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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, it’s
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 VC’Sactual 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 it’s 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:
• Don’t 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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