1. The Entrepreneur’s Guide to Negotiating
a Venture Capital Financing
Phil Schroeder
Allen Matkins Leck Gamble Mallory & Natsis LLP
1900 Main Street, 5th Floor
Irvine, California 92614-7321
949.851.5413
pschroeder@allenmatkins.com
CENTURY CITY | LOS ANGELES | ORANGE COUNTY | SAN DIEGO | SAN FRANCISCO

2. What do you need to know?
 Understand the essential deal terms negotiated in a
Venture Capital financing
 Topics Covered
 Background
 Valuation
 Liquidation Preference
 Dividend Preference
 Anti-dilution Provisions
 Board of Directors
 Veto Rights (Protective Provisions)
 Restrictions on Founders’ Right to Transfer Shares
 Registration Rights
 Current Trends in Convertible Debt

3. Background
Should your company seek Angel or Venture Capital funding?
 Exit Strategy
 Amount of money required to launch the
business (will a loan be enough to get started?)

4. Background
What are the typical documents in a VC financing?
 Preferred Stock Purchase Agreement
 (First Amended and Restated) Certificate of
Incorporation
 Investors’ Rights Agreement
 Voting Agreement
 Right of First Refusal and Co-Sale Agreement

5. Background
Preferred Stock vs. Common Stock
 Preferred Stock has certain rights and preferences
that are superior to Common Stock
 During the life of a company, there may be multiple
“series” of Preferred Stock (e.g. Series A, Series B
and Series C) each having a different set of rights and
preferences
 Typically a new series of Preferred Stock is created
for each round of financing and each successive
series has superior rights and preferences
 Rights and preferences are defined in the Certificate
of Incorporation

6. Background
“Seed” Financing
 Less than $1 million
 Possible terms of “Plain Vanilla” Preferred Stock
 1x, non-participating Liquidation Preference
 NO Dividend Preference
 NO Registration Rights
 NO Anti-dilution Protection
 Limited Veto Rights (Protective Provisions)
 NO Redemption Rights
 “Most favored nations” clause with respect to rights granted
to future investors

7. Valuation
 Terms
 Pre-Money Valuation – valuation of the Company pre-
investment
 Post-Money Valuation – Pre-Money Valuation PLUS amount
invested
 Investors generally want lower valuations and founders
generally want higher valuations, BUT
 Consider the impact of valuations that are too high or too low

8. Valuation
 Valuation is what the investor is willing to pay
 Valuing early stage companies is “more art than science”
 Traditional “scientific” models are of limited usefulness
 Company-specific factors to consider:
 Market Opportunity (size, growth rate, competition)
 Strength of Management Team (credentials, track record,
vision, drive)
 Product/Solution (achievable, salable, scalable, timely,
protectable advantage)
 Progress to Date

9. Valuation
 Negotiating Valuation
 Best Leverage – have multiple sources of funding
 Negotiate based on the merits of the Company
 Ask the investor to explain their valuation analysis
 Valuation may be significantly impacted by liquidation
preference and dividend preference negotiations

10. Liquidation Preference
 Distribution of payments upon any liquidation, dissolution or
winding up of the Company or sale of substantially all of the
assets of the Company
 Holders of stock with a superior liquidation preference will be paid
before other stockholders
 Preferred Stockholders may receive a multiple of the amount they invested
(plus accrued dividends) prior to the Common Stockholders receiving any
payment (e.g. 1x, 2x)
 What happens if funds are not sufficient to cover the liquidation
preference?
 Preferred Stockholders share funds pro-rata; Common Stockholders
receive nothing

11. Liquidation Preference
 Non-participating Preferred – Preferred Stockholders receive
their preference payment and nothing more
 Fully Participating Preferred – Preferred Stockholders receive
their preference payment AND share any remaining funds pro-rata
with the Common Stockholders
 Capped Participating Preferred – Preferred Stockholders
receive their preference payment and participate pro-rata with the
Common Stockholders up to a capped aggregate return
 Cap may be a multiple of amount invested (e.g. 3x, 4x)
 Incentive for investors to convert to Common Stock if the sale
price is high enough and investors can receive more money by
“fully” participating with the Common Stock

