anatomy of-a-term-sheet-for-startups
TRANSCRIPT
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Silicon Valley Term Sheets
Brad Rock DLA Piper LLP (US) 650-833-2111 [email protected]
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Structure of Typical Start Up
• Founders: Partly vested common stock • Employees: Common stock options with vesting over
4 years • Investors: Convertible preferred stock • C corporation: DE or CA • In practice, no variation permitted
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Framework of Analysis
• Like a Prenuptial Agreement?
• Which terms matter • Which don’t matter
• Attributes of Ownership Rights • Economic
• Political
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Which Terms Don’t Matter - Economics
• Dividends (that are not automatic or cumulative) • Conversion rights (always starts 1:1)
• IPO • By choice
• Antidilution (if “broad based” not “ratchet”) • Registration rights
• Demand • S-3 • “Piggy-back” • Lock up (180 days)
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Which Terms Don’t Matter – Economics (cont.)
• Information Rights • Indemnification • D&O Insurance • Management Rights Letter • Proprietary Rights Agreements • Deal expenses (within range) • Right of Co-sale and First Refusal (as to founders and
their stock) • Redemption
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Terms that Matter - Economics
• Valuation (and which shares are “pre-money”) • Liquidation Preferences
• Participating/Non-participating
• “Deemed liquidation” – mergers
• Founder vesting • Up-front vesting?
• Acceleration if terminated without cause?
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Key Political Terms
• Raw Percentage Ownership • “Protective” provisions
• Always part of deal – boundaries
• Class versus Series rights – veto powers
• Board Composition • Determines strategic direction; termination of management
• “Drag along” terms • Who decides to sell company?
• CA vs. Delaware
• Contractual provisions
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Terms Mostly About the Investors
• Right of First Refusal on future financing • “Pay to Play”
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“Cap Table” for Valuation of High Tech, Inc.
Pre-Money % Post-Money % Outstanding Common Stock
3,000,000 shares 75.00% 3,000,000 shares 50.0%
Outstanding Preferred Stock
0 shares -- 2,000,000 shares 33.33%
Outstanding Stock Options
200,000 shares 5.00% 200,000 shares 3.33%
Reserved Options 800,000 shares 20.00% 800,000 shares 13.33% 100.00% 100.00%
4,000,000 shares 6,000,000 shares Valuation: (Series A Preferred Purchase Price = $2.00 per share)
$8.0 million $12.0 million
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Anti-Dilution Protection
• Antidilution • Weighted Average: Most common
• Ratchet: decreasing • None: rare (generally, investor policy)
• Exclusions • Option pool • Warrants for banks/leasing companies
• Pay to Play provisions • Lose future investment rights and preferences
• Harsher terms: Convert to common rather than a “shadow” series of preferred stock
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Basic Protective Provisions
• Authorize more of that series • Authorize series with more senior rights • Change rights of that series • Merger / sale of assets • Limits on changes to number of members of Board of
Directors • Many others possible
• Limits on borrowing, exclusive licenses, dividends, redemption of shares
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Documents for Funding
• Stock Purchase Agreement • Schedule of Exceptions
• Due Diligence
• Articles (Certificate) of Incorporation • Investor Rights Agreement • Registration Rights Agreement
(often combined with Investor Rights Agreement) • Voting Agreement (with “drag along”?) • Co-sale and rights of first refusal
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Due Diligence: Common Start-Up IP Problems
• Hidden founder • Missing IP assignments to company • Prior employer rights • Trademark issues • Exclusive licenses • Tradeshow display before the patent is filed • Unplanned use of Open Source software
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Effect of Liquidation Preference in Merger
Assumed Total Liquidation or Sale Amount (options expire or assumed): $9.0 million
Example A: Non-Participating Preferred
Preferred (per share): $0.80 Common (per share): $0.725
Example B: Fully Participating Preferred (assuming
1 times preferred)
Preferred (per share): $1.28 Common (per share): $0.48
Example C: Participating Preferred up to $2.00 per share
Preferred (per share): $1.28 Common (per share): $0.48
$15.0 million
$1.25 $1.25
$1.78 $0.98
$1.78 $0.98
$20.0 million
$1.67 $1.67
$2.20
$1.40
$2.00 $1.50
$25.0 million
$2.08 $2.08
$2.62
$1.82
$2.08 $2.08