2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

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This is a presentation I made last June at the 2011 Endeavor Summit in San Francisco.

Transcript of 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

  • 1.Hot Topic Session
    Negotiating a Term Sheet: The Devil is in the Details
    Ariel Muslera
    Advisor, The Latin American VC Association
    Partner, CAP Ventures

2. My Affiliations
The Latin American Venture Capital Association (LAVCA) is a not-for-profit membership organization dedicated to supporting the growth of the private equity and venture capital industry in Latin America comprising over 100 firms, from leading global investment firms active in the region to local fund managers from Mexico to Argentina. We are the leading source of data on the industry and also organize the largest Latin American PE/VC events in the region and in NYC.
To learn more visit www.lavca.org.
CAP Ventures is an Argentina-based, $17M venture capital fund. Since 2007, weve been supporting high-growth, high-impact companies in multiple sectors. Our current strategy leans towards Technology investments, with a focus in Consumer Web, Social, SaaS and Infrastructure services.
To learn more visit www.cap.com.ar.
ARCAP is the Argentine Seed, VC and PE association. Launched in 2009, ARCAP seeks to promote and develop the private capital industry in Argentina and has over 30 member firms.
To learn more, visit www.arcap.org.
You can also follow me at:
3. Disclaimer
The views and comments in this presentation are not representative of the views of any of the organizations I represent.
Also, I would like to give credit to Alex Wilmerdings book Term Sheets & Valuations, a line by line look at the intricacies of Term Sheets & Valuations for a lot of the information comprised in this document.
There are many causes of failure in a new venture, but some of the preventable ones include the following pitfalls that Venture Boards sometimes get into:
Inability to confront difficult issues
Distraction and over-commitment
Misalignment of interests between Board Members and investors
Divisiveness on the Board
Paralysis over liability issues
Board Member role confusion
Leadership vacuum
Loss of trust in the CEO
Resolution to fail
5. Lessons from a Term Sheet negotiation
Nevernegotiate individual terms without understanding the term sheet in its entirety
Even if you have been trained in law, you should always bring someone (i.e., not you) with legal expertise and market knowledge to help in the negotiation
A negotiation is also an opportunity for your company to improve the governance and discipline
Entrepreneurs should recognize that VC firms do Term Sheets for a living. The good ones, presumably, have figured out the right balance between their greed and the fairness to entrepreneurs so that ultimately the startups have a better chance to succeed; trying to significantly change the Term Sheet of a VC is like saying you dont like their work
6. The Option of Stock Options
If the current pool of options is not sufficient to enable the company to provide key employees with a competitive options package, the way in which an options pool is increased as part of the financing is critical to the economic value of the round
Look out for
How will they be issued? When? Pre round? Post?
7. Key terms of the Term Sheet
Why? How? What to look for?
8. Dividend Provisions
This clause will be the guide for the Board whenever the company is in a position to generate dividends
From a VC standpoint, it is a tool to ensure at least some prospect of a return in the event of a liquidation of the company
It can have a significant impact in the founders economic outcome in both a liquidation (bad) and a liquidity (good!) scenario
9. Liquidation Preference
Another clause that has huge impact in outcome
Investor favorable wording will be whats usually called Participating Preferred, which means that the Preferred holders will get their money back (plus some return) first, and afterwards, whatever is left is distributed to all (Common and Preferred) on an as-converted basis
Note that this clause does not apply should the Preferred elect to convert to Common (i.e., under an IPO), but what it does is increase the threshold for conversion to be worth it
10. Participating vs. Non-Participating Preferred
11. Redemption
A way to ensure that your company does not become a lifestyle company or, as we call it, a living dead
Puts a finite # of years to an investment, assuming that the company is able to generate enough liquidity
Not seen often in early stage deals, but something to be aware of when pitching certain liquidity scenarios
12. Conversion
Not considered investor or company favorable
Simply allows investors to give up their Preferred rights when converting to Common yields a higher return (i.e., an IPO or a big liquidity event)
However, it is influenced by the terms of the Liquidation Clause, the Automatic Conversion Clause and the Antidilution Provisions
13. Automatic Conversion
This is similar to a Drag. It forces, under certain conditions, to convert Preferred to Common so that the company can generate liquidity to do a Public Offering
The Investors will always try to set a floor for this clause to trigger so that they are not forced but can choose to convert
14. Antidilution Provisions
Single most important tool for investors who want to ensure that any subsequent financing will, at the very least, not dilute the value of their investments below the price paid in a prior round
Key to investors when future rounds are flat or down (a down round)
Most investor favorable clause is called a Full Rachet, meaning that when a liquidity event happens, old investors conversion rate adjusts so that the cost and ownership % is as if that investor invested in the new round side-by-side
This adjustment is usually at the expense of Common Stock holders (i.e., YOU!!), who will be diluted at the time of conversion
15. Voting Rights / Protective Provisions
Simply states that, in the event that a shareholder vote is called, all shares are treated equally
In general, certain protective provisions are set in the Protective Provisions clause to increase power of Preferred for key decisions like future rounds of financing, board member selection, dividends, etc.
The protective provisions section is a good signal of the influence that the investors plan to have in some of the strategic actions of the company
16. Information Rights
No big issue here, although it is important to understand the expectations of the investor in terms of timing, detail and format of information
17. Board Composition and Meetings
Typically, youll aim at having an odd-numbered board, with roughly equal power between investors and management and one independent who is mutually agreed upon
It is important to pay attention at how the board members are elected (for example, allocating the election of a certain number per class as opposed to electing everyone on an as-converted basis) since sometimes that actually makes a difference and gives additional power to the founders
18. Other Clauses That You May See andCan Be Negotiated
Use of Proceeds
Key Person insurance
Restriction on Sales
ESOP details and Stock vesting (read the mess at Skype!!)
Drag / Tag along
Intellectual Property
Legal Counsel for final documentation
Transaction Expenses
Finders fees
Binding vs. non-binding term sheets
No shop
19. Ariel Muslera