Early Stage Financing for Startups

January 2016

Early Stage Financingsfor Start-ups

Asaf Kharal

WSGR Advise more than 300 public and 3,000 private enterprises

Advise more U.S. technology companies on their initial public offerings thanany other law firm (Capital IQ)

Advise more technology companies on their M&A transactions than anyother law firm (Bloomberg)

Represent more companies that receive venture financing than any other lawfirm (Dow Jones VentureSource/ PitchBook)

Most frequently hired securities litigation firm in the country (SecuritiesLaw360)

Selected for inclusion in the Intellectual Property Hot List (The National LawJournal)

2

WSGR

3

IPO/Early PublicCompany

Multibillion-DollarGlobal/Mature

Public Company

Entrepreneur/Start-up/

Venture Capital

Complex Business Litigation

Antitrust

Securities Litigation

White Collar Crime & Government Investigations

Energy & Infrastructure Finance

Debt Finance

Mergers, Acquisitions & Business Realignments

Intellectual Property Litigation

Intellectual Property Counseling & Patents

Trademarks, Copyrights & Advertising

Fund Services

Venture Financing

Early Corporate Organization

Global Outsourcing Transactions

Corporate Governance

Public Company Disclosure & Reporting

Export Controls

Tax – Domestic & International

Public Offerings

Real Estate & Environmental

Employment Law

FDA Regulatory & Healthcare Law

Technology Licensing & Transactions

Employee Benefits & Compensation

Pro Bono

Consumer Regulatory & Privacy

High Level Trends in Early Stage Financings

Pre-Seed is the new Seed; Seed is the new Series A; Series A is the newSeries B

Massive late stage rounds

New sources of money (China, Russia, Middle East, India)

More international startups

Investors care more about pro rata rights

SAFEs gaining ground

4

The New Start-up Financing Ecosystem

5

Incubation(under $100K)

Pre-Seed(Under $500K)

Seed ($1M-$5M)

Series A ($5Mto $15M)

Series B (Over$15M)

Large VentureFunds

Small VentureFunds

Super Angels& Micro-VCs

Angels, Incubators& Accelerators

Pre-Seed is the new SeedSeed is the new Series A

Preparing for Financing

Organization of the company

Founder and team equity

IP protection

– Intellectual property is an important corporate asset, so taking steps to ensurethat it is properly assigned to the company is essential.

– Assignment of IP by founders

– Confidentiality and Invention Assignment Agreements with employees andcontractors

– Data privacy and protection

– Trademarks, copyrights, trade secrets, patents and other registrations

Record keeping

6

Types of Early Stage Investment

Key Elementsof a Financing

Size – how much money should be raised

Source – where is the money coming from

Type of Security

Valuation required – does the investment require avaluation of the company?

Debt based/interest – does the investment mean agrowing debt load?

Impact on control rights

Liquidation preferences

7

Types of Early Stage Financings

8

Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding

Series A Venture Round


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


9

• Founder funding and self funding• Varies in size based on company’s means

and needs• Type – common stock or promissory notes• Important to document capital contributions

and the expectations for equity, repaymentor conversion

• Expectations of repayment upon a futurefinancing may not be met

• Valuation must be handled carefully


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


10

• Converts into later round preferred stock ifsold to investors in connection with laterfinancing

• Intended to solve founder sale of commonat preferred price affecting common FMV

• Must be fully vested (or potentiallyconsidered compensation income)

• Typically, not more than 25% of foundersequity is Series FF

• Cannot be subject to board discretion toallow conversion


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


11

• Highly dependent on facts and circumstances• Varies in size though usually less than

$50,000• Type – common stock, promissory notes

(convertible or non-convertible), contributionsto capital

• A valuation may be required• Equity or debt• Usually no impact on control rights• Typically no liquidation preference• Potential downsides

• Risks to personal relationships• Investors usually have no experience to bring

to the table• These investments are usually not sources of

a large amount of money• Familiarity with investors can lead

entrepreneurs into the trap of inadequatedocumentation


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


12

• Contracts with lead customers/early adoptersfor funding in exchange for early access tothe developed product or service.

