Effectively Negotiating With a Venture Capitalist

Transcription

1 Effectively Negotiating With a Venture Capitalist Alan Kraus Alan Zeiger Wayne Kimmel Ben Franklin Technology Partners Blank Rome LLP ETF Venture Fund Thomas Petro Steve Hobman Moderated by: Fox Chase Bank New Spring Mezzanine Fund Louis Rappaport Blank Rome LLP

2 Introductions Getting to Know Our Panelists What is your role in the process? What is your (or your firm s) investment sweet spot? 2

3 Strategic Considerations of Venture Capital Advantages of Venture Money Gaining a sophisticated partner in dealing with pitfalls of growth Association with VC lends credibility and prestige and may facilitate future financings Introduction to opportunities not otherwise available 3

4 Strategic Considerations of Venture Capital Disadvantages of Venture Money Dilution of Personal Equity Covenants and veto powers imposed by legal documentation Penalties associated with not achieving expectations (loss of employment, equity, control) 4

5 Strategic Considerations of Venture Capital Understanding the Investment Process 1. Business plan review 2. Management meeting warranted? 3. Management meeting 4. Should we proceed to due diligence based on meeting? 5. Identification of top issues 6. Due diligence 7. Modeling out assumptions sensitivity and return analysis 8. Exploring terms for investment 9. Negotiating LOI 10.Investment Decision 5

6 Advance Planning to Raise Capital Advance Planning Matters Strengthen your management and board Create a business plan (including a financial model and audited or auditable financial statements) Hire an outstanding professional team Create protection against competition Eliminate deal killers 6

7 Advance Planning to Raise Capital Deal Killers to Avoid Now Intellectual Property Matters Litigation Matters Non-Compete Issues Tax Problems Non-Market Related Party Relationships Shore Up Financial Reporting and Controls 7

8 Advance Planning to Raise Capital What Your Business Plan Needs to Demonstrate Compelling product or service must demonstrate a compelling benefit to an identified customer market Attractive, growing market for the product/service - defensible market position Highly skilled, determined management team with specific relevant experience (or an ability to recruit necessary talent) Financial returns (in excess of 30% per annum) Exit plan to realize return 8

9 Key Issues Valuation How much is your business worth? Timing of funding Board of directors composition Form of investment and key substantive terms 9

10 Valuation Art vs. Science (or Both)? Art Science Discounted Cash Flow (DCF) Analysis Market Comparisons 10

11 Appearances Can Be Deceiving Conversion of Accrued Dividends into Equity Full Ratchet (10%) vs. Weighted Average Anti-Dilution (90%) Protection Counting Options as Outstanding Stock High Redemption/Liquidation Preference Values (90% = 1x) Participating (70%) vs. Non-Participating (30%) Preferred **Information based on Q4 06 Mid Atlantic Venture Capital Survey 11

12 Participating Preferred Example $10 mm pre-money valuation with a $5 mm investment (investor gets 33% interest) $50 mm liquidity event in three years Participating pref d (10% coupon) gets $6.65 mm, plus 33% of $43.35mm, for a total of $21.1 mm (322% return) Non-participating pref d (10% coupon) gets EITHER $6.65 mm OR $16.67 mm (233% return) $4.43 mm (8.9% of the sale price) was transferred to investors from the entrepreneur as a result of the participating feature 12

13 Funding of Investment Closing or milestone based? Why do you use milestone based? (differences of opinion in valuation, focus management on key drivers of performance, provide comfort of future funding) Composition of the Board of Directors What is the number of board members you like to see and what is the typical makeup? Do you insist on the right to appoint a majority of board members? 13

14 General Types of Investment Structures Common Stock Convertible Promissory Notes aka bridge financing Promissory Notes with Warrants Convertible Preferred Stock 14

15 If investment is in preferred stock... What dividend rate (Cash or PIK) and when does it commence? What liquidation rights? What conversion rights? Is preferred stock participating or not? What voting rights for directors and on other shareholder issues? 15

16 Key Investment Issues What special protection (such as veto rights) are given to preferred stock over corporate actions? What redemption rights are given to holders of preferred stock and to the company? Which anti-dilution protections are applicable? Full-ratchet or weighted-average 16

17 Key Investment Issues Management incentives Stock Options, Restricted Stock and other incentive plans Employment contracts What is your view of management employment agreements? What trends do you see with respect to compensation, including the amount of equity you like a management team to own? Protection of proprietary information Non-disclosure; non-solicitation; non-compete 17

18 Stockholders Agreement Key Investment Issues Rights of first refusal Tag-along rights Drag-along rights and other provisions (could force the sale of the company) Registration Rights How early can the investor require registration How many investors demand registration rights and piggyback rights 18

19 Covenants and Restrictions Financial reporting Board seat or board observation rights Limitation on grants of employee stock options Pre-emptive rights for new stock issuances Pre-approval for capital and operating expense budgets and the company s business plan 19

20 Covenants and Restrictions Limitations on transactions with affiliates Limitations on major corporate transactions Limitation or pre-approval required for compensation and fringe benefits to all officers Pre-approval for charter or by-law amendments or changes in the nature of the business 20

21 Successful Partnering with Your Investor Seek out an investor that is compatible with your vision, style and path to exit Build a partnership with the new investor Get more than just $$$ from your investor The key is CANDOR A successful relationship with a venture capitalist or angel investor develops with trust, honesty and an open line of communication 21

22 Effectively Negotiating with a Venture Capitalist Questions & Answers 22