Negotiating Series A Term Sheets

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Negotiating Series A Term Sheets Benjamin M. Hron Bhron@mccarter.com 617.449.

1 Negotiating Series A Term Sheets Benjamin M. Hron Bhron@mccarter.com James F. Coffey jcoffey@mccarter.com Twitter #mecic

2 Refresher: What is a Term Sheet Control Terms v. Economic Terms Standard Agreements Stock Purchase Agreement Charter Investor Rights Agreement Voting Agreement Right of First Refusal and Co-Sale Agreement Term Sheet to Closing

3 Refresher: Part I covered 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

4 Refresher: 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 If founders equity is subject to vesting, get credit for time served Limit investor right to compel a sale Pay attention to thresholds for Series A votes

5 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

6 Valuation and the Option Pool Shuffle The Original Purchase Price is based upon a fully-diluted pre-money valuation of $[ ] and a fully-diluted post-money valuation of $[ ] (including an employee pool representing [15-20]% of the fully-diluted post-money capitalization).

7 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-fdc If included in pre-money FDC reduces the effective valuation phantom increase to the post-money valuation shifts dilution to existing stockholders

8 Dividends Alternative 1: Dividends will be paid on the Series A Preferred on an as-converted basis when, as, and if paid on the Common Stock Alternative 2: The Series A Preferred will carry an annual [ ]% cumulative dividend [payable upon a liquidation or redemption]. For any other dividends or distributions, the Series A Preferred will participate with the Common Stock on an as-converted basis. Alternative 3: Non-cumulative dividends will be paid on the Series A Preferred in an amount equal to $[ ] per share of Series A Preferred when and if declared by the Board.

9 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

10 Liquidation Preferences In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows: Non-participating Preferred Stock: First pay [one] times the Original Purchase Price [plus accrued dividends] [plus declared and unpaid dividends] on each share of Series A Preferred. The balance of any proceeds shall be distributed pro rata to holders of Common Stock.]

11 Liquidation Preferences In the event of any liquidation, dissolution or winding up of the Company, the proceeds shall be paid as follows: Full participating Preferred Stock: First pay [one] times the Original Purchase Price [plus accrued dividends] [plus declared and unpaid dividends] on each share of Series A Preferred. Thereafter, the Series A Preferred participates with the Common Stock pro rata on an asconverted basis. Cap on Preferred Stock participation rights: First pay [one] times the Original Purchase Price [plus accrued dividends] [plus declared and unpaid dividends] on each share of Series A Preferred. Thereafter, Series A Preferred participates with Common Stock pro rata on an asconverted basis until the holders of Series A Preferred receive an aggregate of [ ] times the Original Purchase Price (including the amount paid pursuant to the preceding sentence).

12 Liquidation Preferences Deemed Liquidation Event: A merger or consolidation (other than one in which stockholders of the Company own a majority by voting power of the outstanding shares of the surviving or acquiring corporation) and a sale, lease, transfer, exclusive license or other disposition of all or substantially all of the assets of the Company will be treated as a liquidation event, thereby triggering payment of the liquidation preferences described above [unless the holders of [ ]% of the Series A Preferred elect otherwise]. [The Investors' entitlement to their liquidation preference shall not be abrogated or diminished in the event part of the consideration is subject to escrow in connection with a Deemed Liquidation Event.]

13 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)

14 Anti-dilution In the event that the Company issues additional securities at a purchase price less than the current Series A Preferred conversion price, such conversion price shall be adjusted in accordance with the following formula: Weighted Average: CP 2 = CP 1 * (A+B) / (A+C) CP 2 = Series A Conversion Price after new issue CP 1 = Series A Conversion Price prior to new issue A = Shares deemed outstanding prior to new issue B = Consideration received for new issue divided by CP 1 C = Shares issued in the subject transaction

15 Anti-dilution In the event that the Company issues additional securities at a purchase price less than the current Series A Preferred conversion price, such conversion price shall be adjusted in accordance with the following formula: Full-ratchet: The conversion price will be reduced to the price at which the new shares are issued.

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 May be broad or narrow 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 Pre-emptive Rights: All [Major] Investors shall have a pro rata right to participate in subsequent issuances of equity securities of the Company (with standard exceptions). In addition, should any [Major] Investor choose not to purchase its full pro rata share, the remaining [Major] Investors shall have the right to purchase the remaining pro rata shares. Pay-to-Play: [Unless the holders of [50-67]% of the Series A elect otherwise,] on any subsequent [down] round all [Major] Investors are required to purchase their pro rata share of the securities set aside by the Board for purchase by the [Major] Investors. All shares of Series A Preferred of any [Major] Investor failing to do so will automatically [lose anti-dilution rights] [lose right to participate in future rounds] [convert to Common Stock and lose the right to a Board seat, if applicable].

18 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)

19 Redemption Rights The Series A Preferred shall be redeemable from funds legally available for distribution at the option of holders of at least [50-67]% of the Series A Preferred commencing any time after [the fifth anniversary of the initial Closing Date] at a price equal to the Original Purchase Price [plus all accrued but unpaid dividends]. Redemption shall occur in three equal annual portions. Upon a redemption request from the holders of the required percentage of the Series A Preferred, all Series A Preferred shares shall be redeemed [(except for any Series A holders who affirmatively opt-out)].

20 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

21 Registration Rights Demand Registration: Upon earliest of (i) [three-five] years after the Closing; or (ii) [six] months following an initial public offering ( IPO ), persons holding [ ]% of the Registrable Securities may request [1 or 2] (consummated) registrations by the Company of their shares. S-3 Registration: The holders of [10-30]% of the Registrable Securities will have the right to require the Company to register on Form S-3, if available for use by the Company. Piggy-back Registration: The holders of Registrable Securities will be entitled to piggyback registration rights, subject to the right of the Company and its underwriters to reduce the number of shares proposed to be registered to a minimum of [20-30]% and to complete reduction on an IPO at the underwriter s discretion. In all events, the shares to be registered by holders of Registrable Securities will be reduced only after all other stockholders shares are reduced.

22 Registration Rights Demand: Usually limited to 1 or 2 S-3: Usually limited to 1 or 2 per year Piggy-back Issues Threshold % to exercise Demand rights Earliest date Demand rights may be exercised # of Demand rights and frequency of S-3 rights Minimum IPO price for Demand rights Founders may be able to get subordinate S-3 and Piggyback rights

23 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 downround financing Pre-emptive Rights should not prevent the company from raising more money Don t sweat Registration Rights

24 Other Terms Tranches and Milestones Conditions to Closing Reps & Warranties Payment of Investor Expenses Should be contingent on closing Cap (typically $35K-$50K)

McCarter & English LLP Questions? Benjamin M. Hron bhron@mccarter.com 617.

25 McCarter & English LLP Questions? Benjamin M. Hron James F. Coffey

Negotiating Series A Term Sheets

Negotiating Series A Term Sheets Benjamin M. Hron Bhron@mccarter.com 617.449.6584 @HronEsq Part I: 10.06.16 Part II: 10.20.16 What is a Term Sheet Control Terms v. Economic Terms Standard Agreements Stock