• Varies in size• No valuation, typically no debt or equity

issued• Later strategic deals may involve ROFR or

ROFN• No liquidation preference• Contracts can raise important issues

including:• Commercial rights and restrictions• Ownership and rights in intellectual property• Confidentiality• Early strategic agreements can make or

break a company


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


13

• A promissory note for the full investmentamount with an interest rate and a maturitydate

• Typical maturities are one year• Automatic conversion on a “qualified

financing”• Optional conversion on other financings• Discount and/or warrants on conversion• Premium on a change of control• Valuation caps for conversion• The larger the convertible debt financing, the

less likely it is to be combined with the newmoney in a preferred stock financing


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


14

• Essentially a convertible note that lacks andinterest rate provision or maturity date

• Not debt, the instrument is bestconceptualized as a placeholder for which theinvestor pays full value up front in exchangefor a future security at a later date

• Perceived to be founder friendly


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


15

• SAFE: Simple Agreement for Future Equity• Another form of convertible equity• Like convertible security it strips the debt like

attributes from the convertible note• Drafted to be layperson friendly as

accessibility is prioritized overcomprehensiveness - only 6 pages long

• It has the backing of Y Combinator and itspartners


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


16

• Size – varies• Source – angel investors; accelerators• Valuation – no• Debt based – no• Control rights given up – typically no• Liquidation preference – yes


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


17

• Common stock at founder price• Plus convertible equity for $15-$100K• YC, AngelPad, TechStars• Avoid creating a high common stock FMV• Additional “blind pool” financing


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


18

• Size – $50,000 to $1M• Source –a single investor or a group of

affiliated investors• Type – common stock, convertible debt,

promissory notes• Valuation – depends on if debt or equity

based• Control rights – depends on the size of the

round, may include a board seat, protectiveprovisions and participation rights

• Liquidation preferences – yes if preferredstock


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


19

• Simplified series A financing documentsavailable at http://www.seriesseed.com/

• Designed to save time and money relative totraditional equity based financing documents,they omit specific provisions in an effort tosimplify

• What they’re missing relative to traditionalseries A documents

• Dividend preference• Registration rights• Anti-dilution protection and other protective

provisions• Voting agreements• Comprehensive representations and

warranties


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


20

• Size – roughly $500,000, typically not largerbecause of investors’ desire for protectiveprovisions

• Source – Angels, Friends and Family• Type - preferred stock• Valuation required – yes• Debt based/interest concerns – no• Control rights given up – often include a

board seat, participation rights and protectiveprovisions

• Liquidation preference – yes 1x non-participating typical


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


21

• Lots of groups call their own documents“series seed” and these can differ from thestandardized documents. Be wary.

• The provisions are relatively inelastic andcannot be easily customized

• They contain fewer investor protections bydefault

• New documents often have to be drafted forlater rounds and things like the certificate ofincorporation must be amended


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


22

• The practice of funding a project or ventureby raising money from large numbers ofpeople, typically over the internet

• It can be conceptualized in two differentcontexts

• Preselling a product – pebble smartwatch,Shenmue III

• Selling equity in a company• This is an evolving area of the law. The

passage of the Jumpstart Our BusinessStartups Act (JOBS Act) in 2012 createdopportunities for funding based on the sale ofequity or debt through the internet, but detailsand a clear regulatory structure have beenslow to emerge.


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


23

• SEC Guidance• Companies will be allowed to raise a

maximum aggregate amount of $1 millionthrough crowdfunding offerings in a 12-monthperiod. Companies must disclose:

• The price to the public of the securities or themethod for determining the price, the targetoffering amount, the deadline to reach thetarget offering amount, and whether thecompany will accept investments in excess ofthe target offering amount

• The company’s financial condition• Reviewed or audited financial statements• A description of the business and the use of

proceeds from the offering• Information about officers and directors as

well as owners of 20% or more of thecompany

• Certain related party transactions


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


24

• Dangers of Crowdfunding:• Securities laws are complicated and securities

offerings are subject to strict reportingrequirements. Failure to comply withsecurities laws can lead to penalties andproblems down the road with future offerings

• Be cautious with Crowdfunding websites.Some websites allow the dissemination ofinvestment information to anyone browsingthe internet. This can constitute a securitieslaw violation. It’s best to know the website youare dealing with and know who yourinformation is being disseminated to

