Negotiating Term Sheets Michael Weiner April 12, 2018

Transcription

1 Negotiating Term Sheets Michael Weiner April 12,

2 Form Convertible Debt (Friends / Angels) SAFE (Friends / Angels) Seed Series Preferred Stock (Angel / Smaller Funds) Preferred Stock (VC) 2

3 Convertible Debt Benefits Avoids Setting a Valuation Few Governance Rights 3

4 Convertible Debt Negatives Priority Over Equity Interest As Issuer raises more debt, can impact size of equity round Caps and discounts can be very investor friendly 4

5 Negotiating Points Conversion Cap Conversion Discount or Warrants Fallback Conversion Price Interest Rate Maturity Repay or Automatic Conversion 5

6 Conversion Cap Concept: Conversion price will not exceed the price set by dividing a valuation by the outstanding shares. Example: Selling stock at $1.00 per share, or $10,000,000 premoney valuation 10,000,000 shares outstanding If conversion cap set at $4,000,000, then conversion price is $4,000,000 / 10,000,000 = $.40 per share. 6

7 SAFE Simple agreement for future equity Similar to convertible debt in concept Not considered debt Conversion discount and conversion cap No interest No maturity date so no ability to force payment 7

8 SAFE Negatives No investor protection Feels like free money 8

9 Seed Series Benefits Very few points and agreements to negotiate Typically Low Governance Company favorable 9

10 Seed Series Negatives Sets company valuation Investors may ask for full rights with small investment Real Founder dilution 10

11 Negotiating Points Pre-money valuation Liquidation preference simple Voting rights Protective provision minimal no vetoes Board seats no/maybe Anti-dilution protection 11

12 Negotiating A Series A Term Sheet Pre-money valuation Liquidation preference multiples/participating Voting rights Protective provisions cover important issues: change of control, future financings, compensation Board seats Drag Along 12

13 Only Two Issues Matter Economics Pre-Money Valuation Amount raised Liquidation preference Control Protective provisions Board seats Drag Along 13

14 Pre-Money Valuation Concept: The value of the company prior to the proposed financing Divide pre-money valuation by current outstanding numbers of shares plus reserved options to provide purchase price per share of Preferred Stock Useful fiction for financing: Preferred Stock and Common Stock are worth the same There is no magic to setting a pre-money valuation Often driven by amount needed to be raised 14

15 Pre-Money Valuation Pre-Money Example # 1 Shares Founders 4,000,000 Employee Pool 1,000,000 Total 5,000,000 Pre-Money Valuation $5,000,000 = $1.00 per share Outstanding Shares 5,000,000 Post-Money Capitalization Founders 4,000,000 50% Employee Pool 1,000, % Investors 3,000, % 8,000, % 15

16 Pre-Money Valuation Pre-Money Example # 2 Shares Founders 4,000,000 Employee Pool 1,000,000 Total 5,000,000 Pre-Money Valuation $5,000,000 = $1.00 per share Outstanding Shares 5,000,000 Post-Money Capitalization Founders 4,000,000 40% Employee Pool 1,000,000 10% Investors 5,000,000 50% 9,166, % 16

17 Liquidation Preference Concept: Preferred stockholders get their money back first on liquidation of the company Liquidation includes changes of control Simple preference Investors get money back or increased multiple off the top, common stock gets residual Investors will convert to common stick if will get more money in liquidation Participating Preferred Investors get money back first, then share with common stock on an as-converted basis Sometimes capped If uncapped, preferred stock will only convert on IPO 17

18 Protective Provisions Concept: Gives investors veto rights over major decisions Stockholder right, can vote differently than at the board level No fiduciary duty owed by investor to company or other stockholders Often without 51%, protective provisions give investors effective control 18

19 Drag Along Concept: Gives Investors right to drag along minority stockholders on sale of the company Minority stockholders lose appraisal rights Appraisal rights: FMV Cash 19

20 Board Seats Aim for odd number of seats Who elects independent board members Majority stockholders Agreement of the classes of stock Agreement of the Board How independent are they? 20

21 Diligence Clean cap table Financials / Payable up to date IP / Licenses in order Understood regulatory pathway 21

22 Common Mistakes Set pre-money valuation too high Lower amount raised to protect pre-money valuation Too much concern over control 51% Too many shares reserved for future employees Independent board members not very independent 22

23 Thank you! For more information, please contact: Michael Weiner 23

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