Negotiating the Series A Round Term Sheet
A Webinar from LeClairRyan’s Venture Capital Practice with Special Guests from Novitas, Harbert, Third Security
October 6, 201012:30 – 1:30 pm EDT
Welcome. With the high number of attendees, please note all lines have been muted for the event. Q&A can be posted at the right of your screen, but any questions (time permitting) will be addressed at the end of the event. If using Q&A – please send to both the host and the presenter. Chat will not be enabled. You can send direct questions (including request for copy of slides) to [email protected] with VC Webinar in the subject for reply after the event.
Bill Oberdorf Andrew White
Tad Fisher Third Security
Paul Schmitt Novitas Capital
Brian Carney Harbert Venture Partners
Today’s presenters
Negotiating the Series A Round Term Sheet
Theodore J. FisherThird Security, LLC
LeClairRyan Web Seminar
October 6, 2010
Third Security, LLC
• Dedicated to investing in high-growth, technology driven companies, primarily in life sciences
• Led by R.J. Kirk, its founder, CEO and Senior Managing Director
• Differentiated approach to life-science investing, focusing on investments across broad spectrum of developmental and investment stages in both private and public companies
Influence: Third Security affiliates are typically the sole institutional investors in a company
Domain-based collaboration: Third Security delivers a wide variety of operational resources to portfolio companies
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Valuation
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• We are sellers, not buyers Help in the difficult transition from an R&D company to a commercial enterprise
Buy-in to a common vision is essential
We have the relationships and the horsepower to help make the vision a reality
• Significant equity pool for management team Options granted based upon value of common stock relative to the Series A Preferred, creating a low strike price in light of the
liquidation preference
Fosters “owner” rather than “employee” mentality
• It may not be in the company’s best interest to pursue an aggressive valuation in a Series A round; funding a company at an unrealistic valuation can make the next financing difficult
• If a company wants to shop the deal to get the best valuation, then Third Security is not the right investor
Deal Structure Issues
• Liquidation Preference Participating preferred stock
Dividend rates have crept higher in this market environment
Will agree to cap in limited circumstances
• Founder Shares Stock restriction agreements typically only apply to sweat equity
Significant negotiation over valuation methodology in the event a repurchase of such shares is triggered and length of vesting period
• Negative Covenants We insist on written approval over anything outside of ordinary course
Opportunity to help the company execute; we never want to hinder the company’s progress
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Founder to CEO to Exit transition
Target management upgrades and additions
Board approval versus operating roles
Financial reporting discipline
Board and investor communications
Management Issues
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Art vs. Science
Early stage technology/biotech
Revenue/EBITDA runway
Be realistic…know comparables
Strike quickly
Valuations
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Understand comparables
1 to 1.5x is a win/win
+3x…something is wrong!
Expect creativity
Liquidation Preferences
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Harbert® Venture Partners II, L.P. | 10
Overview of Harbert Venture Partners LLC
Venture capital fund focused on early stage investments in information technology and healthcare companies
Offices in Richmond, VA, Birmingham AL and Gainesville, FL
Currently investing HVP II. $110+ million in venture funds under management
Investment Focus : Early growth stage, healthcare and IT, Southeast & Mid‐Atlantic US
Active involvement in regional venture community, on boards of Council for Entrepreneurial Development, Florida Venture Forum, Mid‐Atlantic Venture Association, Atlanta Venture Forum, etc.
Affiliate of Harbert Management Corp., an investment management firm focused on alternative asset classes with ~$2.7 billion in assets under management
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Harbert® Venture Partners II, L.P. | 11
Generally structured as a syndicate, with a lead investor
Stock interest in a C corporation
Usually in the form of “participating” preferred: pays back
investment, with dividends, and converts to common
Sometimes structured with milestones and / or tranches
Typically carries board participation rights
How is a VC Investment Structured?
Venture Capital Term Sheet – Series A
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Harbert® Venture Partners II, L.P. | 12
Discussion Points
Venture Capital Term Sheet – Series A
Valuation vs. terms
Terms:
Economic:
Pre‐money valuation
Liquidation preferences
Conversion ratios
Option pool
Dividends
Ant‐dilution protection
Pay to Play Provision
ROFR/Co‐Sale/Preemptive rights
Governance:
Board composition
Voting rights
Protective provisions
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Harbert® Venture Partners II, L.P. | 13
Discussion Points
Venture Capital Term Sheet – Series A
Economic:
Pre‐money valuation
Liquidation preferences
Participating Preferred vs. Convertible Preferred
1.0x, 2.0x, etc.
Conversion ratios
Option pool
Existing team, planned additions to management team
Increase pool pre or post deal
Dividends
Anti‐dilution protection
Weighted‐Average vs. Full Ratchet
Pay to Play Provision
ROFR/Co‐Sale/Preemptive rights
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Harbert® Venture Partners II, L.P. | 14
Discussion Points
Venture Capital Term Sheet – Series A
Governance:
Board composition
Investors, Management Team, Independents
Voting rights
Vote on as‐if converted basis
Protective provisions
Certain actions require approval of Preferred shareholders
Sale of assets or company
Changes to liquidation preferences or rights of preferred stock
Redeem shares
Authorize shares
Change By‐laws
Etc..
ROFR, Co-Sale and Drag-Along: Sweat the Small Stuff
Appropriate Ground Rules, but watch for Technical Pitfalls
Drag-Along Rights: • Disproportionate Exit Leverage?• Practical Limitations• “Ok I’ll sell, but I’m not signing anything”
Protective Provisions
Appropriate Gap-Fillers:• Amending Charter or Bylaws• New Series of Stock, Senior to Series A• M&A, Debt, Increasing Board, etc.
“This is a Stick-Up!” How Much Control is Enough?
Liquidity of Last Resort:Redemption Rights
The Minority View Counter to Needs of Cash-Starved Start-up State Law Problems It’s About Leverage
Registration Rights
Mandatory, Piggyback and S-3 Practical Limitations Is this a Good Use of Bargaining Chips
(and legal fees)?
Questions and Answers
Disclaimer
This presentation provides general information and is not legal advice and should not be used or taken as legal advice for specific situations. You should consult legal counsel before taking any action or making any decisions concerning the matters in this presentation.
This communication does not create an attorney-client relationship between LeClairRyan, A Professional Corporation, and the recipient.
Copyright 2010 LeClairRyan, A Professional Corporation. All rights reserved.