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

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Page 1: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

Hot Topic SessionNegotiating a Term Sheet: The Devil is in the Details

Ariel MusleraAdvisor, The Latin American VC AssociationPartner, CAP Ventures

Page 2: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

My Affiliations

CAP Ventures is an Argentina-based, $17M venture capital fund. Since 2007, we’ve 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.

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.

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.

@Bluelabel

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www.arielmuslera.com

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Page 3: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

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 Wilmerding’s 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.

Page 4: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

THE TEN COMMON PITFALLS OF VENTURE BOARDS

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:

Complacency

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

Page 5: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

LESSONS FROM A TERM SHEET NEGOTIATION

Never negotiate 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 don’t like their work

Page 6: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

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?

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Key terms of the Term Sheet

Why? How? What to look for?

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Dividend ProvisionsThis 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 founder’s economic outcome in both a liquidation (bad) and a liquidity (good!) scenario

Page 9: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

Liquidation PreferenceAnother clause that has huge impact in outcome

Investor favorable wording will be what’s 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

Page 10: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

Participating vs. Non-Participating Preferred

Page 11: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

RedemptionA 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

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ConversionNot 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

Page 13: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

Automatic ConversionThis 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

Page 14: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

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

Page 15: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

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

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Information RightsNo big issue here, although it is important to

understand the expectations of the investor in terms of timing, detail and format of information

Page 17: 2011 Endeavor Summit Hot Topic workshop: Term Sheet Negotiations, the devil is in the details

Board Composition and Meetings

Typically, you’ll 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

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Other Clauses That You May See and Can 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

Non-competes

Non-disclosures

Binding vs. non-binding term sheets

Expiration

No shop

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Ariel Muslera@Bluelabel

www.linkedin.com/in/amuslera

www.arielmuslera.com

www.slideshare.net/amuslera