Venture Capital Term Sheets (April 7, 2009)
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Transcript of Venture Capital Term Sheets (April 7, 2009)
Venture Capital Term SheetsNC State University | April 7, 2009
Glen E. Caplan
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Sources of Capital
Self Funding
Angel
Venture Capitalists (VCs)
Corporate Investment (Strategic Investment)
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Capital Structure of Typical Start Up
Founders: Common Stock(Vesting over time)
Employees: Common Stock Options(With vesting over 4 years)
Investors: Convertible Preferred Stock
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Angel Investors = High Net WorthIndividuals with High Risk Appetite
Early stage preferenceUsually “one and done”
Terms offered by company rather than investors
Less sophisticated on terms and value
Less “value-added”
Endangered species?
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How to Approach Angels
Individuals (network)Other successful entrepreneurs
Organized Groups (TIG, Atlantis, PAN, CAP, CHAP)
One signature for all dealings
Follow-on investments possible
Better preparation for institutional rounds
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Venture Capital Requirements
25-30% Internal Rate of Return
Market Size / Position
Management Team “Bet on Jockeys, not Horses”
Clear Exit Strategy
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Current Venture Capital Environment
Plenty of Capital in the System?$28 billion committed in 2008 (21% decline)
Investors More Cautious with Deals
Potential Exits Uncertain and Delayed
Valuations Declining Have We Bottomed Out?
Terms Heavily Negotiated
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4 Principles of Term Sheets
Valuation
Exit Strategy
Down-Side Protection
Control4
3
2
1
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Principles of Term Sheets
1 Valuation
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Valuation Calculation
Post-Money (shares)Pre-Money (shares)
Capitalization
2,000,0000Outstanding Preferred Stock
2,000,0002,000,000Outstanding Common Stock
200,000200,000Reserved Stock Options
100,000100,000Outstanding Stock Options
$8.6 milliion$4.6 millionSeries A Preferred Purchase Price = $2.00 per share)
Valuation:
4,300,0002,300,000
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Principles of Term Sheets
Exit Strategy2
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Acquisition
Liquidation Preference
Multiple of Liquidation PreferencePreferred gets multiple times investment back before Common gets any money
Participating PreferredPreferred gets investment back first, remaining proceeds shared between Common and Preferred pro-rata
Limited or Capped ParticipationPreferred gets investment back first, remaining proceeds shared between Common and Preferred until Preferred reaches a multiple of investment (usually 2x – 5x) and remainder goes to Common
Non-Participating PreferredPreferred gets investment back first, remaining proceeds go to Common
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Effect of Liquidation Preference
Hi-Tec, Inc. has 2,000,000 shares of Series A Preferred outstanding that was purchased for $1.00 per share and 2,000,000 shares of Common Stock outstanding.
It has just been acquired for $15M. How is the money divided?
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Effect of Liquidation Prefere nce
4x Multiple of Liquidation Preference with Full Participation:
1. Preferred receives 4x liquidation preference ($8M). 2. The remaining $7 million is split pro rata between the
Common and Preferred ($3.5 million each).
3.5 millionCommon
11.5 millionPreferred
Total return
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Effect of Liquidation Preference, cont.
1x Liquidation PreferenceParticipation Capped at 4x:
1. Preferred receives liquidation preference ($2M). 2. The remaining $13M is split pro rata between the
Common and Preferred until Preferred receives $8M (i.e. $6 million each).
3. The remaining $1M goes to the Common Stock holders.
7 millionCommon
8 millionPreferredTotal return
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Effect of Liquidation Preference
Non-Participating Preferred:
1. Preferred receives liquidation preference ($2M).
2. The remaining $13M goes to the Common, but because the Common holders will receive more than the Preferred holders, the Preferred holders will convert into Common and all holders will be treated equally.
7.5 millionCommon
7.5 millionPreferred
Total return
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Liquidation Preference Summary
Current Trends
Multiple Liquidation Preferences15% of financings
1x – 2x = 70% (down from 80% in Q407)2x – 3x = 20%>3x = 10% (up from 0% in Q407)
Participating Preferred57% of financings
51% were uncapped (up from 41% in Q407)Source: Fenwick & West LLP – Trends in Terms of
Venture Financings in the San Francisco Bay Area (Fourth Quarter 2008)
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IPO
Registration RightsDemand Rights
S-3 Rights
Piggy Back Rights
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Principles of Term Sheets
Down-Side Protection3
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Down-Side Protection
Anti-Dilution Protection
Ratchet (Largest adjustment)
Conversion price of Preferred adjusted down to price of dilutive issuance
Broad based weighted average (Least adjustment)
Conversion price of Preferred adjusted down based on a weighted average of outstanding securities, including options and warrants
Narrow based weighted average (Medium adjustment)
Conversion price of Preferred adjusted down based on a weighted average of outstanding capital stock – does not include options and warrants
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Down-Side Protection
Don’t Forget Exclusions
Option pool of limited size
Mergers / acquisitions
Warrants for banks / leasing companies
Strategic transactions
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Anti-Dilution Calculation
Facts:
Hi-Tec, Inc. has:
3,000,000 shares of Common Stock,
5,000,000 shares of Series A Preferred Stock
Options to purchase 2,000,000 shares of Common Stock outstanding.
