3
Sources of Capital: Mass ChallengeJuly 7, 2011
Jean Hammond - Angel Investor, Member Golden Seeds, Launchpad Venture Group and Hub Angels
Dan Allred - Senior Relationship Manager, Silicon Valley Bank
Phil Holberton SBIR consultant …. Babson and Brandeis
Miguel Granier –Founder/Director Invested Development
Ed Mallen – CEO TimeTrade
Funding Options
High Growth Business Model
Angel & Venture Term Sheets
Pitching the Business Plan
Preparing for Growth & Exits
Building a Fundable Team
Non-Dilutive Capital Alternatives
TCN Roundtable Curriculum
Negotiation & Valuation
TCN ProgramsFinancing Roundtables
Special Events
Expert Lunch Series
Venture Coaching
Interactive Expert Panel Breakfasts and Evening Events on Early Stage Fundraising topics.
Small working lunch sessions led by Experts for member entrepreneurs.
• 1-Day Venture Fast Track
• Mixers• Co-Promotions and
Partnership Events• Networking Events• Team Building
Fairs• Large Panel
Presentations
Members-only tailored Mentoring Program led by teams of serial entrepreneurs.
6
Agenda
• Capital Sources:– What is your company’s growth profile, how much capital is needed?– Where are the funding sources
• Panel Presentations– Equity Funding VCs & angels (and other State Sources)– Debt Capital: venture debt– Process for SBIR grants– Social Entrepreneurship– Entrepreneur views
• Q & A
7
High Growth Company? Normal Growth Company?
How fast will it grow?• Factors to Consider
– How large is the total market?
– Is technology unique or are there other barriers to entry?
– How large will your sales and marketing team need to be to address that market?
– Is the company extremely scalable?
– What are the cash needs?
– How long will it take for the business to be profitable?
– How profitable when scaled?
– How predictable are the cash flows?
– How experienced and complete is your team in the industry; have they entered a new or emerging market, and is team successful in start-ups?
– What are the multiples in the category?
• These help determine the amount of funding / expected return
• In general, normal growth ‘revenue companies’ that grow one resource at a time can payback debt capital as they grow
What Stage is this Company?
• Crystal Stage: Idea to Business Plan and Technology Proof• Figuring out if there is a business there• Key activity – learning from the market proving technology• Entrepreneur / visionary
• Demonstration Stage: Business Plan to Prototype• Good understanding of "successful offering“ • Customer discussions started• Interest from investors/ advisors- ideally a mentor or a coach
• Market Entry Stage: Running Market Effectiveness Trials• Real entrepreneur team, sweat invested, define marketing trials• Product / Service in a ‘Beta’ test or about to ship for revenue• Multiple customer/partner discussions underway• Starting relationship with marquee customer• Supportive ‘door opening’ investors / advisors / mentors
• Early Growth Stage: Early Repeatable Business Model• Complete team – detailed knowledge of challenges this firm faces• Technology works – and we can show it (and have patents, etc.)• Reference-able relationship with marquee customers• Marketing and sales processes… with a repeatable, scalable business model• Estimate of total cash required; identification of “deep enough pockets” to match market potential
• Scaling Stage: Repeatable Growth• Mapping of market growth (and capital required) to revenues is understood
• Equity investors are trying balance return expectations against risk• Risk is lower at later stages
Many types of Entrepreneurship: Don’t raise money until you know where you are
5 ye
ar g
row
th r
ate
$1-3M >>>>
Investment required to reach breakeven
Project finance/Other
sources
Small CAPEX“normal growth”
business(MOST COMMON)Mostly bank debt
Home run long shot(VERY RARE!)
VC Funding
Cheap fast growing business (RARE!)