12. Dividend Preference
 Holders of stock with a superior dividend preference will
receive dividends before other stockholders
 Non-Cumulative Dividends – a set dividend is defined
but it will be paid only “when and if declared by the
Board”
 Cumulative Dividends – a set dividend will “accrue”
each year whether or not declared by the Board;
cumulative dividends are typically paid upon a liquidation

13. Anti-Dilution Provisions
 Protects Preferred Stockholders from dilution in the
event that stock is sold at a lower valuation in a later
financing round
 Adjusts the rate at which Preferred Stock converts into
Common Stock (typically, 1:1 at first)
 Conversion rates may effect liquidation provisions,
voting rights, rights of first refusal, registration rights, etc.

14. Anti-Dilution Provisions
 Full-ratchet Adjustment – Conversion price reduced to
the price at which the new shares are sold
 Weighted Average Adjustment
 The amount of the adjustment is affected by the valuation in
the down round and the amount of shares issued in the “down
round” compared to the “fully-diluted” outstanding shares
 The more shares that are issued in the “down round”, the
greater the adjustment

15. Anti-Dilution Provisions
 Broad-based weighted average
 Company-friendly
 “Fully-diluted” shares includes options and shares reserved
for option plan
 Narrow-based weighted average
 Investor-friendly
 “Fully-diluted shares does NOT include options

16. Board of Directors
 Voting Agreement
 Preferred Stockholders will be able to appoint one or
more members to the Board (typically investor affiliates)
 Common Stockholders may be able to appoint one or
more members to the Board (e.g. founders, CEO or
other officers)
 Remaining stockholders may be independent directors
elected by all stockholders
 Rights to appoint directors may terminate if stockholders
sell a certain percentage of their stock

17. Veto Rights (Protective Provisions)
 The Company may not take certain actions
without the approval of the Preferred
Stockholders
 approval threshold will be a percentage of the
outstanding Preferred Stock
 the exact percentage will be negotiated between the
investors

18. Veto Rights (Protective Provisions)
 Actions that typically require approval by the Series A
Preferred Stockholders:
 liquidate, dissolve or wind-up the affairs of the Company, or
effect any deemed liquidation event;
 amend, alter, or repeal any provision of the Certificate of
Incorporation or Bylaws;
 create or authorize the creation of or issue any other security
convertible into or exercisable for any equity security, having
rights, preferences or privileges senior to or on parity with the
Series A Preferred, or increase the authorized number of
shares of Series A Preferred;

19. Veto Rights (Protective Provisions)
 Actions that typically require approval of the holder of
Series A Preferred Stock:
 purchase or redeem or pay any dividend on any capital stock
prior to the Series A Preferred, other than stock repurchased
from former employees or consultants in connection with the
cessation of their employment/ services, at the lower of fair
market value or cost;
 create or authorize the creation of any debt security if the
Company’s aggregate indebtedness would exceed $[____]
other than equipment leases or bank lines of credit; and
 increase or decrease the size of the Board of Directors.

20. Restrictions on Founders’ Rights
to Transfer Shares
 Why do the investors want to place restrictions
on the founders’ stock?
 The investors are investing in the people as much as
the idea
 The investors want to make sure that the founders
remain motivated and will not abandon the business

21. Restrictions on Founders’ Rights
to Transfer Shares
 Vesting Schedule – Attach a vesting schedule to the
founders’ Common Stock
 Company has a right to repurchase the founder’s unvested
stock if the founder terminates employment
 typically vests over three to fours years in monthly increments
 Repurchase Price – equal to founder’s cost or fair market
value at the time of repurchase
 Mandatory Repurchase vs. Discretion of the Board

22. Restrictions on Founders’ Rights
to Transfer Shares
 Right of First Refusal – The Preferred Stockholders
and/or the Company have the right to purchase the
offered shares on the same terms.
 prevents unknown parties from becoming stockholders of the Company
 Co-Sale Rights – The Preferred Stockholders have
the right to sell their pro-rata number of shares to the
proposed buyer
 effectively reduces the amount of shares that the founder may sell
(stops them from selling out)
 gives the investors some liquidity (allows the investors to sell their
stake to the same extent as the founder)