The Series A Preferred Stock was sold at $1.00 per share.
Hi-Tec, Inc. now would like to issue 4,000,000 shares of Series B Preferred Stock at $0.50 per share.
How is Series A Preferred Stock affected?
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Anti-Dilution Calculation, cont.
Ratchet:Series A initially converts to Common on a 1:1 ratio based on
its purchase price $1.00/$1.00.
After the issuance of Series B, the conversion price is ratcheted down to $0.50.
The new conversion ratio is calculated as follows: $1.00/$0.50 (or 1:2). So, for every 1 share of Series A converted, the holder will receive 2 shares of Common.
So, the 5,000,000 shares of Series A will convert into 10,000,000 shares of Common Stock.
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Anti-Dilution Calculation, cont.
Broad-Based Weighted Average:
Formula: (all outstanding securities) x Conversion Price + Amount RaisedAll outstanding securities + New Securities Issued
Calculation: (3,000,000 + 5,000,000 + 2,000,000) x $1.00 + $2,000,000 = 0.85714283,000,000 + 5,000,000 + 2,000,000 + 4,000,000
Conversion Ratio: $1.00 ÷ $0.8571428 = 1.166
So, the 5,000,000 shares of Series A will convert into 5,833,333 shares of Common Stock.
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Anti-Dilution Calculation, cont.
Narrow-Based Weighted Average:
Formula: (Common + Preferred) x Conversion Price + Amount RaisedCommon + Preferred + New Securities Issued
Calculation: (3,000,000 + 5,000,000) x $1.00 + $2,000,000 = 0.83333333,000,000 + 5,000,000 + 4,000,000
Conversion Ratio: $1.00 ÷ $0.8333333 = 1.2
So, the 5,000,000 shares of Series A will convert into 6,000,000 shares of Common Stock.
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Down-Side Protection - Summary
Current Trends
Ratchet = 2%
Weighted Average = 98%
No Anti-Dilution Protection = 0%
Source: Fenwick & West LLP – Trends in Terms of Venture Financings in the San Francisco Bay Area (Fourth Quarter 2008)
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A Tale of Two Term SheetsTwo companies financed under exactly the same conditions
Initial Capitalization3,000,000 founders shares2,000,000 shares initially reserved for options
Series A FinancingRaises $5M at a $5M pre-money valuation
Series B FinancingRaises $2M at a $5.5M pre-money valuation (and adds 1M shares to option pool)
Series C FinancingRaises $21M at a $63M pre-money valuation (and adds 1M shares to option pool) at a $84M post-money valuation
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Key Financing Terms
Company ANarrow-based weighted average anti-dilution protection
Participating Preferred capped at 4x Liquidation Preference
Company BRatchet Anti-Dilution
4x Participating Preferred with no cap
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Cap Tables Following Last Financing
Company A Company B
5,666,666Series C
4,000,000Series B
Common Ownership: 13.24%
5,000,000(6,000,000)Series A
4,000,000Options
3,000,000Common
7,000,000Series C
4,000,000Series B
Common Ownership: 10.71%
5,000,000(10,000,000)Series A
4,000,000Options
3,000,000Common
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Payout Scenarios
$40M acquisition?Company A: $1.6 million (or 4%)Company B: -0-
$100 million acquisition?Company A: Approximately $10.5 million (or 10.5%)Company B: -0-
$200 million acquisition?Company A: Approximately $23.7 million (or 11.85%)Company B: Approximately $9.4 million (or 4.7%)
$500 million acquisition?Company A: Approximately $66.2 million (or 13.24%)Company B: Approximately $41.6 million (or 8.32%)
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Down-Side Protection - Redemption
Forced liquidity: Zombie companies
Timing: 5-7 years
Amount (all at once or percentage)
Forced exercise during certain period or “any time” after target date
Statutory limits on share repurchase
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Principles of Term Sheets
Control4
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Control
Board of Directors
Key RightsAppoint and fire officersSet policy/Make major decisionsIssue options
Number of directorsInvestors: Election of BOD members by “series” or “class” vote
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Control
Protective Provisions
Must obtain approval of the Preferred to:
Authorize additional shares of stock
Create a new series of stock with equal or greater rights
Complete a merger/sale of assets
Change the size of Board of Directors
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Control
Typical Additional Investor Rights
Information Rights
Co-Sale Rights
First Refusal Rights
Preemptive Rights
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Hutchison Law Group
Serving the Southeast’s life science and technology communities.
Represent companies of all sizes, with a strong focus on emerging growth companies from inception through exit.
Serve clients along the Southeast corridor from Maryland to Florida.
Extraordinary depth and experience in law, technology and business.
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Glen CaplanHutchison Law [email protected]/in/glencaplan
Questions?(and hopefully answers)