Navigating Your Series A Round

Presentation to

September 2015

Stephanie L. Zeppa, Esq. Co-Leader, Social Media and Video Games Group

Sheppard Mullin Richter & Hampton LLP

Top Three Term Sheet Mistakes Founders

Make

Presented by: Stephanie L. Zeppa, Esq.

Sheppard Mullin Richter & Hampton LLP

Unknowingly Giving Away the Farm

▪ How? Liquidation Preferences ▪ Liquidation rights determine the allocation of the

proceeds when a start-up is sold.

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Example: Participating Preferred Stock

▪ Figure 1a: Fully participating

▪ Figure 1b: Participating with a 3x

cap

▪ Figure 1c: Nonparticipating

Source: Michael Klausner and Stephen Venuto, Liquidation Rights and Incentive Misalignment in Start-up Financing, Cornell L. Rev., vol. 98, 1407 (2013).

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Diluting Stock Causes Destablization

▪ How? Full Ratchet Anti-Dilution Used Instead of Weighted-Average

▪ Conversion price of the preferred stock outstanding prior to a “down round” is reduced to a price equal to the price per share paid in the dilutive financing.

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Example: Full Ratchet Anti-Dilution

▪ Full Ratchet – Series A Adjustment

• Conversion price of Series A becomes $0.50/share

• The number of common shares issuable upon conversion becomes: (2,500,000) * ($1.00/$0.50) = 5,000,000 shares

• Series A conversion rate of 2:1

– Series B Adjustment • Conversion price of Series B

becomes $0.50/share • The number of common shares

issuable upon conversion becomes: (2,000,000) * ($2.00/$0.50) = 8,000,000 shares

• Series A conversion rate of 4:1

▪ Weighted Average – Series A Adjustment

• (7,000,000 + 1,000,000) (7,000,000 + 2,000,000) = $1.00 * (8/9) = $0.88 • The number of common shares issuable upon

conversion becomes: (2,500,000) x ($1.00 / 0.88) = 2,812,500 shares

• Series A Conversion Rate of 1.125:1

– Series B Adjustment • (7,000,000 + 500,000) (7,000,000 + 2,000,000) = $2.00 * (7.5 / 9) = $1.67 • The number of common shares issuable upon

conversion of Series B becomes: (2,000,000) x ($2.00 / $1.67) = 2,400,000 shares

• Series B Conversion Rate of 1.20:1

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Founders Are Beholden to Inept CEO

▪ How? Not Having Board Designee Separate from CEO

▪ The right to appoint the common stock designee may be subject to additional requirements.

▪ Example: – The typical Board of Directors of a post-Series A company

is composed of: • 1-2 investor designees • 1 common stock designee • 1 CEO director • 1 at-large director

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Questions?

Stephanie Zeppa Partner, Emerging Growth Silicon Valley / San Francisco Direct: (650) 815.2646 Cell: (415) 342-0927 Email: szeppa@sheppardmullin.com

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Representative Videogame Clients

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