Funding for Early Stage Startups

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  • Copyright 2017 by K&L Gates LLP. All rights reserved.

    Presented by Stan Lewandowskistan.lewandowski@klgates.com 650.798.6743January 26, 2017

    Silicon Valley Startup: Idea to IPO

    Funding for Early Stage Startups

  • 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 K&L Gates. Particular legal issues should be addressed through consultation with your own legal counsel, not by reliance on this presentation or these materials. Attorney Advertising. Prior results do not guarantee a similar outcome. K&L Gates LLP 2017.

    Circular 230 DisclosureTo ensure compliance with requirements imposed by the IRS, please be advised that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, 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 within.

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  • INTRODUCTIONS Stan Lewandowski, Esq., Partner (Emerging

    Growth/Corporate/M&A)

    Works primarily in the Silicon Valley and SF offices of K&L Gates in Palo Alto

    Advised clients (issuers and investors) in more than 100 closed angel and venture capital financings

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  • OVERVIEW The startup lifecycle

    Latest VC financing data (as of 12/31/2016)

    Latest trends relevant for early stage companies

    Most commonly used funding vehicles available to and used by early stage startups

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  • THE STARTUP LIFECYCLE Idea

    Sketches, rough prototype Proof of concept

    MVP or MVVP Building

    Capital raising Scaling Maturity and exit

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  • THE U.S. VC FUNDING SCENE 2014

    $68.9B Aggregate Deal Value 10,550 Number of Closed Deals

    2015 $79.3B Aggregate Deal Value 10,468 Number of Closed Deals

    2016 $69.1B Aggregate Deal Value (second annual total after 2015

    in the past 11 years) 8,136 - Number of Closed Deals

    Source: PitchBook 7

  • THE U.S. VC FUNDING SCENE

    Source: PitchBook 8

    $29.1 $35.5 $37.2 $26.5 $31.2 $44.3 $40.6 $44.8 $68.9 $79.3 $69.1

    3,301

    4,2924,707 4,458

    5,411

    6,771

    7,987

    9,326

    10,550 10,468

    8,136

    2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*$0

    $10

    $20

    $30

    $40

    $50

    $60

    $70

    $80

    $90

    0

    2,000

    4,000

    6,000

    8,000

    10,000

    12,000

    Deal value ($B)

    # of deals closed

    US VC activity by year2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*

    Deal value ($B) 29.08 35.55 37.16 26.48 31.18 44.30 40.63 44.82 68.86 79.26 69.11

    # of deals closed 3,301 4,292 4,707 4,458 5,411 6,771 7,987 9,326 10,550 10,468 8,136

    Company count 3,067 3,953 4,328 4,136 4,966 6,233 7,365 8,548 9,656 9,742 7,751

    *As of 12/31/2016

  • THE U.S. VC FUNDING SCENE

    Source: PitchBook 9

    US VC activity (#) by round size2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*

    Under $500K 259 430 559 768 1,090 1,409 1,875 2,258 2,404 2,198 1,544 $500K-$1M 219 304 382 434 558 765 918 1,042 1,109 1,079 806 $1M-$5M 1,013 1,333 1,464 1,449 1,744 1,995 2,302 2,785 3,063 3,197 2,716

    $5M-$10M 686 779 823 659 654 737 800 888 969 988 927 $10M-$25M 639 781 817 577 630 728 734 769 897 975 866

    $25M+ 248 336 318 205 260 354 373 404 636 709 606

    *As of 12/31/2016

    2006

    2007

    2008

    2009

    2010

    2011

    2012

    2013

    2014

    2015

    2016

    *0%

    20%

    40%

    60%

    80%

    100%

    $25M+

    $10M-$25M

    $5M-$10M

    $1M-$5M

    $500K-$1M

    Under $500K

  • THE U.S. VC FUNDING SCENE

    Source: PitchBook 10

    0.75 0.95

    4.50

    5.28

    10.25 10.00

    2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*$0

    $2

    $4

    $6

    $8

    $10

    $12Angel/Seed Early VC

    Later VC

  • THE U.S. VC FUNDING SCENE

    Source: PitchBook 11

    1.67 1.74

    9.43 10.75

    28.28 26.92

    2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016*$0

    $5

    $10

    $15

    $20

    $25

    $30Angel/Seed Early VC

    Later VC

  • MOST ACTIVE ANGEL/SEED/EARLY STAGE INVESTORS IN Q4 2016

    Source: Pitchbook 12

  • TRENDS

    Pre-Seed - new Seed Seed new Series A Series A - new B

    Where does the capital for early stage startups come from?

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  • U.S. FINANCING ECOSYSTEM

    Incubation up to ~$150K Pre-Seed up to ~$500K Seed - $1M to $5M

    Series A $4-5M to $15M Series B over $15M

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  • TERM SHEET AND ITS ROLE AKA LETTER OF INTENT (LOI),

    MEMORANDUM OF UNDERSTANDING (MOU) Sets out the key terms of a transaction agreed on in

    principle by the parties

    Outlines the timetable and obligations of the parties during negotiations

    Contains some legally binding terms (confidentiality, exclusivity, transaction expenses and more)

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  • MOST COMMONLY USED FUNDING VEHICLES Friends, Family and (FFF)

    Convertible Promissory Notes (Notes)

    Simple Agreements For Equity (SAFEs)

    Keep It Simple Agreements (KISSes)

    Other Options (crowdfunding, grants, etc.)