Angel Funding (and some VC)
Higher
Lower
50%
Blended Funds
Debt
Non-profitFunds
Summary of Capital Sources
11
Equity Capital Sources: High Growth Companies
Estimate exit potential based on multiples of revenue levels achieved Use projected 4-5 year revenues to estimate exit potential• Companies with low profits and/or revenues < $2M: arms length equity capital not interested• Angels look for $7-10M revenue targets with room for growth• VCs (most) need to see north of $30-40M revenue with great potential
• No “exact” rules but stage of VC fund and total capital in use will point toward exit expectations
Stage Crystallize Idea & Early
Demonstration
Demonstrate Product &
Market Interest
$500,000 and $5,000,000,
EarlyScalingGrowth
Repeatable Growth
Source Founders, Friends & Family,Grants
AcceleratorsIndividual Angels &
Angel Groups
Most
Venture Funds
Investment
$25,000 to $100,000
$100,000 to $500,000
$5,000,000 and up(initial capital may be smaller)
Market Entry & Early Growth
Angel Groups and Angel Group Syndication
Micro-cap Funds
12
Sources of Equity Funds for Entrepreneurs
Sources: Money Tree and UNH Venture Center
• Sources: Money Tree and UNH Venture Center
• Angels (est.):– Angel groups ~10-15%,
– Informal networks and one-time-investors ~15-20%,
– Super angels ~25-30%,
– Family offices ~35-45%
13
founders
employees
angels
Equity Capital: Goal is Increasing Value Do you want 90% of $1M Firm or 10% of a $100M Enterprise
founders
employees
angels
VCs
foundersemployees
• Remember it’s the area of the pie slice not the %
• All parties agree … focus on building value
Equity requires an exit
14
Agenda
• Capital Sources:– What is your company’s growth profile, how much capital is needed?– Where are the funding sources
• Panel Presentations– Equity Funding VCs & angels (and other State Sources)– Debt Capital: venture debt– Process for SBIR grants– Social Entrepreneurship– Entrepreneur views
• Q & A
15
Equity: Friends & Family, Angel or VC ??
• No right answer• Family funds are flexible but losses hurt those you care about
– Do NOT leave it to “what you thought you heard”– www.virginmoneyus.com/
• Investors in Your Backyard: How to Raise Business Capital from the People You Know by Asheesh Advani
• Angels– May coach more especially at the beginning – Often very interested in ‘early’ exits… for angels a 2.5x exit in 2 years is the
same (58% IRR) return as a 10x exit in 5 years • VCs
– Support CEOs with CEO forums etc.… very active role in hiring– Connections, connections… lots of exit experience– Swing from the fences… BUT a 10-15x return on $20-50M in is a big return
• Rational approach -- understand capital requirements of your business and the multiples for your type of play in your industry
16
Process with Average Angel Group
• Application – on line– Combined with an introduction
• Screening – we read, phone call, or hold a meeting• Presentation – at our forum meeting
– We assess interest in deal (at least 5 people)
• Due diligence – starts with a 2 hour meeting• Investigate market, business model, product, team
– about 1-1.5 months
• Deal negotiation• Valuation, terms, expectation alignment • Documents• Closing – signatures & $$• Board relationship and quarterly reporting
17
Company Attributes that Improve Odds with Angel Groups
Factors Companies getting angel investment
Companies that don’t
CEO Some experience or ‘coachable’, wants listen
CEO talks about him or her ‘expertise’ forever
Team Enthusiastic! match to required skills, “owners”
One person, says no one will work without $$
Unique, Need
A neat idea, could be bigTalks to customers- needed
Seems ‘me too’“my” idea -doesn’t talk to mkt.
Stage Lots done, working code, just needs mkt. entry $$
Idea and ppt., or a complex science project, or “old”
Market size, str.
Market is big and can be reached Market is huge orMarket extremely fragmented
Total investment
Cash flow breakeven soon,Can use more $$
Needs $10-20M more after this round
Valuation Willing discuss a range of values & funding strategies
Is fixated on a very unrealistic high value
18
Angel (group) Attributes that Lead to Deals
• Each angel group gets 10-20 applications for each presentation and ¼ of those presenting get funded
• Despite the huge amount ($20B)* of angel money, there are always more entrepreneurs (other presenters at same meeting)
• A Champion (at an angel group) is most important– Champion has expertise to match company
– Champion and CEO having fun together
– Group respects Champion
• Work is done by convivial team– Due diligence completed quickly
– Terms negotiation fast (lawyers work)
• Level of interest is similar to funds required by company
Selecting a VC
• Talk with fellow entrepreneurs, VC friends and service providers
• Check compatibility with focus, stage, and investment size• Learn as much as you can, including
– Competitive investments– Successful investments– Interests/background of partners
• Develop a prioritized list of funding sources• Plenty of organizations and on-line sources to help• Wherever possible, get an introduction
– Other VCs, entrepreneurs, attorneys
Engaging Feedback
• Solicit input to gauge VCs interest and fit– Understand investor assumptions– VCs can add value even when your company isn’t an
investment candidate for their firm– Don’t argue their reasoning, ask questions to test your
hypotheses
• Give yourself time between VC meetings to be able to react to the feedback – Don’t overshop it without initial feedback– Keep the door open so you can follow-up
• Remember these are long-term relationships with hopefully multiple rounds of funding; keep the VCs as your friends
Responding to Feedback
• Give yourself time between VC meetings to be able to react to the feedback – Don’t overshop it without initial feedback
• Keep the door open so you can follow-up– Remember these are long-term relationships with
hopefully multiple rounds of funding; keep the VCs as your friends
• When you do follow-up, refer to their feedback and how it helped shape your thinking
• Know that sometimes it’s a good business, but just not VC-backable
22
Raising Money ?