• Since it involves disclosing your company andidea, this funding is more appropriate forsome types of start-ups than others

• Established sites that limit access arepreferred


25

• Size – varies. Typically $2-10 million• Source – venture capital investors, often

several• Type – preferred stock• Valuation – Yes• Debt based – Not typically• Control rights given up – Yes, at least a board

seat• Liquidation preference – Yes

Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding



Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


26

• Choosing the right VC Partner• What network does the specific partner you

are working with bring to bear?• What past experience does that partner have

that might be helpful if on your board?• Speak to members of that partners current

and past portfolio• How involved will the VC Partner want to be in

your company


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


27

• Key Parts of a Series A Term Sheet:• Valuation• Pre and Post Money Valuations• Option Pool• Dividends – Non-Cumulative• Liquidation Preference

• Initial Preference• Participating or non-participating• Participation caps• Non-cumulative

• Antidilution – broad-based weighted average• Board Composition• CEO seat• Founder Vesting• Drag Along• Protective Provisions


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Convertible Debt

Convertible Equity

SAFE Instruments

Incubators

Angels

Seed Rounds

Crowdfunding


28

• Valuation Jargon• “3 on 3” means $3M pre-money with $3M

round• With a $6M post-money ($3+$3)• VCs will own 50% of the company• Let’s assume the required option pool is 15%

• This is what the cap table will look like:• Investors 50%• Founders 35%• Option Pool 15%

ASAF KHARAL

Wilson Sonsini Goodrich & Rosati, P.C.

650 Page Mill Road, Palo Alto CA 94304

Direct: 650-320-4557

[email protected]

Thank You

PALO ALTO650 Page Mill Road

Palo Alto, CA 94304-1050

Phone 650.493.9300

Fax 650.493.6811

AUSTIN900 South Capital of Texas Hwy

Las Cimas IV, Fifth Floor

Austin, TX 78746-5546

Phone 512.338.5400

Fax 512.338.5499

NEW YORK1301 Avenue of the Americas

40th Floor

New York, NY 10019-6022

Phone 212.999.5800

Fax 212.999.5899

SAN DIEGO12235 El Camino Real

Suite 200

San Diego, CA 92130-3002

Phone 858.350.2300

Fax 858.350.2399

SAN FRANCISCOOne Market Plaza

Spear Tower, Suite 3300

San Francisco, CA 94105-1126

Phone 415.947.2000

Fax 415.947.2099

SHANGHAIJin Mao Tower, 38F, Unit 03

88 Century Blvd, Pudong,

Shanghai 200121, China

Phone +86.21.6165.1700

Fax +86.21.6165.1799

WASHINGTON, D.C.1700 K Street NW, Fifth Floor

Washington, D.C., 20006-3817

Phone 202.973.8800

Fax 202.973.8899

SEATTLE701 Fifth Avenue

Suite 5100

Seattle, WA 98104-7036

Phone 206.883.2500

Fax 206.883.2699

Our Offices

WILMINGTON, DE222 Delaware Avenue

Suite 800

Wilmington, DE 19801

Phone 302.304.7600

Fax 866.974.7329

LOS ANGELES633 West Fifth Street

Suite 1550

Los Angeles, CA 90071

Phone 323.210.2900

Fax 866.974.7329

BEIJINGUnit 2901, 29F, Tower C

Beijing Yintai Centre

No. 2 Jianguomenwai Avenue

Chaoyang District, Beijing 100022

China

Phone +86.10.6529.8300

Fax +86.10.6529.8399

HONG KONGSuites 1509-1512

15/F, Jardine House

1 Connaught Place

Central, Hong Kong

Phone +852.3972.4955

Fax +852.3972.4999

BRUSSELSRue Montoyer 47

1000 Brussels, Belgium

Phone +32.2.274.57.00

Fax +32.2.274.57.99

UNITED STATES

ASIA EUROPE

SAN FRANCISCO/

SOMA139 Townsend Street

Suite 150

San Francisco, CA 94107

Phone 415.471.3940

Fax 866.974.7329

www.wsgr.com

Austin Beijing Brussels Hong Kong Los Angeles New York Palo Alto San Diego San Francisco Seattle Shanghai Washington, DC Wilmington, DE