Negotiating the Series A Round Term Sheet

Negotiating the Series A Round Term Sheet

A Webinar from LeClairRyan’s Venture Capital Practice with Special Guests from Novitas, Harbert, Third Security

October 6, 201012:30 – 1:30 pm EDT

Welcome. With the high number of attendees, please note all lines have been muted for the event. Q&A can be posted at the right of your screen, but any questions (time permitting) will be addressed at the end of the event. If using Q&A – please send to both the host and the presenter. Chat will not be enabled. You can send direct questions (including request for copy of slides) to [email protected] with VC Webinar in the subject for reply after the event.

Bill Oberdorf Andrew White

Tad Fisher Third Security

Paul Schmitt Novitas Capital

Brian Carney Harbert Venture Partners

Today’s presenters

Negotiating the Series A Round Term Sheet

Theodore J. FisherThird Security, LLC

LeClairRyan Web Seminar

October 6, 2010

Third Security, LLC

• Dedicated to investing in high-growth, technology driven companies, primarily in life sciences

• Led by R.J. Kirk, its founder, CEO and Senior Managing Director

• Differentiated approach to life-science investing, focusing on investments across broad spectrum of developmental and investment stages in both private and public companies

Influence: Third Security affiliates are typically the sole institutional investors in a company

Domain-based collaboration: Third Security delivers a wide variety of operational resources to portfolio companies

1

Valuation

2

• We are sellers, not buyers Help in the difficult transition from an R&D company to a commercial enterprise

Buy-in to a common vision is essential

We have the relationships and the horsepower to help make the vision a reality

• Significant equity pool for management team Options granted based upon value of common stock relative to the Series A Preferred, creating a low strike price in light of the

liquidation preference

Fosters “owner” rather than “employee” mentality

• It may not be in the company’s best interest to pursue an aggressive valuation in a Series A round; funding a company at an unrealistic valuation can make the next financing difficult

• If a company wants to shop the deal to get the best valuation, then Third Security is not the right investor

Deal Structure Issues

• Liquidation Preference Participating preferred stock

Dividend rates have crept higher in this market environment

Will agree to cap in limited circumstances

• Founder Shares Stock restriction agreements typically only apply to sweat equity

Significant negotiation over valuation methodology in the event a repurchase of such shares is triggered and length of vesting period

• Negative Covenants We insist on written approval over anything outside of ordinary course

Opportunity to help the company execute; we never want to hinder the company’s progress

6

7 7

Founder to CEO to Exit transition

Target management upgrades and additions

Board approval versus operating roles

Financial reporting discipline

Board and investor communications

Management Issues

8 8

Art vs. Science

Early stage technology/biotech

Revenue/EBITDA runway

Be realistic…know comparables

Strike quickly

Valuations

9 9

Understand comparables

1 to 1.5x is a win/win

+3x…something is wrong!

Expect creativity

Liquidation Preferences

SM

Harbert® Venture Partners II, L.P. | 10

Overview of Harbert Venture Partners LLC

Venture capital fund focused on early stage investments in information technology and healthcare companies

Offices in Richmond, VA, Birmingham AL and Gainesville, FL

Currently investing HVP II. $110+ million in venture funds under management

Investment Focus : Early growth stage, healthcare and IT, Southeast & Mid‐Atlantic US

Active involvement in regional venture community, on boards of Council for Entrepreneurial Development, Florida Venture Forum, Mid‐Atlantic Venture Association, Atlanta Venture Forum, etc.

Affiliate of Harbert Management Corp., an investment management firm focused on alternative asset classes with ~$2.7 billion in assets under management

SM


Generally structured as a syndicate, with a lead investor

Stock interest in a C corporation

Usually in the form of “participating” preferred: pays back

investment, with dividends, and converts to common

Sometimes structured with milestones and / or tranches

Typically carries board participation rights

How is a VC Investment Structured?

Venture Capital Term Sheet – Series A

SM


Discussion Points


Valuation vs. terms

Terms:

Economic:

Pre‐money valuation

Liquidation preferences

Conversion ratios

Option pool

Dividends

Ant‐dilution protection

Pay to Play Provision

ROFR/Co‐Sale/Preemptive rights

Governance:

Board composition

Voting rights

Protective provisions

SM


Discussion Points


Economic:

Pre‐money valuation

Liquidation preferences

Participating Preferred vs. Convertible Preferred

1.0x, 2.0x, etc.

Conversion ratios

Option pool

Existing team, planned additions to management team

Increase pool pre or post deal

Dividends

Anti‐dilution protection

Weighted‐Average vs. Full Ratchet

Pay to Play Provision

ROFR/Co‐Sale/Preemptive rights

SM


Discussion Points


Governance:

Board composition

Investors, Management Team, Independents

Voting rights

Vote on as‐if converted basis

Protective provisions

Certain actions require approval of Preferred shareholders

Sale of assets or company

Changes to liquidation preferences or rights of preferred stock

Redeem shares

Authorize shares

Change By‐laws

Etc..

ROFR, Co-Sale and Drag-Along: Sweat the Small Stuff

Appropriate Ground Rules, but watch for Technical Pitfalls

Drag-Along Rights: • Disproportionate Exit Leverage?• Practical Limitations• “Ok I’ll sell, but I’m not signing anything”

Protective Provisions

Appropriate Gap-Fillers:• Amending Charter or Bylaws• New Series of Stock, Senior to Series A• M&A, Debt, Increasing Board, etc.

“This is a Stick-Up!” How Much Control is Enough?

Liquidity of Last Resort:Redemption Rights

The Minority View Counter to Needs of Cash-Starved Start-up State Law Problems It’s About Leverage

Registration Rights

Mandatory, Piggyback and S-3 Practical Limitations Is this a Good Use of Bargaining Chips

(and legal fees)?

Questions and Answers

Thank You.

Bill Oberdorf – [email protected]

Andrew White - [email protected]

Disclaimer

This presentation provides general information and is not legal advice and should not be used or taken as legal advice for specific situations. You should consult legal counsel before taking any action or making any decisions concerning the matters in this presentation.

This communication does not create an attorney-client relationship between LeClairRyan, A Professional Corporation, and the recipient.

Copyright 2010 LeClairRyan, A Professional Corporation. All rights reserved.

Negotiating the Series A Round Term Sheet

Documents

Transcript of Negotiating the Series A Round Term Sheet