23. Registration Rights
 Background – Shares that are “registered” may be sold
publicly, which creates liquidity for the stockholder
 Publicly traded companies must file periodic reports with
the SEC (can be expensive and time consuming)
 In addition to the holders of Preferred Stock, the
founders and management also may have registration
rights
 Rights are subject to underwriter cutbacks

24. Registration Rights
 Demand Rights – Certain investors can cause the
Company to undertake an IPO and/or register their
shares
 Typically, can only force the company to register shares a
certain number of times (usually one or two times)
 Demand rights typically may not be exercised until three to five
years after the financing or [6] months after an IPO

25. Registration Rights
 S-3 Registration Rights – Certain investors can
cause the Company to register their shares using
Form S-3
 Form S-3 is a short form registration statement (reduces
workload because the Company can refer to information
in prior SEC filings)
 Typically, can only force the company to register shares
one or two times per 12-month period
 Minimum aggregate value of shares to be registered
(typically $1-5 million)

26. Registration Rights
 Piggy-back Registration Rights – Allows certain
stockholders to register their shares when the Company
has already elected to make a public offering or register
the shares of other stockholders

27. Other Terms
 Right to Participate Pro Rata in Future Rounds
 Pay to Play – penalize investors who do not invest pro
rata in future rounds (convert their Preferred Stock into
Common Stock, lose anti-dilution rights, lose Board seat
or lose right to participate in future rounds)
 Redemption Rights – Investors can force the Company
to repurchase their shares at some time in the future

28. Current Trends in Convertible Debt
 Alternative to Equity Financing to reduce transaction
costs
 Loan Converts into Preferred Stock at the next
Preferred Stock financing
 At the same price as the next round, or
 At a discount to the next round price
 Recent Trend – Cap on conversion price
 Effect is hard to predict; can result in a huge discount to next
round valuation
 Complicates negotiations

29. Questions?

30. Phil Schroeder
Phil's practice focuses on fulfilling the general corporate needs of early stage to middle market
companies with an emphasis on financing transactions and technology transfer agreements.
Phil provides advice with respect to transactions geared toward growth including preferred
stock financings, bridge loan financings, and mergers and acquisitions. He also represents
clients with respect to a wide range of other contractual arrangements including stockholders
agreements, employment and consulting agreements, and employee compensation plans
(including stock options and other forms of equity incentive plans). Phil has extensive
experience advising founders on choice of entity and setting up new companies including
limited liability companies, S-corporations and C-corporations.
In addition to his corporate and securities work, Phil develops strategies for protecting his
Philip C. Schroeder clients' intellectual property and advises clients with respect to the various protections afforded
Senior Counsel by patent, trademark, copyright and trade secret laws. Phil's intellectual property practice
Orange County Office
Phone: 949.851.5413
involves representing clients in connection with licensing agreements, trademark prosecution,
Facsimile: 949.553.8354 nondisclosure agreements, technology acquisition agreements, technology development
pschroeder@allenmatkins.com agreements, manufacturing agreements, distribution agreements and a broad range of other
commercial agreements involving the use, development or transfer of intellectual property.
Focus Phil is an active member of the technology and venture capital community. He served as the
Corporate and Securities firm's focal point in its role as a preferred provider to Tech Coast Works, an Orange County-
Emerging Companies and Venture based technology incubator, and serves as the firm's designee in connection with its
Capital International Trademark Association (INTA) membership. Phil is also a member of OCTANe.
Technology and Intellectual Property
Mergers and Acquisitions Prior to his legal career, Phil worked as a Project Engineer for six and one-half years in the
aircraft and medical device manufacturing industries. He is a licensed Professional Mechanical
Education Engineer.
J.D., cum laude, Loyola Law School, Memberships
Los Angeles, 2003
M.S. in Mechanical Engineering,  International Trademark Association (INTA)
University of California, Irvine, 1993  OCTANe
B.S. in Mechanical Engineering,
Columbia Admissions
University, New York, 1992  State Bar of California
 Licensed Patent Attorney