• Your Diligence: Checking out ANY Investor
• Know the social rules of the road – get introduced, as high as possible up the food chain!
• Check the investment history
• Check out things like stage of the fund
• The investment size is close enough to fit
• If possible, find the best-fit partner
• Be sure to make your presentation fit
• Call the CEOs of the portfolio and find out how the investor behaves
• Get members of your advisory board or board to play an active role
• MassDevelopment - www.massdevelopment.com• Emerging Tech Fund for manufacturing facilities & equipment
• Massachusetts Life Sciences Center - www.masslifesciences.com• Accelerator loan program for early-stage companies • Life Sciences Tax Incentive Program - Cooperative Research Grants
• BDC Capital - www.bdcnewengland.com• SBA 504 and specialty financing (brownfields, recycling, etc.)
• MA Community Development Finance Corp. - www.mcdfc.com• Gap financing to promote jobs
• Massachusetts Workforce Training Fund - www.detma.org/workforce• Matching grants for workforce development
• Business incubators with a range of services and networks (ATMC in Fall River, Enterprise Center at Salem State College)
MA QUASI-PUBLIC LENDERS & INVESTORS
• MCRC - MA Capital Resource Company – www.masscapital.com
• Finances manufacturing, distribution and service companies
• MCRC’s Life Insurance Initiative
• Capital for economic development
• MA Economic Stabilization Trust www.commcorp.org/trust
• Manufacturers, including restructures
• Mass Technology Development Corp. - www.mtdc.com• Equity & sub debt for early stage technology companies since 1982• Usually $250-$500K• Jobs – leverage – technical innovation – nurture entrepreneurship
• Mass Technology Collaborative - www.mtpc.org• Debt/equity for renewable energy technology firms
MA QUASI-PUBLIC LENDERS & INVESTORS
Federal, State, City Business Support
MSBDC – MA Small Business Development Centers• 6 SBDCs throughout the state• MA Export Center• PTAC/ Government Contracting
– Types of loans• SBA Backed Bank Loans
• 504s
• Department of Commerce
• Export Loans
• Other federal agency resources, i.e., USDA
26
Examples of Equity Investors in Boston
• Angel Groups– Hub Angels– Common Angels– Launchpad– Mass Medical Angels– Walnut Group– Golden Seeds– Boston Harbor
• Smaller VCs ($25-150 million funds)– Launch Capital– Long River– Founders Collaborative– Next Stage
• Bigger VCs ($250+ million funds)– Castile– Polaris– Highland– Atlas– Charles River– 406– Venrock– Oxford Bioscience– NorthBridge
27
Agenda
• Capital Sources:– What is your company’s growth profile, how much capital is needed?– Where are the funding sources
• Panel Presentations– Equity Funding VCs & angels (and other State Sources)– Debt Capital: venture debt– Process for SBIR grants– Social Entrepreneurship– Entrepreneur views
• Q & A
TimeTrade makes a “click-to-schedule” capability for websites, e-mail, and socialmedia that changes the way you do business.
‘Click-to-Schedule” creates new customers more quickly than you can now, and increases the satisfaction level of customers you already have.
Who Uses TimeTrade?
