Private Equity FinancingsPrivate Equity Financings

Downside Protection:

What’s Important,

What’s Not

& Why

Down-Side ProtectionDown-Side Protection

Liquidation Preference

Right of Redemption

Price-based Anti-Dilution Protection

Liquidation PreferenceLiquidation Preference The “New” Standard: participating Issues:

Participating vs Non-ParticipatingDisincentivize management team, if LP too

large Negotiation Ideas:

Repay Preferred, then pay common, THEN share upside

– Balances investor protection with management incentive

Liquidation PreferenceLiquidation PreferenceNegotiation Ideas cont’dBalance downside protection with

upside benefit–Different LP for M&A vs

Liquidation–LP subordinated to retention

bonuses – Fixed return for investors for greater

downside protection

Liquidation PreferenceLiquidation Preference The New Standard: Priority Issue: Priority vs Pari Passu Non-Issue:

– Generally, an investor issue -- potential conflict between classes, but money controls

– Cal. Corp. Code (§903(b) - Some class protection

– Some protection through board/observer rights

RedemptionRedemptionThe New Standard: More common, but not

“standard”Issues:

– Jeopardize company if insufficient $$ to repay– Gives investors inordinate bargaining power– Makes company less attractive acquisition

candidate

RedemptionRedemption

– Old CW: Non-issue Push off for 5 years, which was a long

timeWithin 5 years, company will either

exit or foldCorporations code protection, if

company cannot not afford redemption

RedemptionRedemption

– New CW: Issue? Longer liquidity path - 5 years is

“shorter” Corporations code protection, but Obligation still affects company’s

attractiveness for merger

RedemptionRedemption Negotiating Points

– Disincentive to Management – fully vest and then diminish value of shares

– Essentially converts equity into debt – so use it to bargain on valuation

– Push off as far into future as possible, and redeem over time

– Might deter future investors – whose proceeds are used to pay redemption

– Permit Company to delay redemption for cause– Require “call”, if must have redemption

Anti-Dilution ProtectionAnti-Dilution Protection The “New” Standard: Weighted Average Issues:

– Broad vs Narrow-based– Full Rachet

Negotiation Points– Push hard against full rachet

Disincentive to additional investorsSee example

– Recommend limited rachet – tied to reduction of risk (e.g., hitting milestones)

Founder Vesting & Founder Vesting & AccelerationAcceleration

Issues:– if Founder can’t get liquid, valuation is

secondary Negotiate V&A in context of valuation

– Removal by Board for “convenience” Acceleration on termination “without cause” Include Constructive Termination Double Trigger

TERM SHEETS 101TERM SHEETS 101

Thursday, march 15, 2001

8:30am- 12:00pm

Software Development Forum