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Term Sheet Negotiations (08.24.2015)

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Term Sheet Negotiations (08.24.2015)

  1. 1. 1 Term Sheet Negotiations August 24, 2015 Chris Austin, Partner, Orrick Liz Wessel, CEO WayUp Ellie Wheeler, Principal, Greycroft Partners
  2. 2. 2 Anatomy of a Term Sheet: Agenda • Key Points • Pre-Financing Strategy • Term Sheet Review — Allocating Value — Managing the Company — Investors Rights —Miscellaneous Terms • Questions
  3. 3. 3 Anatomy of a Term Sheet: Overview • Allocating Value —Valuation —Capitalization —Liquidation —Dividends • Managing the Company —Board Composition —Protective Provisions —Drag Along Rights • Investor Rights —Anti-Dilution Protection —Right of First Refusal & Co-Sale Right —Redemption • Miscellaneous Terms
  4. 4. 4 Allocating Value: Valuation (TS: Page 1) • Valuation: Science and Art —Valuation Example: VC Hells Kitchen Ventures and others are investing $4 million at a $10 million pre-money. —Higher Valuation is not always best – Look for good fit, strategic value, understanding of business • Investment Amount: Usually 20-40%
  5. 5. 5 Allocating Value: Capitalization (TS: Pages 1/2) Founder Vesting • Standard Schedule is a 4 year term with a 1 year cliff • Acceleration – Single and Double Trigger • Setup prior to VC negotiations and keep terms within the market range (founder favorable side). You do not want this to be a point of negotiation with VCs. • Vesting for a portion of time served usually allowed Stock Option Pool • Key issue: What will you need to compensate your employees between this round and the next? No one answer – depends on current team
  6. 6. 6 Founder and Employee Equity Summary: • Incentives: Investors and management want to align incentives to build value • Control: Founders have the opportunity to obtaining favorable terms if such terms are established prior to term sheet negotiations • Precedent: Be wary of the terms of grants to key employees and consultants Allocating Value: Capitalization (TS: Pages 1/2)
  7. 7. 7 Allocating Value: Dividends (TS: Page 2) • A key component of Preferred Stock ~ basically, it’s interest. • This is not a “coupon” investment. Keep at 8% or less (8% is standard) • Try to stay away from cumulative dividends. Current market standard is “as, if and when declared” (which is generally never…. So no dividends)
  8. 8. 8 Allocating Value: Liquidation Preference (TS: Page 2) • At Liquidation/Dissolution, VC gets: —The right to receive the proceeds first - preference —Piece of the remaining proceeds – participation – try to NOT have participating preferred • Examples: —Both liquidation multiples and participation will the VC’S actual return —$20 million investment for 25% of company, and later $50 million exit —Participating = $20 mm + 25% of $30 mm = $27.5 MM to VC, $22.5 to everyone else —Non-participating = $20 MM to VC and $30 MM to everyone else
  9. 9. 9 Allocating Value: Liquidation Preference (TS: Page 2) Liquidation Summary: • Incentives: Liquidation Preferences will guide incentives toward liquidity • Control: Even though the Common stockholders may own the majority of the company, they may be excluded from the liquidity proceeds • Precedent: Subsequent rounds can lead to stacking preferences
  10. 10. 10 Managing the Company: Protective Provisions (TS: Page 3) Protective Provisions • Without the vote of a % of Preferred, Company will not be able to take actions that affect equity/ownership. For example: —Authorize/Issue Preferred Stock —Grant options beyond a certain limit —Amend the charter —Sell the Company • These are in every deal – look to confirm that set of restrictions is standard
  11. 11. 11 Managing the Company: Board Structure (TS: Page 3) Board Composition • Generally at Series A, VC will ask for 1-2 seats • VC will ask for special provisions ~ Preferred Director consent • At Series A, be sure VC is not board majority
  12. 12. 12 Managing the Company: Drag Along Rights (TS: Page 5) Drag-Along Rights • Investors can force Common Stockholders to participate in a sale of the Company. • Drag-Along rights are not present in every deal, but becoming more frequent • Try to make is so that majority common + majority preferred required – then it’s used to clean up little holders
  13. 13. 13 Managing the Company: Recommendations Protective Provisions: • Question your ability to satisfy business objectives • Consider class voting • Keep standard market terms Board Dynamics: • Don’t give up Board control in the early rounds • Consider a nomination process for the independent seat Drag Along: • Push for exclusion of this term • If a Drag Along is included, provide that the drag can only be induced if the Common Stock holders (first choice) or the board (second choice) approve the deal.
  14. 14. 14 Investor Rights Further Protection for the VC: Reducing Risk • Right of First Offer (TS: Page 4) • Anti-Dilution Protection (TS: Page 2) • Right of First Refusal & Co-Sale Right (TS: Page 5) • Redemption (TS: Page 3) • Registration Rights (TS: Page 4)
  15. 15. 15 Investor Rights: Right of First Offer (TS: Page 4) • With certain standard exceptions, if the company issues stock, VC has the right to maintain its pro rata percentage ownership of the company. —This measurement should be based on the fully-diluted values, not the outstanding values • ROFO is a standard term, but limit who has the right
  16. 16. 16 Investor Rights: Antidilution Protection (TS: Page 2) • If the Company subsequently issues cheaper stock (subject to standard exceptions), conversion ratio is adjusted so that upon conversion to common, they get more than 1:1 • A few methods (Broad/Narrow/Ratchet); varying levels of punishment • Broad-based is overwhelmingly the market trend
  17. 17. 17 Investor Rights: Right of First Refusal and Co-Sale (TS: Page 5) Right of First Refusal • Before Founder can sell, he must give Company and Investors right to buy Co-Sale Right • If the Investors and the Company decline to buy, then the Founder must give Investors a right to participate in that sale
  18. 18. 18 Investor Rights: Right of First Refusal and Co-Sale (TS: Page 5) Recommendations • Right of First Refusal & Co-Sale is completely standard • Be sure to limit who has the right with a share threshold. • Be wary of carve-outs for founders---example of why your attorney should draft the documents
  19. 19. 19 Investor Rights: Redemption (TS: Page 3) • Force the Company to return the money to investors at specified time (i.e., in 7 years, VC can ask for money back) • Push for exclusion of this term (very bad precedent); however, if it is included confirm that the terms provide: —Enough runway (5-10 years) —Redeeming investors only receive what they paid + dividends —Higher approval threshold (other Investors must consent)
  20. 20. 20 Investor Rights: Registration Rights (TS: Page 4) Registration Rights • Investors can make the company file for IPO, follow-on offerings • Don't spend too much time on this section
  21. 21. 21 Term Sheets: Miscellaneous Terms • Information and Management Rights: Opening the books • Legal Fees: Investor Counsel fees $25k-35k • No-Shop (“Exclusivity”): Reasonable term
  22. 22. 22 Chris Austin +1.212.506.5234 caustin@orrick.com Contact