Term Sheets
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This document provides an overview of key terms and considerations for preferred stock term sheets in venture capital investing. It discusses the most common early-stage securities of convertible debt and preferred stock. Key aspects covered include the economics of equity deals such as pre-money valuation, liquidation preferences, anti-dilution protection, and dividends. It also examines governance issues like board representation and control rights granted to investors.
Term Sheets
- 1. Venture Boot Camp – Term Sheets June 18, 2013
- 2. Overview of a Term Sheet • Two most common early-‐stage securi8es: – 1) Conver8ble Debt – 2) Preferred Stock • Conver8ble preferred stock • Redeemable preferred stock 2
- 3. What is Preferred Stock? • Fairly standard in early-‐stage investment • Has certain preferences: – Liquida8on preference – Dividends (maybe) – Board representa8on and blocking rights – An8-‐dilu8on protec8on – Redemp8on rights 3
- 4. Preferred Stock Term Sheet • What is a term sheet? – Agree on fundamentals before legal draOing • A term sheet is generally non-‐binding, but... – Confiden8ality – No-‐shops – Expense provisions 4
- 5. Overview of Economics: Equity • Price Terms – Pre-‐money valua8on? – Op8on Pool – size and 8ming of addi8on • Treatment of Dividends – Cumula8ve dividends • Liquida8on Preferences – Par8cipa8ng vs. Non-‐Par8cipa8ng; dollar-‐capped – The effect on “Ownership Percentage” • Price Protec8on – An8-‐Dilu8on – Full vs. weighted average • Redemp8on Features – Timing and consequences 5
- 6. Equity Pricing: Terms to Understand • Pre-‐Money – What the investor believes the company is worth prior to their investment • Post Money – Simply the pre-‐money valua8on plus the investment amount 6
- 7. Equity Pricing: Terms to Understand • Op8on Pool – Given to incen8vize employees – Feel ownership in company – How does it impact Founder economics/ownership? – Who benefits? • Considera8ons – When does it get added? – How big should it be? – What is the ves8ng schedule? – Is there accelera8on on a liquidity event? 7
- 8. Equity : Liquida8on Preferences • Preferred – First out in “liquida8on event” – Liquida8on event: • Merger, acquisi8on, change of control, true liquida8on – Return of investment before common stock then... – Is it Par8cipa8ng Preferred or Non-‐Par8cipa8ng? • With Par8cipa8ng Preferred, the investor gets its liquida8on preference and then par8cipates in all residual distribu8ons on an as converted basis • With Non-‐Par8cipa8ng Preferred, the investor is only en8tled to its liquida8on preference 8
- 9. Equity: Par8cipa8ng Preferred vs. Non • An example: • 10M shares of common stock outstanding (assuming exercise of all op8ons in pool) • Investors hold 10M shares of preferred purchased for $1.00 per share • Preferred convert to common on a 1-‐for-‐1 basis • Preferred has a 1X liquida8on preference 9
- 10. Equity: Par8cipa8ng Preferred vs. Non 10 Common Shareholders Share of Sale $ Sale Price Participating Non-Participating $10M $0 $0 $15M $2.5M $5.0M $25M $7.5M $12.5M $50M $20M $25M $100M $45M $50M
- 11. An8-‐Dilu8on • Allows investors to “re-‐price” • Two types: – 1) Weighted Average – 2) Full Ratchet 11
- 12. Governance • Board of Directors – Who chooses? How chosen? – Observa8on rights – who, how monitored – Skills needed to fill out team – Audit, Compensa8on Commiiees – Fiduciary du8es • Financial and Repor8ng Requirements – Financial statements – monthly, quarterly, annual – audited or not? – Who gets these? • Other Informa8on Rights? – What informa8on and who? – Visita8on rights? 12
- 13. Control – Vo8ng • Ability of board, stockholders, or class holders to block certain ac8ons • Who elects the board? – Vo8ng on “as if” Converted Basis – Class Vo8ng and Protec8ve Provisions – Nega8ve Covenants • What you can and can’t do without investor approval 13
- 14. Stockholders Rights • Transfer Rights – Right of First Refusal • Par8cipa8on in future financings • Founder restric8ons – Reverse ves8ng of stock – Non-‐compe88on – Founder representa8ons in purchase agreement 14
- 15. Stockholders Rights • Registra8on Rights • Drag along • Right of Co-‐sale • Redemp8on 15