30 million Click-to-Schedule prospecting, sales and Customer-care appointments each year
30 million Click-to-Schedule prospecting, sales and Customer-care appointments each year
4,000 TimeTrade customers4,000 TimeTrade customers
Angel Networks
High Net Worth individuals
Experienced Entrepreneurs
High Net Worth individuals
Experienced Entrepreneurs
Angels
Financing
Personal & Business Networking
Venture Firms
Network Angels to Angel Firms
Business Case and Sales model Developed
Develop the Relationships Early
Scaling Apparent
Banks
Integral to the Process
Debt, Business Modeling, Networks
Financing Technology:Trends in debt & equity termsheets
Dan AllredSilicon Valley Bank
(617) [email protected]
Twitter: @dgallredhttp://danallred.tumblr.com
Technology Risk vs. Market Risk
Funding sources: the lines are blurring
Debt vs. Equity
Debt• Lower risk: first money to
be paid back• Relatively inexpensive• First lien on company assets• Negative covenants
Equity• Higher risk: lives & dies with
the company• Very expensive• Unsecured (typically)• BOD governance
Primary uses of debt
• Financing assets– Working capital– Fixed assets
• Financing growth– Growth capital– “Venture debt”
• Special situations– Bridge loans– Financing “near” assets
Think like a lender
The traditional credit model– Primary source of repayment: cash-flow
• Question: what is the probability that cash-flow will be sufficient to support operations and repay the loan?
– Secondary source of repayment: collateral value • Question: what is the probability that the liquidation
value of the assets would be sufficient to repay the loan should the cash-flow prove insufficient?
Think like a “venture lender”
A twist on the traditional credit model– Primary source of repayment: cash-flow from
future equity• Question: what is the probability that the investors will
provide additional equity sufficient to support operations and repay the loan?
– Secondary source of repayment: enterprise value• Question: what is the probability that the enterprise
value (IP, customer base, licenses, etc.) is sufficient to repay the loan should the venture support prove insufficient?
Venture debt termsheets• Uses of capital
– General corporate purposes– Financing specific fixed assets
• Security– First priority lien on all business assets– Typically a negative pledge on IP
• Structure– 6-9 month interest-only draw period followed by ~30-36 month
principal repayment– Few financial covenants– Standard negative covenants (i.e. consents needed for M&A,
subordinate financing, changes in management, etc.)• Pricing
– Interest rates in the high single digits to low double digits– Warrants typically equal to ~0.25-1.00% fully diluted ownership
Think like a working capital lender
Another twist on the traditional credit model– Primary: cash-flow within the working capital cycle
• Question: what is the probability that the accounts receivable are collectable in a timeframe sufficient to revolve the loan?
– Secondary: collateral value of working capital assets• Question: what is the probability that the Bank could collect
the accounts receivable and liquidate the other working capital assets after the Company ceases operations?
Working capital termsheets• Uses of capital
– Financing working capital assets such as A/R and inventory– Sometimes includes a portion available to finance POs
• Security– First priority lien on all business assets– Typically a negative pledge on IP
• Structure– Revolving line of credit with formula borrowing base (i.e. 80% of A/R)– Financial covenants to measure liquidity (i.e. balance sheet covenant)
& performance to plan (i.e. income statement covenant)– Standard negative covenants (similar to prior slide)
• Pricing– Prime based interest rates ranging from Prime to mid double digits
based on liquidity levels– Commitment fee ~0.5-1.0% and perhaps unused line fees as well– Warrants may be included if there is an element of “venture risk”
Special Situations
A few examples:
Questions?
Dan AllredSilicon Valley Bank
(617) [email protected]
Twitter: @dgallredhttp://danallred.tumblr.com
Using SBIR Grants in Your Funding Strategy
Phil Holberton
Material Courtesy of NIH
SBIR - Grant Awards
• Innovation
• Basic and Applied
Research
• Proof of Principle
SBIR Purpose and Goals
Small Business Innovation Development Act of 1982
• Stimulate technological innovation
• Use small business to meet Federal R&D needs
• Foster and encourage participation by minorities and disadvantaged persons in technological innovation
• Increase private-sector commercialization innovations derived from Federal R&D
• PHASE II – R44• Full Research/R&D
• $1M and 2-year Award (SBIR)
• Commercialization plan required
• PHASE III• Commercialization Stage
• Use of non-SBIR Funds
• PHASE I – R43• Feasibility Study • $150K and 6-month (SBIR)
SBIR: 3-Phase Program
SBIR Eligibility Criteria
Organized as for-profit U.S. business
Small: 500 or fewer employees, including affiliates
PD/PI’s primary employment must be with small business concern at time of award and for duration of project period
At least 51% U.S.- owned by individuals and independently operated or At least 51% owned and controlled by another (one) business concern that is at least 51% owned and controlled by one or more individuals
• DOD• HHS• NASA • DOE • NSF • DHS• USDA• DOC• ED• EPA• DOT
SBIR Participating Agencies
$672M
Lessons Learned Along the Way
• Do Homework & Research Possibilities
• Connect and Network with Program Officials
• Ask Questions
• Be Respectful and Professional
• Program Managers - Want Us to Succeed
9 Grants = $2.6 Million9 Grants = $2.6 Million
FUNDING OPTIONS FORSOCIAL ENTREPRENEURSAn overview of funding resources available
to for- and not-for-profit Social Entrepreneurs
DEFINING THE DIFFERENCE
What is a Social Entrepreneur?• A social entrepreneur recognizes a social problem
and uses entrepreneurial principles to organize, create, and manage a venture to achieve social change (Wikipedia)
Are all Social Enterprises/Ventures not-for-profit?
