Hacking Term Sheets

Hacking Term Sheets Day 2 - Oct 1, 2010

a presentation by James Chan

Friday, October 1, 2010

Just to make sure you’re in the right room...

Today, we’re talking term sheets for early-stage investments


Before we begin...here’s a little bit about myself.

+

x 20+ term sheets

(from 2006 - 2010)

=

Professional VC

Me!

x 8 investments

&

If you’re more experienced, please join me up in front!


Pitch to friendly investors as early as possible.

Raise financing as late as possible; preferably only after you’ve got users and/or data to support your hypothesis.


The money you raise should be just enough - with some buffer - to get you to your next key milestones; faster &

quicker than your competition.

Raise financing as late as possible, preferably only after you’ve got data to support your hypothesis.


Understand how the venture capital industry works.

Are you a lifestyle business, or a venture business?Make sure you’re barking up the right tree.


Raising $ from investors can be especially daunting and stressful for entrepreneurs.

VCs issue term sheets for a living. Entrepreneurs don’t, and aren’t always as experienced at it.


Naughty investors use your lack of expertise with term sheets against you.

Nice investors leave nothing to your imagination and always explain their term sheets thoroughly to you.

Naughty?

Nice!

www.displaycostume.com


Pitch Negotiations Term SheetDefinitive Documents

Due DiligenceCompletion

The entire process can be really quick, but can also drag on. It’s hard to find one size that fits all.

No-shop kicks in

3Fs, sophisticated angels, institutional investors? Or a blend? There’s trade-offs to be had. YMMV, but above

all, GIWYEO.

Investment syndicate

Investment Committee


???Price

Liquidation Preference

Investment Instrument

Board of Directors

Protective Provisions

Tag-along & Drag-along

Anti-dilution

Pay-to-play

Dividends

Redemption Rights

Conversion

Conditions Precedent

Information Rights

Registration Rights

Right of First Refusal

Voting Rights

ESOP

Restriction on Sales

Co-Sale Agreement

Founders activities

Confidentiality & No-Shop

Indemnification & Assignment


EconomicsControl

Drown out the noise, and focus on what matters most.

Investor-entrepreneur trust is paramount.


The term sheet is a preliminary, non-binding agreement.

Word-smiths are not welcomed.


???Price



Board of Directors



Anti-dilution

Pay-to-play

Dividends

Redemption Rights

Conversion


Information Rights

Registration Rights


Voting Rights

ESOP


Co-Sale Agreement

Founders activities




!!!Price



Board of Directors


Anti-dilution



Preference Shares

Convertible Notes

+Warrants

Common Shares


PriceAmounted

raised

Price per share, Conversion price

Price modifiers: warrants & ESOPs

Pre-, post-money

Price: $______ per share (the Original Purchase Price). The Original Purchase Price represents a fully-diluted pre-money valuation of $ __ million and a fully-diluted post money valuation of $__ million. For purposes of the above calculation and any other reference to fully-diluted in this term sheet, fully-diluted assumes the conversion of all outstanding preferred stock of the Company, the exercise of all authorized and currently existing stock options and warrants of the Company, and the increase of the Company’s existing option pool by [ ] shares prior to this financing.

This is what matters.

Not this!


ParticipationLiquidation Preference: In the event of any liquidation or winding up of the Company, the holders of the Series A Preferred shall be entitled to receive in preference to the holders of the Common Stock a per share amount equal to [x] the Original Purchase Price plus any declared but unpaid dividends (the Liquidation Preference)

Participation: After the payment of the Liquidation Preference to the holders of the Series A Preferred, the remaining assets shall be distributed ratably to the holders of the Common Stock and the Series A Preferred on a common equivalent basis.

OR ;provided that the holders of Series A Preferred will stop participating once they have received a total liquidation amount per share equal to [X] times the Original Purchase Price, plus any declared but unpaid dividends. Thereafter, the remaining assets shall be distributed ratably to the holders of the Common Stock.

Typically 1x

Not so nice, no matter regardless of the form.



Best Practices

“Bored” composition

Board of Directors

Board Representation: The holders of Series A Preferred will have the right to elect one representative to the Company’s Board of Directors, based on a three member Board of Directors. The holders of the Series A will have the right to have observers attend all meetings of the Board of Directors.

Founder(s)

Independent

Investor



Veto rights that investors have on certain actions of the companyTypically covers actions that:

(i) changes rights, preferences or privileges of the class of stock that investors are holding

(ii) changes authorized number of shares of Common and/or Preferred

(iii) fund-raising veto of any instrument type, possibly with an amount cap

(iv) changes or waivers to the company’s articles/by-laws

(v) changes to board size and composition

(vi) payment or declaration of dividends(vii) capital expenditures in excess of

$35,000(viii) issuance of debt in excess of $100,000(ix) mergers, corporate reorganization,

sale of control or any transaction that results in sale of assets of company

Though some are just out of this world...(i) investments by the company which

is deemed by NRF Holdings to be illegal, criminal or which affects the interests, integrity or public security or national security of Singapore or the Singapore Government


Anti-dilution

Full ratchet Broad-based WA

Bad Entrepreneur-friendly

Entrepreneur bears 100% of dilutive effects in a downround; Investor(s)’ shareholding % is maintained.

For Weighted Average, investor(s) and entrepreneur share the dilutive effect.

CP2 = CP1 × (A+B) ÷ (A+C)where

CP2 = New Conversion PriceCP1 = Prior Conversion PriceA = # of shares outstanding prior to current roundB = ($ raised in current round ÷ CP1)

= # of shares issued as if raised at Prior Conversion Price

C = # of shares issued in current round

Narrow-based WA

Middle ground


Good lawyers are really hard to find. If you meet one, hang on as tightly as you would to your soul mate.

For the rest of us, manage your lawyer well, lest he or she manages you. Your investor is watching.


Questions? I’ll do my best with them.

Thank you!


Price



Board of Directors



Anti-dilution

Pay-to-play

Dividends

Redemption Rights

Conversion


Information Rights

Registration Rights


Voting Rights

ESOP


Co-Sale Agreement

Founders activities



!!!


Hacking Term Sheets

Business

Transcript of Hacking Term Sheets