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  • CONVERTIBLE PROMISSORY NOTES Debt instruments with a conversion into equity feature

    Features

    Maturity date

    Interest

    Mostly, automatic conversion into equity in a qualified financing

    Conversion discount (~20%) or a valuation cap (max. pre-money valuation), or

    Premium on acquisition (1X+)

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  • CONVERTIBLE PROMISSORY NOTES Conversion Options Automatic Conversion

    Upon Qualified Financing

    What is a Qualified Financing?

    Discount

    Valuation Cap

    Fully Diluted Capitalization

    What if the valuation cap in the note is lower than that agreed by the company and the investors?

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  • CONVERTIBLE PROMISSORY NOTES

    Conversion Options Automatic Conversion

    If No Qualified Financing or Acquisition Before Maturity Date

    Conversion into Common Stock at a Pre-Agreed Valuation Cap on a Fully Diluted Basis

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  • SAFE (CONVERTIBLE EQUITY)

    Convertible equity instrument

    No debt features

    Interest

    Maturity

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  • SAFE (CONVERTIBLE EQUITY)

    Four available versions

    Price cap, no discount (no minimum amount for conversion)

    Discount, no price cap (no minimum amount for conversion)

    Price cap and discount

    Most favored nation (MFN) provision (no price cap or discount but MFN treatment, minimum amount for conversion)

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  • SAFE (CONVERTIBLE EQUITY)

    Price Cap, no Discount (no minimum for conversion)

    Price cap = valuation cap

    Conversion into Standard Preferred Stock or Safe Preferred Stock

    Same or different price per share

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  • SAFE (CONVERTIBLE EQUITY)

    Discount, no Price Cap (no minimum for conversion)

    Discount rate = [100 - the discount]%

    Conversion into shares of Standard Preferred Stock based on principal amount divided by price of Standard Preferred Stock sold in Equity Financing

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  • SAFE (CONVERTIBLE EQUITY)

    Price Cap and Discount

    Conversion into number of shares of Preferred Stock equal to:

    The principal amount divided either by:

    Safe Price (valuation cap/capitalization of company), or

    Discount Price (standard price of stock sold in Equity Financing x discount rate), whichever results in a greater number of shares

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  • SAFE (CONVERTIBLE EQUITY)

    Most Favored Nation (MFN) provision (no price cap or discount but MFN treatment, minimum

    amount for conversion)

    Whats the benefit?

    Amendment of existing documents to reflect better terms offered to investors purchasing issuers convertible securities in the future

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  • SAFE (CONVERTIBLE EQUITY)

    Now, what if:

    Company is acquired by another person before conversion of your principal amount into preferred stock?

    You can elect to:

    Receive your money back, or

    Automatically receive shares of common stock equal to the principal amount divided by FMV of companys common stock, if you fail to elect receipt of cash

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  • SAFE (CONVERTIBLE EQUITY)

    Now, what if:

    Company terminates its operations, liquidates, dissolves or winds up before conversion of your principal amount into preferred stock?

    You will:

    It depends

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  • SAFE (CONVERTIBLE EQUITY)

    Now, what if:

    Your investor asks for participation rights as part of its investment?

    Few options are available

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  • KISS DOCUMENTS

    Two versions

    Debt

    Equity (more favorable to the issuer)

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  • KISS DOCUMENTS

    Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

    Treatment in financing

    Conversion into preferred stock in a qualified financing round (~$1M, for instance) at a price thats lesser of cap or discount

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  • KISS DOCUMENTS

    Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

    Treatment in acquisition

    You elect to either convert principal into shares of common stock at a valuation cap or multiple of investment plus interest (2X)

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  • KISS DOCUMENTS

    Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

    Treatment at maturity

    If not converted in equity financing or part of an acquisition, then, on or after maturity, the majority in interest will elect to either convert into Series Seed Preferred Stock at a cap OR demand repayment from issuer

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  • KISS DOCUMENTS

    Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

    Most favored nation treatment

    Right to exchange the existing instrument for one issued subsequently to other investors on terms more favorable than the terms of the instruments issued to existing investors if such subsequent issuance occurs before conversion or repayment of the existing instrument

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  • KISS DOCUMENTS

    Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

    Information and participation rights

    Rights for Major Investors? Who is Major Investor?

    What are the rights?

    Information Participation (pro rata, 1X+ investment amount)

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  • OTHER OPTIONS TO SECURE CAPITAL

    AngelList (https://angel.co)

    Crowdfunding (www.kickstarter.com)

    Factoring (selling AR)

    Customer financing

    Grants

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  • THANK YOUFor Further Questions Please Contact:

    Stan LewandowskiPartner, K&L Gates LLP

    (650) 798-6743E-mail: stan.lewandowski@klgates.com

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