Preferred Stock RightsInvestor Redemption Rights
Earliest demand date
Redemption price
When repurchased
Sinking fund
5 years
Cost plus 10%
Over 3 years
None - so legal limitations apply
24
Issue Normal Provision
Preferred Stock RightsConversion Rights
When investors can convert at their option
Forced conversion by other investors
At any time, partial or total
80% majority can force remainder to convert
25
Issue Normal Provision
Preferred Stock RightsVoting Rights
Vote number of Preferred
shares or as if converted to
Common
Classified Board of Directors
Vote on as-converted basis
Each series represented. In Articles of Incorporation if required by investors
26
Negotiating A Term Sheet
Preferred Stock Rights
Preferred Stock Restrictions
Contractual Rights
Liquidation Preference
Anti-Dilution Protection
Protective Provisions
Investor Redemption Rights
Conversion Rights
Voting Rights
Automatic Conversion
Company Redemption Rights
Board Representation
Maintain Ownership
Information Rights
Registration Rights
Employee Equity
27
Issue Normal Provision
Preferred Stock RestrictionsAutomatic Conversion
Earliest date
Minimum valuation
Minimum IPO deal size
IPO only, or also merger
Forced conversion by other
investors
3 years after investment
3-5 times investment value
$10-15 million
IPO only
80% of all investors can force
remainder to convert
28
Issue Normal Provision
Preferred Stock RestrictionsCompany Redemption Rights
Earliest demand date
Redemption price
When redeemed
Opportunity to convert before
redemption
3-4 years after investment
Cost plus 10%
One-time purchase
Yes
29
Negotiating A Term Sheet
Preferred Stock Rights
Preferred Stock Restrictions
Contractual Rights
Liquidation Preference
Anti-Dilution Protection
Protective Provisions
Investor Redemption Rights
Conversion Rights
Voting Rights
Automatic Conversion
Company Redemption Rights
Board Representation
Maintain Ownership
Information Rights
Registration Rights
Employee Equity
30
Issue Normal Provision
Contractual RightsBoard Representation
Classified Board
Voting agreement and proxies
Company’s best efforts to elect person nominated by Preferred
Observer rights
Termination
Each series represented. Traditionally dominant, but recent trend away from classified boards
Occasional
Most frequently used
Large investors
On IPO or if diluted to below 10%
31
Issue Normal Provision
Contractual RightsMaintain Ownership
Preemptive right or right to buy after closing
Decision time period
Excluded transactions
Termination
Time
IPO/merger
Failure to exercise rights
Preemptive right (“Right of First Refusal”)
15 days
Employees and consultants
Acquisitions
Bank lending
Equipment financings
Licenses
5 years
Yes
No
32
Issue Normal Provision
Contractual RightsInformation Rights
Who receives rights
Type of information
Large investors (often $300,000-$500,000 minimum)
Annual audited within 90 days
Monthly unaudited within 20-30 days
Annual budget when presented to/approved by Board
33
Issue Normal Provision
Contractual RightsRegistration Rights
When investors can demand IPO
How many investors must demand
Participation in IPO
Demand rights after IPO
Lockup after IPO
3-5 years
Holders of over 40%
Cutbacks to zero
1 to 3 on Form S-1, annual on Form S-3
180 days if directors, officers and 1% holders sign
34
Contractual RightsEmployee Equity
Buy-back on founders’ shares
Vesting of options
Co-sale rights
Issue Normal Provision
Reverse vesting over 4 years; cost buy-back
4 years; 6 or 12 month delay after employment starts
Investors can sell if founders sell
35
Contractual RightsEmployee Equity
Reverse vesting of founder shares
1 2 3 4
100%
75%
50%
25%
years