yetizen speaks: top 3 term sheet mistakes founders make
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Navigating Your Series A Round
Presentation to
September 2015
Stephanie L. Zeppa, Esq. Co-Leader, Social Media and Video Games Group
Sheppard Mullin Richter & Hampton LLP
Top Three Term Sheet Mistakes Founders
Make
Presented by: Stephanie L. Zeppa, Esq.
Sheppard Mullin Richter & Hampton LLP
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Unknowingly Giving Away the Farm
▪ How? Liquidation Preferences ▪ Liquidation rights determine the allocation of the
proceeds when a start-up is sold.
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Example: Participating Preferred Stock
▪ Figure 1a: Fully participating
▪ Figure 1b: Participating with a 3x
cap
▪ Figure 1c: Nonparticipating
Source: Michael Klausner and Stephen Venuto, Liquidation Rights and Incentive Misalignment in Start-up Financing, Cornell L. Rev., vol. 98, 1407 (2013).
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Diluting Stock Causes Destablization
▪ How? Full Ratchet Anti-Dilution Used Instead of Weighted-Average
▪ Conversion price of the preferred stock outstanding prior to a “down round” is reduced to a price equal to the price per share paid in the dilutive financing.
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Example: Full Ratchet Anti-Dilution
▪ Full Ratchet – Series A Adjustment
• Conversion price of Series A becomes $0.50/share
• The number of common shares issuable upon conversion becomes: (2,500,000) * ($1.00/$0.50) = 5,000,000 shares
• Series A conversion rate of 2:1
– Series B Adjustment • Conversion price of Series B
becomes $0.50/share • The number of common shares
issuable upon conversion becomes: (2,000,000) * ($2.00/$0.50) = 8,000,000 shares
• Series A conversion rate of 4:1
▪ Weighted Average – Series A Adjustment
• (7,000,000 + 1,000,000) (7,000,000 + 2,000,000) = $1.00 * (8/9) = $0.88 • The number of common shares issuable upon
conversion becomes: (2,500,000) x ($1.00 / 0.88) = 2,812,500 shares
• Series A Conversion Rate of 1.125:1
– Series B Adjustment • (7,000,000 + 500,000) (7,000,000 + 2,000,000) = $2.00 * (7.5 / 9) = $1.67 • The number of common shares issuable upon
conversion of Series B becomes: (2,000,000) x ($2.00 / $1.67) = 2,400,000 shares
• Series B Conversion Rate of 1.20:1
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Founders Are Beholden to Inept CEO
▪ How? Not Having Board Designee Separate from CEO
▪ The right to appoint the common stock designee may be subject to additional requirements.
▪ Example: – The typical Board of Directors of a post-Series A company
is composed of: • 1-2 investor designees • 1 common stock designee • 1 CEO director • 1 at-large director
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Questions?
Stephanie Zeppa Partner, Emerging Growth Silicon Valley / San Francisco Direct: (650) 815.2646 Cell: (415) 342-0927 Email: [email protected]
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Representative Videogame Clients
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