April 21, 2015: Speaker, Larry Kane, Partner, Orrick

1. Negotiating Venture Capital Term Sheets
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Negotiating Venture Capital Term Sheets
Larry Kane, Partner, Orrick
April 21, 2015

2. Terms for Venture Financing:
•Series A as a precedent for future rounds
•Institutional Venture Round versus Angel Round
•Pick your VC Carefully– you will be partners on the business going forward
•Pre-Financing Strategy (No Legal Risks)
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•Pre-Financing Strategy (No Legal Risks)
 Proper Organization and Documents
 IP Documents (CIAA, Assignments of IP, Patents)
 Stock Options with 409A
 Stock Issuances to Advisors
 Series Seed/CN
 Securities Law Filings
 EXECUTED DOCUMENTS

3. Terms for Venture Capital Financing:
Principal Term Sheet Purposes:
• Guides to Drafting-
• Even if not binding- parties will look to term sheet
• Sets the Valuation (Pricing)
• Participating Preferred Alters the Valuation
• Management of the Company Going Forward
• Investors Rights
• Exclusivity Period/Timing From Signing to Close – expect 3 to 5 weeks from signing of term
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• Exclusivity Period/Timing From Signing to Close – expect 3 to 5 weeks from signing of term
sheet to closing
 No shop – Need to give your self flexibility to Raise Cash to get to Next Financing
if Deal Does not Close
 Diligence Period
 Drafting Period (Who Drafts)
 Costs – Company pays legal fees for investors plus your fees
 Expect company fees to be 2x to 3x investor fees (depends on how clean the
company is and how many angel investors, etc).
 Investor may need to call capital which may take 15 days
 Offshore Investors may need a few weeks to get government and banking approval

4. Terms for Venture Capital Financing:
Venture Capital Terms
•Pricing/Valuation
 Initial Valuation and Capitalization
 Liquidation Preference
 Dividends
 Anti-dilution Protection
 Rights to Participate
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•Management Controls
 Board Rights
 Protective Provisions
•Liquidity Events
 Registration Rights
 Co-Sale/Rights of First Refusal
 Drag Along Rights

5. Terms for Venture Capital Financing: Type of Security
Convertible Preferred Stock (not Common Stock)
•Convertible Preferred Stock
•Senior to Common Stock
 Converts into Common upon certain events
 Receives Dividends [if and when declared] – very rare
 Protective Rights
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•Convertible Note, Series Seed and Convertible Equity
 Angel/Small Rounds – generally less than $1.0 million

6. Terms for Venture Capital Financing:
Round Size and Valuation
• Amount Raised
 More investment = more dilution (sometimes easier to raise more)
 What does your company plan to do with the money raised?
 Keep Flexible
•Pre-Money Valuation
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• Are Convertible Notes Pre-Money?
• Pro- Forma Capitalization

7. Terms for Venture Capital Financing:
Valuation/Capitalization Structure
•Valuation is Generally based on Fully-Diluted Shares
 Outstanding Shares
 Convertible Securities (options, warrants)
 Not pure authorized shares
 Watch for dilutive shares being added to pre-money shares
•Generally Need to Include:
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•Generally Need to Include:
 Founders Stock (vesting often required)
 Advisors/Partners
 Available Employee Stock Pool (10-20% after deal)
 Convertible Equity/Notes
•Warrants/Stock Granted to Third Parties

8. Terms for Venture Capital Financing:
Pro-Forma Example
Assume $7.0m pre-money valuation and $3.0m of new cash for a $10.0m post-money
valuation with a 20% option pool:
Post-Money Cap Table:
Founders 50.0%
Option Pool 20.0%
New Investors 30.0%
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New Investors 30.0%
Total: 100%
What about Convertible Securities and discounts?
PAY ATTENTION TO VOTING PERCENTAGES
VOTING = CONTROL

9. Terms for Venture Capital Financing: Return on
Investment/Power boosting the Investor Returns
• Dividends
 Cumulative vs. non-cumulative dividends
 Generally, non-cumulative dividends are never paid as they are payable only “when and
if declared by the Board of Directors”
 East Coast VCs with Private Equity Background look to Cumulative Dividends
 Generally set around 8.0% per annum – can be used in redemption provisions
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 Cumulative may be treated as debt for accounting
• Liquidation Preference -Paid on Sale of Company
 “Preference” = preferred stock’s down side protection.
 “Participation” = changes the valuation
 Cap on participation = making lemonade out of lemon

10. Terms for Venture Capital Financing: Return on
Investment - Redemption
• Redemption – not overly common but at leas 5 years
 May force sale of the Company like Drag Along
 Return is often similar to liquidation preference but with a hurdle
 Timing for redemption – the further out the better
 Triggers for calling a redemption – the more difficult the better
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 Installments – the more the merrier as it may not require sale of the company

