Anatomy of a Term SheetJuly 18, 2002

Starter Fluid, L.P.Robert von Goeben, Managing Director

rvg@starterfluid.comhttp://www.starterfluid.com

SM

Anatomy of a Term Sheet

Anatomy of a Term Sheet

1) Vital Parts•Shares issued

•Investors and amounts

•Capitalization table

2) Operating Terms•Board Composition

•Voting Rights

•Founders vesting

3) Financial Terms•Valuation

•Liquidation Preferences

•Antidilution Provisions

•Dividends & Redemptions

•Legal Costs

Part One: Vital PartsPart One: Vital Parts

• “Deal at a glance”

• Designed to save time and limit legal expenses

• Always have cap table included on term sheets

• Clearly spell out investors, counsels and amounts invested

Part Two: Operating Terms

Part Two: Operating Terms

Board of DirectorsBoard of Directors

• Most institutional investors push for board seat, some angels also

• Typical series A board size is 5– 2 series A– 2 common (one must be CEO)– 1 outside agreeable to A & common

• Good practice to name board members on term sheet

• Strive for “balance of interest”

Founders VestingFounders Vesting

• Founders typically seek credit for “past work, investors want to tie founders to company

• 25% of stock can immediately vest depending on past work

• Remainder on 4-5 year vesting schedule, with 6 month or 1 year cliff

• Acceleration for termination w/cause or double-trigger for acquisition

Voting ProvisionsVoting Provisions

• Very important to control factors that affect a class of stock

• Typical provisions:– Transfer of control or liquidation– Any adverse change in rights to class– Creation of senior security– Change in size of board– Declaration of dividends

Part Three: Financial Terms

Part Three: Financial Terms

ValuationValuation

• Some say “valuation is all that matters”• “All deals are A rounds”

– Current market has valuation equal to financing amount

– Today seeing 50% dilution to company

• Q1 2002 valuation stats*– 57% down rounds– 10% flat from previous round– 33% up-rounds

*Source: Fenwick & West LLP

Liquidation PreferencesLiquidation Preferences

• Who gets money in what order • New investors are getting in the front of the

line• Q1 2002 Stats*

– 62% of deals had senior liquidation prefs to earlier round

– 58% had multiple preferences– Of multiple preferences:

• 66% were 2X• 27% were 3X• 7% were greater than 3X

*Source: Fenwick & West LLP

Antidilution ProvisionsAntidilution Provisions

• Two types of antidilution:– Ratchet – “Price protection”, share price

reduced to new round price within 6-12 mos.– Weighted Average – Formula on how stock

gets repriced

• Q1 2002 Stats*– 29% ratchet antidilution– 69% weighted average antidilution– 2% no anti-dilution

*Source: Fenwick & West LLP

Dividends & RedemptionDividends & Redemption

• 2002 stats on redemptions*– 36% of the financings provided for

mandatory redemption or redemption at the option of the investor

• Dividends have historically been “when and if declared by board of directors”

• Non-cumulative, not mandatory

*Source: Fenwick & West LLP

“Pay-to-Play”“Pay-to-Play”

• Current trend to “wash out” previous investors over and above dilution

• New investors pushing tough “pay-to-play” provisions

• Q1 2002 Stats*– 20% of financings had pay-to-play– 56% converted non-participating to common– 22% converted to “shadow preferred”– 22% blend of common and shadow

*Source: Fenwick & West LLP

Legal CostsLegal Costs

• Company usually pays investor legal expenses

• Company pushes hard to put cap on expenses

• Typical seed deals: up to $10K

• Later stages: up to $25-50K

• Depends on fees in geography

Other TermsOther Terms

1. Right of first refusal on new-issue and founders selling shares

2. Information rights is key– Make sure your # shares falls within limits

3. Key-Person insurance on founders4. Employment, confidentiality and invention

agreements with founders5. Registration, piggy back rights, demand

rights: get standard terms through attorneys

Good Terms Sheet Practices

Good Terms Sheet Practices

• Short (2-4 pages)

• Designed to reduce legal fees

• Don’t go it alone: get good legal counsel

• Term sheet is mostly business terms

• Be aware you’re setting precedent on terms for later investors!

Starter FluidStarter Fluid

Starter Fluid is one of the only professionally-managed,

institutionally-backed pure seed funds.

• Closed $32M - June 2000• $100-500K initial investments, up to $3M total• Investors:

– Institutions: Univ Chicago, Searle Trust, FLAG Venture Management, Tucker Anthony, Compaq Computers, Crossroads Ventures, and others

Anatomy of a Term SheetJuly 18, 2002

SM