negotiating venture capital term sheets
TRANSCRIPT
Negotiating Venture Capital Term Sheets
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Negotiating Venture Capital Term Sheets
Larry Kane, Partner, OrrickApril 21, 2015
Terms for Venture Financing:
•Series A as a precedent for future rounds
•Institutional Venture Round versus Angel Round
•Pick your VC Carefully– you will be partners on the business going forward
•Pre-Financing Strategy (No Legal Risks)
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•Pre-Financing Strategy (No Legal Risks)
Proper Organization and Documents
IP Documents (CIAA, Assignments of IP, Patents)
Stock Options with 409A
Stock Issuances to Advisors
Series Seed/CN
Securities Law Filings
EXECUTED DOCUMENTS
Terms for Venture Capital Financing:
Principal Term Sheet Purposes:
• Guides to Drafting-
• Even if not binding- parties will look to term sheet
• Sets the Valuation (Pricing)
• Participating Preferred Alters the Valuation
• Management of the Company Going Forward
• Investors Rights
• Exclusivity Period/Timing From Signing to Close – expect 3 to 5 weeks from signing of term
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• Exclusivity Period/Timing From Signing to Close – expect 3 to 5 weeks from signing of term
sheet to closing
No shop – Need to give your self flexibility to Raise Cash to get to Next Financing
if Deal Does not Close
Diligence Period
Drafting Period (Who Drafts)
Costs – Company pays legal fees for investors plus your fees
Expect company fees to be 2x to 3x investor fees (depends on how clean the
company is and how many angel investors, etc).
Investor may need to call capital which may take 15 days
Offshore Investors may need a few weeks to get government and banking approval
Terms for Venture Capital Financing:Venture Capital Terms
•Pricing/Valuation
Initial Valuation and Capitalization
Liquidation Preference
Dividends
Anti-dilution Protection
Rights to Participate
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•Management Controls
Board Rights
Protective Provisions
•Liquidity Events
Registration Rights
Co-Sale/Rights of First Refusal
Drag Along Rights
Terms for Venture Capital Financing: Type of SecurityConvertible Preferred Stock (not Common Stock)
•Convertible Preferred Stock
•Senior to Common Stock
Converts into Common upon certain events
Receives Dividends [if and when declared] – very rare
Protective Rights
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•Convertible Note, Series Seed and Convertible Equity
Angel/Small Rounds – generally less than $1.0 million
Terms for Venture Capital Financing:Round Size and Valuation
• Amount Raised
More investment = more dilution (sometimes easier to raise more)
What does your company plan to do with the money raised?
Keep Flexible
•Pre-Money Valuation
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• Are Convertible Notes Pre-Money?
• Pro- Forma Capitalization
Terms for Venture Capital Financing:Valuation/Capitalization Structure
•Valuation is Generally based on Fully-Diluted Shares
Outstanding Shares
Convertible Securities (options, warrants)
Not pure authorized shares
Watch for dilutive shares being added to pre-money shares
•Generally Need to Include:
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•Generally Need to Include:
Founders Stock (vesting often required)
Advisors/Partners
Available Employee Stock Pool (10-20% after deal)
Convertible Equity/Notes
•Warrants/Stock Granted to Third Parties
Terms for Venture Capital Financing:Pro-Forma Example
Assume $7.0m pre-money valuation and $3.0m of new cash for a $10.0m post-money
valuation with a 20% option pool:
Post-Money Cap Table:
Founders 50.0%
Option Pool 20.0%
New Investors 30.0%
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New Investors 30.0%
Total: 100%
What about Convertible Securities and discounts?
PAY ATTENTION TO VOTING PERCENTAGES
VOTING = CONTROL
Terms for Venture Capital Financing: Return onInvestment/Power boosting the Investor Returns
• Dividends
Cumulative vs. non-cumulative dividends
Generally, non-cumulative dividends are never paid as they are payable only “when andif declared by the Board of Directors”
East Coast VCs with Private Equity Background look to Cumulative Dividends
Generally set around 8.0% per annum – can be used in redemption provisions
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Cumulative may be treated as debt for accounting
• Liquidation Preference -Paid on Sale of Company
“Preference” = preferred stock’s down side protection.
“Participation” = changes the valuation
Cap on participation = making lemonade out of lemon
Terms for Venture Capital Financing: Return onInvestment - Redemption
• Redemption – not overly common but at leas 5 years
May force sale of the Company like Drag Along
Return is often similar to liquidation preference but with a hurdle
Timing for redemption – the further out the better
Triggers for calling a redemption – the more difficult the better
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Installments – the more the merrier as it may not require sale of the company
Terms for Venture Capital Financing: Conversion
• Optional Conversion
Preferred stock is convertible into common stock at any time.
