Term Sheet Negotiations (08.24.2015)

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    Term Sheet NegotiationsAugust 24, 2015

    Chris Austin, Partner, Orrick

    Liz Wessel, CEO WayUp

    Ellie Wheeler, Principal, Greycroft Partners

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    Anatomy of a Term Sheet: Agenda

    Key Points

    Pre-Financing Strategy

    Term Sheet Review

    Allocating Value

    Managing the Company

    Investors Rights

    Miscellaneous Terms

    Questions

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    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

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    Allocating Value: Valuation(TS: Page 1)

    Valuation: Science and Art

    Valuation Example: VC Hells Kitchen Ventures and othersare 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%

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    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

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    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)

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    Allocating Value: Dividends(TS: Page 2)

    A key component of Preferred Stock ~ basically, its

    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)

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    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 NOThave participating preferred

    Examples:

    Both liquidation multiples and participation will the VCSactual return

    $20 million investment for 25% of company, and later $50million 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 everyoneelse

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    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

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    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

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    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

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    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 its used to clean up little

    holders

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    Managing the Company: Recommendations

    Protective Provisions:

    Question your ability to satisfy business objectives

    Consider class voting

    Keep standard market terms

    Board Dynamics:

    Dont 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.

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    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)

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    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-dilutedvalues, not the outstanding values

    ROFO is a standard term, but limit who has the right

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    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

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    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

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    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

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    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)

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    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

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    Term Sheets: Miscellaneous Terms

    Information and Management Rights: Opening the books

    Legal Fees: Investor Counsel fees $25k-35k

    No-Shop (Exclusivity): Reasonable term

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    Chris Austin

    +1.212.506.5234

    caustin@orrick.com

    Contact

    mailto:caustin@orrick.com

    Slide Number 1Anatomy of a Term Sheet: AgendaAnatomy of a Term Sheet: OverviewAllocating Value: Valuation (TS: Page 1)Allocating Value: Capitalization (TS: Pages 1/2)Allocating Value: Capitalization (TS: Pages 1/2)Allocating Value: Dividends (TS: Page 2)Allocating Value: Liquidation Preference (TS: Page 2)Allocating Value: Liquidation Preference (TS: Page 2)Managing the Company: Protective Provisions (TS: Page 3)Managing the Company: Board Structure (TS: Page 3)Managing the Company: Drag Along Rights (TS: Page 5)Managing the Company: RecommendationsInvestor RightsInvestor Rights: Right of First Offer (TS: Page 4)Investor Rights: Antidilution Protection (TS: Page 2)Investor Rights: Right of First Refusal and Co-Sale(TS: Page 5)Investor Rights: Right of First Refusal and Co-Sale(TS: Page 5)Investor Rights: Redemption (TS: Page 3)Investor Rights: Registration Rights (TS: Page 4)Term Sheets: Miscellaneous TermsContact