• Social Enterprise can be for- or not-for-profits.• Leverage revenue-generating models and don’t
rely on grant financing alone (or at all)
Funding Options for Social Entrepreneurs
GOING BEYOND THE IDEA (PRE-SEED)
How to get those first few dollars• Forget the bank!• Risk/return might be too high even for F3…
Leveraging the mission to get financing• Seek out grants, awards, competitions and
fellowships that match your mission and current requirements
Funding Options for Social Entrepreneurs
GETTING SEED FUNDING
Proving the concept• Business plan (how you will scale)• Successful small pilot (potential not profits)• Team (buying experience)• Demand not need (selling not giving)
Where to get your first real investment• Scale grants – from larger organizations• Mission/Program Related Inv. – from foundations• Impact Angels – high-net worth individuals and
groups• Seed/Super Angel Funds – like ID!
Funding Options for Social Entrepreneurs
SCALING THE ENTERPRISE
Money, scale, and impact• Show them the money (have proven revenue)• Show them the scale (illustrate a vast market
and product iterations)• Show them the impact (measure the
improvements)
Returning the capital• Debt repayment schedule (easy if you have
revenue)• Exists for equity (the hardest thing in S.E.)
Funding Options for Social Entrepreneurs
INVESTED DEVELOPMENT (ID)
ID is a Boston-based investment management firm focused on scalable innovations for emerging markets. •BSP Fund
– Seed-stage investment fund committed to supporting entrepreneurs with radically affordable innovations in alternative energy and mobile technologies.
•BETA– provides pre-seed support and co-creates
enterprise with innovators whose technologies fit the BSP Fund focus areas.
Funding Options for Social Entrepreneurs
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 65© 2011 Foley Hoag LLP. All Rights Reserved.
TCN & Mass ChallengeJuly 7, 2011
Paul G. SweeneyPartner
(617) [email protected]
© 2011 Foley Hoag LLP. All Rights Reserved.
Angel Group and Venture CapitalTerm Sheets
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 66© 2011 Foley Hoag LLP. All Rights Reserved.
These materials have been prepared solely for educational purposes. The
presentation of these materials does not establish any form of attorney-client
relationship with the author or Foley Hoag LLP. Specific legal issues should
be addressed through consultation with your own counsel, not by reliance on
this presentation or these materials. Attorney Advertising. Prior results do not
guarantee a similar outcome. © Foley Hoag LLP 2011.
United States Treasury Regulations require us to disclose the following: Any
tax advice included in this document and its attachments was not intended or
written to be used, and it cannot be used by the taxpayer, for the purpose of
(i) avoiding penalties under the Internal Revenue Code or (ii) promoting,
marketing or recommending to another party any transaction or matter
addressed herein.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 67© 2011 Foley Hoag LLP. All Rights Reserved.
The Lawyer’s Perspective – Paul Sweeney
Corporate Partner at Foley Hoag LLP
Close to 100 angel and venture capital financings (debt and equity) since 1998.
SCVNGR (Highland, Google Ventures, Balderton - $15M)
Vanu (Charles River Ventures, Norwest - $32 M)
Centive (Polaris, TWP - $28 M)
Kyruus (Highland, Venrock - $5.5 M)
© 2011 Foley Hoag LLP. All Rights Reserved.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 68© 2011 Foley Hoag LLP. All Rights Reserved.