• Anti-dilution Provisions -if you sell stock at a lower price in the future
Full ratchet vs. weighted average anti-dilution adjustment
Broad based vs. narrow based weighted average anti-dilution adjustment
Some variable in the weighted average formula
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Some variable in the weighted average formula
Exceptions for Non-Financing Offerings
Stock Options (watch for caps)
JV and Commercial Agreement
• Mandatory Conversion
Triggers for mandatory conversion – IPO or vote by the preferred stock
Percent preferred vote necessary to trigger conversion
Terms for Venture Capital Financing: ControlMechanisms & Board Composition
• Voting Rights
• Generally votes with Common
• Board Composition (Voting Agreement)
Generally expect 5 person board with 2 from VC; 2 from founders one of which is CEOand one independent
Preferred stock votes with common stock on an as-converted basis
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Preferred stock votes with common stock on an as-converted basis
Board seat designation rights of preferred stock
Expect a CEO board seat
Expect Independent director board seat (how determined)
Under Delaware law, certain Directors can have more than one vote
• Board Observer Rights
Terms for Venture Capital Financing: ControlMechanisms & Protective Provisions
• Investor vote required for Key Decisions:
• Pay Attention: Board versus Shareholder Approval:
Authorize/Issue new Preferred Stock
Amending the terms of the existing Preferred Stock
Grant options beyond a certain limit
Amend the charter
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Sell the Company – exit events
No Additional Debt
Change in the Business
Key Hires
Acquisitions
• Be careful on the percentages and multiple investors holding separatevetoes
• Remember, these terms can slow the management of a company.
Terms for Venture Capital Financing:Liquidity Events
• Drag Along: Investors can force Common Stockholders to participate in a sale of
the Company
Triggers for activating the drag along
Conditions for enforcing the drag along
Preferred and Common have different exit outcomes:
oRequire High Percentage of Approval at Shareholder and Board level
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• Pay to Play
Requires Investors to Keep Investing or conversion into Common
Triggers for activating the pay to play
Consequences for failure to pay
Terms for Venture Capital Financing:Investor Rights: Investor Rights
• Registration Rights
Common Rights – Don’t spend too much time on this
Demand registration = forcing function for your company to go public
S-3 registration = short form registration for eligible issuers
Piggyback registration = investors tagging along company registration
Lock-up = absolutely necessary for company to retain underwriters
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Lock-up = absolutely necessary for company to retain underwriters
• Information Rights
Reserved for “Major Investors”
Financial statements – annual, quarterly, monthly; audited vs. unaudited
budget
cap table
Visitation rights – conditions for exclusion
Terms for Venture Capital Financing:Investor Rights (Continued)
• Preemptive Right (Right to Participate)
Common right for investors to maintain ownership
Standard Right for “Major Investors”
Calculation of pro rata share
Excepted company issuances
Accredited Investors
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Lose if they don’t exercise?
• Negative Covenants
Ordinary course of business items vs. extraordinary events
Dollar threshold
• Affirmative Covenants
Non-compete, non-solicit, non-disclosure and inventions assignment
Board matters
Option vesting
Key person and D&O insurance
Terms for Venture Capital Financing:Transfer Restrictions
• Right of First Refusal and Co-Sale on Sale of Stock of Founders and Existing
Stockholders
Restricted parties
Participants
Excepted transfers
• “Reverse vesting” / vesting resets
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• “Reverse vesting” / vesting resets
Customary Terms for Founders- best to have in place prior to deal
4 year vesting with credit for time served with double trigger on change of control and
acceleration on termination without cause
Terms for Venture Capital Financing:Exclusivity and Other Terms
• Closing Conditions
All Consultants/Employees Sign CIAA
Employment/Vesting Agreements with Founders (structures exit of Founder)
Legal Opinion
Shareholders all signing voting and ROFR Agreement
Amendment of Charter
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Amendment of Charter
Representations True and Correct
Terms for Venture Capital Financing:What About Strategic Investors?
• Great For Market Valuation or Acknowledgement
• Often Tied to Strategic Business Deal / Active Business Purpose
• Beware of Access to Confidential Information and Conflicts of Interest
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Thank You!
CONTACT
Larry Kane
Partner, Orrick’s Technologies Companies Group
(415) 773-5827
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