venture capital deal structure prof. dell, spring 2009
TRANSCRIPT
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Venture Capital Deal Structure
Prof. Dell, Spring 2009
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FORM OF TRANSACTION
• Debt or Equity?
• Distinction between the two types of investments
• Series A Preferred Stock or Convertible Promissory Note?
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CONVERTIBLE PROMISSORY NOTE
• Still a sale of “security” • No voting rights, dividend distributions or
inspection rights - only a creditor of the company with priority on liquidation.
• Easy to structure - speed of transaction• Interest Rate• Maturity Date
Conversion feature
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TYPICAL DEAL POINTS
• Equity Kicker– Amount of warrant coverage, or– Discount upon conversion into next round of
equity financing
• Conversion feature (e.g., triggered upon next round of financing of at least $1,000,000)
• Mandatory or discretionary conversion?
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TYPICAL DEAL POINTS (CONTINUED)
• What if equity financing does not occur?
• Board observer?
• Information rights (e.g., financials)?
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SERIES A ROUND EQUITY FINANCING [SOME BUSINESS POINTS]
• Valuation of the technology company
• Management team
• Market space
• How much money does the company need (or want)?
• Percentage ownership of the company (on a fully-diluted basis, including option pool)
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PREFERRED OR COMMON?
• Attributes of preferred stock (still behind creditors)
• Common stock deal prices stock options for employees (ISOs issued for FMV)
• Common stock - no negotiation on terms (pari passu with the founders)
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PREFERRED OR COMMON? (CONTINUED)
• No protective provisions for investors
• Preferred deal is much more common
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ATTRIBUTES OF SERIES A PREFERRED
• Anti-Dilution Provision
– Grant of additional equity to protect your investment
– Protection from a down round
– Protection from the company granting additional equity to others.
– Weighed-Average Anti-dilution (standard)
vs.
– Full Ratchet Anti-dilution (harsh)
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ATTRIBUTES OF SERIES A PREFERRED
• Dividend “when, as and if declared”
– Noncumulative v. cumulative
– %
• Priority on dividend payments
• Liquidation preference
– “Participating Preferred”
– Money back times 3, or
– Money back, then pro-rata with founders
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ATTRIBUTES OF PREFERRED STOCK
• Liquidation Preference
Sale / Merger / Acquisition / Liquidation 3rd: Series A
2nd: Series B1st: Debt Holders
4th: Common
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MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
• Merger or asset sale treated as a liquidation – Consent of Series A Preferred required (50%,
66 2/3%, or more)– Must decide whether to treat merger or asset
sale as a liquidation (“cram down”)
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MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
• Redemption (or not)– Beginning year 6, then year 7 and 8– Purchase price + accrued dividends (if any)
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MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
• Conversion– Convertible at any time by dividing Purchase
Price by Conversion Price (1:1 basis)– Automatic conversion on IPO– Adjustment to conversion price (“full ratchet”)
• excludes options for employees and warrants for service providers
– Very lengthy provision but price of new equity issuances is key
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MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
• Pro Rata Investment Rights– Right to maintain ownership levels in future
rounds of financing.– If a VC owns 15% of the company, then during
a subsequent round of financing, the VC has the “right” to invest up to 15% of the total $s raised in that round.
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MORE ATTRIBUTES OF SERIES A
• Voting Rights - generally 1:1
• Protective Provisions
– Sale of the company
– Create new class of securities
– Amend Certificate of Incorporation/Bylaws
– Redeem shares
– Change number of Board members
• Amended and Restated Certificate of Incorporation vs. Certificate of Designation
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SERIES A TRANSACTION DOCUMENTS
• Series A Preferred Stock Purchase Agreement– Reps/warranties from company (capitalization,
IP, contracts, etc.)– Rep/warranties from investors (“accredited
investor,” no distribution under securities laws, Rule 144, etc.)
• Schedule of Investors
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SERIES A TRANSACTION DOCUMENTS (CONTINUED)
• Investors’ Rights Agreement– Demand registration rights– S-3 registration rights– “Piggyback” registration Rights– Financial information rights– Right of First Offer– Right of First Refusal (among Preferred SHs)
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SERIES A TRANSACTION DOCUMENTS (CONTINUED)
• Stockholder Agreement– Includes founders– Right of first refusal for sales by founders (first,
to the company and then to the shareholders)– Right of co-sale if ROFR is not exercised
• Voting Agreement (for Board seats)
• Indemnification Agreement
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POINTS TO CONSIDER
• Size of the option pool (20%, 30%??)• Board observer rights?• Stock Restriction Agreements for founders
(vesting provisions)• Employment Agreement for founders• Form of investment - individually or through LP?• Tax issues??• Exit strategy
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Series A (Dilution)
Series A – Raise $5m @ $10m pre-money
Pre Money: $10m
Post Money: $15m
Series A Investor bought: 33% of the company
Founders, existing (Angel) investors: diluted by 33%
BUT, Series A required a 30% ISO Pool POST Series A
So….Founders, existing investors: diluted by 63%!
30%
33%
37%
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Series B (Dilution…Yes More!)
Series B – Raise $20m @ $30m pre-money
Pre Money: $30m
Post Money: $50m
Series B Investor bought: 40% of the company
Founders, Angel, Series A, ISO: diluted by 40%
22.2%
40%Series B: 40%
Series A: 33% x 60% = 19.8%
Founders: 37% x 60% = 22.2%
ISO: 30% x 60% = 18%18%19.8%