11. Terms for Venture Capital Financing: Conversion
• Optional Conversion
 Preferred stock is convertible into common stock at any time.
• Anti-dilution Provisions -if you sell stock at a lower price in the future
 Full ratchet vs. weighted average anti-dilution adjustment
 Broad based vs. narrow based weighted average anti-dilution adjustment
 Some variable in the weighted average formula
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 Some variable in the weighted average formula
 Exceptions for Non-Financing Offerings
 Stock Options (watch for caps)
 JV and Commercial Agreement
• Mandatory Conversion
 Triggers for mandatory conversion – IPO or vote by the preferred stock
 Percent preferred vote necessary to trigger conversion

12. Terms for Venture Capital Financing: Control
Mechanisms & Board Composition
• Voting Rights
• Generally votes with Common
• Board Composition (Voting Agreement)
 Generally expect 5 person board with 2 from VC; 2 from founders one of which is CEO
and one independent
 Preferred stock votes with common stock on an as-converted basis
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 Preferred stock votes with common stock on an as-converted basis
 Board seat designation rights of preferred stock
 Expect a CEO board seat
 Expect Independent director board seat (how determined)
 Under Delaware law, certain Directors can have more than one vote
• Board Observer Rights

13. Terms for Venture Capital Financing: Control
Mechanisms & Protective Provisions
• Investor vote required for Key Decisions:
• Pay Attention: Board versus Shareholder Approval:
 Authorize/Issue new Preferred Stock
 Amending the terms of the existing Preferred Stock
 Grant options beyond a certain limit
 Amend the charter
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 Sell the Company – exit events
 No Additional Debt
 Change in the Business
 Key Hires
 Acquisitions
• Be careful on the percentages and multiple investors holding separate
vetoes
• Remember, these terms can slow the management of a company.

14. Terms for Venture Capital Financing:
Liquidity Events
• Drag Along: Investors can force Common Stockholders to participate in a sale of
the Company
 Triggers for activating the drag along
 Conditions for enforcing the drag along
 Preferred and Common have different exit outcomes:
oRequire High Percentage of Approval at Shareholder and Board level
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o
• Pay to Play
 Requires Investors to Keep Investing or conversion into Common
 Triggers for activating the pay to play
 Consequences for failure to pay

15. Terms for Venture Capital Financing:
Investor Rights: Investor Rights
• Registration Rights
 Common Rights – Don’t spend too much time on this
 Demand registration = forcing function for your company to go public
 S-3 registration = short form registration for eligible issuers
 Piggyback registration = investors tagging along company registration
 Lock-up = absolutely necessary for company to retain underwriters
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 Lock-up = absolutely necessary for company to retain underwriters
• Information Rights
 Reserved for “Major Investors”
 Financial statements – annual, quarterly, monthly; audited vs. unaudited
 budget
 cap table
 Visitation rights – conditions for exclusion

16. Terms for Venture Capital Financing:
Investor Rights (Continued)
• Preemptive Right (Right to Participate)
 Common right for investors to maintain ownership
 Standard Right for “Major Investors”
 Calculation of pro rata share
 Excepted company issuances
 Accredited Investors
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 Lose if they don’t exercise?
• Negative Covenants
 Ordinary course of business items vs. extraordinary events
 Dollar threshold
• Affirmative Covenants
 Non-compete, non-solicit, non-disclosure and inventions assignment
 Board matters
 Option vesting
 Key person and D&O insurance

17. Terms for Venture Capital Financing:
Transfer Restrictions
• Right of First Refusal and Co-Sale on Sale of Stock of Founders and Existing
Stockholders
 Restricted parties
 Participants
 Excepted transfers
• “Reverse vesting” / vesting resets
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• “Reverse vesting” / vesting resets
 Customary Terms for Founders- best to have in place prior to deal
 4 year vesting with credit for time served with double trigger on change of control and
acceleration on termination without cause

18. Terms for Venture Capital Financing:
Exclusivity and Other Terms
• Closing Conditions
 All Consultants/Employees Sign CIAA
 Employment/Vesting Agreements with Founders (structures exit of Founder)
 Legal Opinion
 Shareholders all signing voting and ROFR Agreement
 Amendment of Charter
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 Amendment of Charter
 Representations True and Correct

19. Terms for Venture Capital Financing:
What About Strategic Investors?
• Great For Market Valuation or Acknowledgement
• Often Tied to Strategic Business Deal / Active Business Purpose
• Beware of Access to Confidential Information and Conflicts of Interest
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20. Thank You!
CONTACT
Larry Kane
Partner, Orrick’s Technologies Companies Group
lkane@orrick.com
(415) 773-5827
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