General Trends
Angel and venture capital has finally begun to flow again since 2008 freeze
Valuations are rising in some sectors, although deals still take more time, and terms are trending more favorable to companies and founders
Syndicates are still desirable to investors
Early stage deal sizes tend to be shrinking
Huge need to be quick and lean
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 69© 2011 Foley Hoag LLP. All Rights Reserved.
What is a term sheet?
aka- “Letter of Intent,” “Memorandum of Understanding,” “Agreement in Principle”
Basic agreement on the material terms of the transaction – Road map, marching orders
More detail is generally better (especially for the company/seller)
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 70© 2011 Foley Hoag LLP. All Rights Reserved.
Non Binding (But…..)
Generally not a binding agreement
–Subject to actual documents being negotiated
–Subject to due diligence
–Subject to other closing conditions (consents, etc.)
Confidentiality (“No Shop”)
–No disclosure of terms (and even existence) of the term sheet
Exclusivity
–Investor has some period of exclusivity (45 to 90 days)
If you really want to mess up your transaction, this is the place to do it
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 71© 2011 Foley Hoag LLP. All Rights Reserved.
Founders’ Main Concerns
Loss of control over your company
Dilution of your personal equity position
Stock subject to repurchase if terminated
Is the financing adequate for your plans
Future capital needs and dilution
Success of partnership with angels and VCs – access to key industry contacts, future $, business guidance
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 72© 2011 Foley Hoag LLP. All Rights Reserved.
Investors’ Main Concerns
Accuracy of valuation (both present and projected)
Risk level of investment
Projected returns on investment (ROI)
Liquidity if business in distress (downside protection)
Ability to participate in later rounds (upside protection)
Influence and control over management and strategic direction
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 73© 2011 Foley Hoag LLP. All Rights Reserved.
Pre-Money Valuation
“Pre-Money Valuation” = value of the company before the new money is invested
– Helps calculate price per share, and % of the company being sold
Share Price = Pre-Money Valuation
Pre-money Shares Outstanding
Critical Issue –What shares are counted as “Outstanding”?– All outstanding options?
– All options reserved for issuance under the option pool?
– Note: The higher this number, the lower the share price, and thus the higher the number of shares issued for the same amount invested
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 74© 2011 Foley Hoag LLP. All Rights Reserved.
Post-Money Valuation
“Post-Money Valuation” = pre-money valuation + the amount invested.
Pop Quiz: New investor values your company at a pre-money valuation of $10,000,000, and offers to invest $5,000,000 into the company.
Question: What percentage of the company would the investor own after the investment?
A: 33%
B: 50%
C: It’s too soon after lunch for a math quiz
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 75© 2011 Foley Hoag LLP. All Rights Reserved.
Key Terms – Pre Money Valuation
Pre Money Valuation (Without Option Pool)
33%
67%
Investors
Founders
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 76© 2011 Foley Hoag LLP. All Rights Reserved.
Key Terms – Pre Money Valuation
Pre Money Valuation (With Option Pool)
33%
47%
20%
Investors
Founders
Option
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 77© 2011 Foley Hoag LLP. All Rights Reserved.
CAUTION!
Pre-Money Valuation is only one of many economic terms.
“You can name the valuation, if I can name all the other terms.”
- Angel / VC Investor
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 78© 2011 Foley Hoag LLP. All Rights Reserved.
Convertible Preferred Stock
Why Convertible Preferred Stock?– “Stock” – All the upside of equity ownership
– “Convertible” – Converts into common stock
– “Preferred” - Preference over common stock on dividends, distributions, liquidation, redemption, etc.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 79© 2011 Foley Hoag LLP. All Rights Reserved.
Liquidation Preference
Applies when a “liquidation event” occurs (usually M&A)
When distributing liquidation proceeds, preferred stock has right to get its money back (and perhaps more) before the common stock gets anything.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 80© 2011 Foley Hoag LLP. All Rights Reserved.
Liquidation Preference
Sometimes “multiples” are used (1x, 2x, 3x the investment amount). Sometimes accruing dividends are included.
“Preference overhang” is the total amount of proceeds due to the preferred stock – can make the common stock virtually worthless.
Three main flavors:
– Non-participating
– Participating preferred (without cap)
– Participating preferred (with cap)
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 81© 2011 Foley Hoag LLP. All Rights Reserved.
