Bentley Presentation C
- 1. Negotiating Series A Term Sheets Richard M. Lucash rlucash@mccarter.com 617.449.6568 @RickLucash 10/1512
- 2. What is a Term Sheet ♦ Control Terms and Economic Terms ♦ For Sale of Preferred Stock – Liquidation PREFERENCE – Conversion & Antidilution
- 3. Documents to implement Term Sheet ♦ Stock Purchase Agreement ♦ Charter ♦ Bylaws ♦ Investor Rights Agreement ♦ Voting Agreement ♦ Right of First Refusal and Co-Sale Agreement
- 4. Part I: Control Terms Voting Rights and Board Seats Investor Protective Provisions Information Rights Vesting of Founders’ Equity Right of First Refusal and Co-Sale Drag-Along
- 5. Voting Rights and Board Seats ♦ On most matters Series A votes with Common ♦ Typically 5 Directors (3 for smaller financings) – 2 Investor Directors – 1 Founder Director – CEO – 1 Independent Director
- 6. Investor Protective Provisions ♦ Investor Approvals: – Significant corporate events (ex. sale) – Actions that could adversely impact Series A – More $$ More Protections ♦ Series A Director Approvals – Lending/Borrowing – Insider transactions – Hiring/Firing Key Employees ♦ Key Issues – Stockholder v. Series A Director approval – % of stockholders required to approve
- 7. Information Rights ♦ Right to receive periodic reports ♦ Management Rights Letter ♦ Key Issues – Which investors have rights to information – Frequency (quarterly or monthly) – Consequences for failure – Confidentiality ♦ Nobody ever complies with information rights!
- 8. Vesting of Founders’ Equity ♦ Right to repurchase shares if Founder leaves ♦ Term: 3-4 years; 25% after 1 yr, then monthly ♦ Key Issues – Credit for time served before the financing? – Repurchase of vested shares in some situations? – Acceleration on: Change of Control (single/double trigger) Termination without Cause Leaving for Good Reason
- 9. Right of First Refusal and Co-Sale ♦ ROFR: – Right to buy shares offered for sale by others – Usually company has first right; investors second – May be “all or none” – May be applied to investors as well ♦ Co-Sale (aka Tag Along): – Right to sell alongside (subject to ROFR) – May be applied to investors as well
- 10. Drag-Along ♦ Compels subject stockholders approve a sale ♦ Facilitates exit where interests differ ♦ Key Issues – Threshold for exercising – Is consent of common or founders required? – Is Board approval required?
- 11. Control Terms: Key Takeaways ♦ Board composition and director election determines who controls the company ♦ Obtaining approval of actions from directors is simpler than obtaining consent from investors ♦ Limit investor right to “drag” other stockholders ♦ If founders’ equity is subject to vesting, get credit for time served
- 12. Part II: Economic Terms Valuation and the Option Pool Shuffle Dividends Liquidation Preference Anti-dilution Pre-emptive Rights and Pay-to-Play Redemption Rights Registration Rights
- 13. Valuation and the Option Pool Shuffle ♦ Valuation – Just one of several the economic terms – Need to consider terms as a package – Model outcome in various exit scenarios ♦ Option Pool Shuffle – Option pool is typically 15-20% of post – If included in pre-money: reduces the effective valuation “phantom” increase to the post-money valuation shifts dilution to existing stockholders
- 14. Dividends ♦ Range from 5-10% ♦ Typically convert when Series A converts ♦ Key Issues – Try to eliminate/delay accruing dividends – Fight cumulative dividends – Strongly resist compounding dividends ♦ Value of dividends can add up – Most important in middle-of-the-road exit
- 15. Liquidation Preferences ♦ Most important economic term after valuation ♦ 3 Types – Non-participating – Founder favorable – Full Participating – Very Investor favorable – Capped Participating – Investor favorable ♦ Investors get 1-3x (plus dividends) before others ♦ Participating preferred also shares with Common ♦ Applies to any exit, not just liquidation (ex. sale)
- 16. Anti-dilution ♦ Conversion Ratio = Conversion Price / Sale Price ♦ Adjusts conversion price for “down” rounds ♦ Weighted Average: – Proportionate to size and price of down round ♦ Full Ratchet: – Adjusts conv. price to equal price in down round – Red Flag: investor is aggressive on terms ♦ Exceptions for certain share issuances
- 17. Pre-emptive Rights and Pay-to-Play ♦ Types of Pre-emptive Rights – Right to maintain % – Right to purchase a multiple of % – Right to purchase (collectively) 100% ♦ Over-Allotment Right ♦ Limitations – Major Investors – Pay-to-Play – Use or Lose (Pay-to-Play Lite)
- 18. Redemption Rights ♦ Right to force redemption after ~5 years ♦ Creates an “exit” option, but rarely (never?) used ♦ May create leverage to force other exits ♦ Key Issues – Optional v. Mandatory – Time before right matures – Length of time allowed for payout – Consequences of failing to redeem
- 19. Registration Rights ♦ Demand: Usually limited to 1 or 2 ♦ Generally not worth negotiating; underwriters will rule ♦ S-3: Usually limited to 1 or 2 per year
- 20. Economic Terms: Key Takeaways ♦ Dividends and liquidation preferences can have significant impact on economics ♦ Option pool should be sufficient for near future ♦ Understand if option pool is in pre-money ♦ Full ratchet anti-dilution is very investor favorable ♦ Pay-to-Play helps mitigate anti-dilution in down- round financing ♦ Pre-emptive Rights should not prevent the company from raising more money ♦ Don’t sweat Registration Rights
- 21. Other Terms ♦ Tranches and Milestones ♦ Conditions to Closing ♦ Reps & Warranties ♦ Payment of Investor Expenses – Should be contingent on closing – Cap (typically $35K-$50K) Series Seed and other downward pressure on prices
- 22. McCarter & English LLP Questions? Richard M. Lucash rlucash@mccarter.com 617.449.6568 @RickLucash