2014 Valla & Associates, Inc., P.C. www.vallalaw.com 1 Majda Barazzutti July 23, 2014

THE VENTURE CAPITAL FINANCING PROCESS: TERM SHEET NEGOTIATION 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 2 ENTREPRENEURIAL JOURNEY

Financing is a Staged Process Common Stock Bootstrapping Friends and Family Angels: Equity, Warrants, Convertible Notes Series seed financing Series A Preferred (B, C, etc.) Liquidity Event 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 3

Convertible Debt Bridge loan before financings Useful when the company does not have a satisfactory valuation Risks of repayment feature No minimum capital but insolvency changes the rules Better include a provision to force conversion 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 4

Warrants: option to purchase company shares at a price within a set period Kicker to increase the potential investment value Warrants increase in value as the value of the underlying shares increase in relation to the exercise price Usually issued with bridge financing 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 5 Warrants

Alternatives: Strategic Investors Aims Differ Not Interested in Helping the Company Grow Conflict of Interest: greater returns from commercial rights than growth Expertise Could affect future VC financings 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 6

Venture Capital Identify the Right VC Due Diligence The Risk of Finders 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 7

Prior to Investing: Document Employees Founders Relationships Securities filings Confidentiality and Invention Agreements Prepare for VCs due diligence 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 8 Clean Up

Preferred Stock (Series) Why Preferred? Liquidation Preference Preserve a low common stock value for option grants (ratio 1:4 to 1:8): Common Stock was bought at cheap price, $0.10 to founders. If Common were sold at same time at $5.00 to VC, tax consequences for founders. No limits to Preferred/Common ratio 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 9

Sample Term Sheet Binding Provisions: No Shop Confidentiality Applicable law ALL other provisions are not binding See examples: NVCA (http://www.nvca.org) 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 10

A Typical Term Sheet Valuation/Number of Shares/Price Liquidation Preference Redemption Conversion Vesting of founders stock Antidilution Voting Rights Protective Provisions 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 11

Valuation/Price Pre-money/Post-money valuation: Option pool shuffle How are your shares valued? 8M pre-money valuation, 6M shares outstanding $8M pre-money 6M existing shares = $1.33/share, right? WRONG: The share price is $1.00 WHY? Read the term sheet: The $8 million pre-money valuation includes an option pool equal to 20% of the post- financing fully diluted capitalization. $8M pre-money (6M existing shares+2M options )= $1/share. Pre-money valuation includes an unallocated option pool for new employees -- lowering pre-money valuation 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 12

Liquidation Preferences Liquidation Preference: 1x or more 2x, 2x Participating Preferred: Straight/Non-participating 67% Full participating (double-dip) 19% Capped participating 14% Preferred has the option to convert into Common Interaction of various series: First pay B, then A, then all; all participate equally, etc. Deemed Liquidation: good times and bad times Not an IPO 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 13

Dividends No expectation of dividends, but: Cumulative Dividends: __ % cumulative dividend accrues over time, whether or not the company declares it - PLUS participation with Common Stock on an as-converted basis. Non-cumulative Dividends: An amount equal to $[_____] per share of Series A Preferred when, as and if declared by the Board PIK (payment-in-kind) dividends. Company option to pay accrued and unpaid dividends in cash or in common shares valued at fair market value. Usually payable on liquidation or redemption, not conversion 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 14

Redemption Optional (Company call): Company can repurchase stock at original price (plus dividends) if Investors dont convert to Common after x years Mandatory (Investors Put) Investor can force Company to repurchase shares after x years beware of redemption premium Guaranteed exit path for VC if Company is successful enough But, Company must have legally available funds 22% of all VC financings in 2012, 35% in down rounds 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 15

Conversion Preferred always has a conversion to Common feature, but loses all preferred privileges Optional Conversion Automatic Conversion: IPO Conversion Ratio is initially 1:1, modified based on anti-dilution provisions 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 16

Anti-Dilution Protect investors if company issues equity at a lower valuation than preferred Full Ratchet 3% Weighted Average: Broad Base: more favorable 92% Weighted Average: Narrow Base: less favorable to company 4% 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 17

Exclusions from Dilution Carve-outs from anti-dilution: Options grants to employees, consultants (negotiate all or only authorized pool) Warrants to lenders (approved by majority vs. unanimous board approval) Warrants to service providers, strategic partners Shares issued in mergers / acquisitions Exercises or conversions of current stock or grants 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 18

Other Terms: Vesting of founders stock, acceleration Right of first refusal: new issuance and transfers by founders Employee pool Co-sale agreement (drag along, tag along) : force a sale Registration rights Board Control 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 19

Other Terms: No-shop agreement Information rights Confidentiality Indemnification Counsel expenses up to ___ Lock-up provisions 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 20

Bottom Line (Almost) anything can be negotiated Pick your battles: Liquidation Preferences, Protective Provisions, Board Control Make sure you understand what youre signing 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 21

Thank you IN BOCCA AL LUPO! Valla & Associates, Inc., P.C. 1990 N. California Blvd., Suite 1060 Walnut Creek, CA 94596 USA E-mail: majda.barazzutti@vallalaw.com Phone: +1 925 705 7623 Fax: +1 925 705 7629 www.vallalaw.com 2014 Valla & Associates, Inc., P.C. www.vallalaw.com 22