Liquidation Proceeds
Source: www.wikipedia.org
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 82© 2011 Foley Hoag LLP. All Rights Reserved.
Non-Participating Preferred
Source: www.wikipedia.org
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 83© 2011 Foley Hoag LLP. All Rights Reserved.
Participating Preferred
Source: www.wikipedia.org
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 84© 2011 Foley Hoag LLP. All Rights Reserved.
Current Trends (Q1/11 – Q2/11)
For Series A financings, 28-50% had some form of participating preferred.
For Series B+ financings, 55-72% had some form of participating preferred.
Source: Foley Hoag’s Perspectives – June 2011
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 85© 2011 Foley Hoag LLP. All Rights Reserved.
Antidilution Protection
Addresses Investors’ concern re: valuation
Protect investors in a “down round” - when new money comes in later at a pre-money valuation (or price per share) that is lower than the previous round’s post-money valuation.
All preferred stock converts to common stock at a certain ratio, usually 1-for-1.
Anti-dilution protection, if triggered, changes the conversion ratio, resulting in the preferred getting more shares of common upon conversion
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 86© 2011 Foley Hoag LLP. All Rights Reserved.
Weighted Average
Takes into account the proportional relevance (or weight) of each component in the calculation rather than treating each component similarly.
Result - the conversion ratio based on the average of the price at which the company sold the new stock, valuing the common stock outstanding at the pre-adjusted conversion price.
Sometimes formulated as “broad-based” and sometimes as “narrowly-based” (“narrowly-based” is more favorable to the protected preferred stock.)
More typical, and much less onerous to un-protected stockholders, than full ratchet.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 87© 2011 Foley Hoag LLP. All Rights Reserved.
Full Ratchet
The conversion ratio of the protected preferred stock is “ratcheted down” to the lowest price at which securities are sold in the down-round.
This applies even if only one share is sold! Treats all down-rounds the same, irrespective of number of shares actually issued.
Very onerous, and not the standard approach.
Usually seen in company’s without bargaining leverage, in distress, or with a history of down rounds.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 88© 2011 Foley Hoag LLP. All Rights Reserved.
Current Trends (Q1/11 – Q2/11)
For Series A financings, 8% had full ratchet; remainder were evenly split between narrowly based and broadly based weighted average.
For Series B+ financings, 18% had full ratchet.
Source: Foley Hoag’s Perspectives – June 2011
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 89© 2011 Foley Hoag LLP. All Rights Reserved.
Other Key Terms for Company
Dividends
Redemption
Voting Rights – Board Seats
– “Protective Provisions”
Pre-emptive rights
Information rights
Registration rights
Legal fees / Drafting control
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 90© 2011 Foley Hoag LLP. All Rights Reserved.
Other Key Terms for Founders
Reverse Vesting
Non-competition and Non-solicitation Agreements
Non-Disclosures and IP Development Agreements
Right of first refusal
Drag along rights / Tag along rights
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 91© 2011 Foley Hoag LLP. All Rights Reserved.
Convertible Notes
Automatic conversion on qualified financing
Discounts are increasingly common; sometimes coupled with a cap on valuation
Paid or converted upon acquisition
Interest Rate
Maturity Date
Collateral (secured or not)
% needed to amend terms
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 92© 2011 Foley Hoag LLP. All Rights Reserved.
Final Thoughts
Focus on what’s in the best interest of the company.
Don’t be afraid to ask “why” when terms are proposed.
All money is not created equal. Choose your investors wisely – their belief in YOU is more important than their capital.
© 2008 Foley Hoag LLP. All Rights Reserved. Presentation Title | 93© 2011 Foley Hoag LLP. All Rights Reserved.
Other Resources
www.emergingenterprisecenter.com:– Glossary (commonly used terms)
– Ask the Startup Lawyers (common questions and answers; submit your questions!)
– EEC Perspectives (our quarterly publication tracking terms of New England VC deals)
NVCA Model Venture Capital Financing Documents (including model term sheet):– www.nvca.org (click “Resources” then “Model Legal
Documents”) or use http://bit.ly/bj7Pn
– Forms are intended as starting point only
Paul G. SweeneyPartner
(617) [email protected]
© 2011 Foley Hoag LLP. All Rights Reserved.
Questions?
•Jeff Bussgang
•Colin Angle
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