Pillsbury Winthrop Shaw Pittman LLP

Angel Investment SecuritiesPillsbury Winthrop Shaw Pittman LLP

October 15, 2008

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Introduction

Steven L. Meltzer, Esq. Striking Resemblance to Fred Flintstone

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Introduction

Kevin R. Learned, Esq. Always wins office Halloween costume contest

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Types of Securities

Common Stock

Convertible Notes

Preferred Stock

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Common Stock

Typical security issued to Founders and family/friend Investors

No inherent economic advantage for the Investors over the FoundersInvestors can be protected through contractual arrangements

Stockholders Agreement Voting Agreement (giving the Investors a Board seat) Right of First Refusal and Co-Sale Agreement

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Example (Common Stock)

Investment of $1 million

Founders: Bill Gatesly and Steve Casey each own 150,000 shares of Common Stock of Slushy Software, Inc., valued at $3 million

Investors: Warren Buffer and Donald Trumpet each purchase 50,000 shares of Common Stock for $10 per share, for a total investment of $1 million

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Example (Common Stock)

Post-closing capitalization

Slushy Software, Inc., valued at $4 million Warren and Donald own 100,000 shares of Common

Stock (25%) Bill and Steve own 300,000 shares of Common Stock

(75%)

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Example (Common Stock)

Sale for $20 million Warren and Donald receive $5 million Bill and Steve receive $15 million

Sale for $2 million Warren and Donald receive $500,000 Bill and Steve receive $1.5 million

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Convertible Notes

Typical security offered to sophisticated Investors prior to a Series A Preferred Stock round

Hopeful bridge to a Series A financing

Avoids setting valuation of the Company

Allows Investors to piggy-back

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Convertible Notes

Debt security rather than an equity interest Senior to Founders and other equity holders Generally unsecured Interest rate typically at 8% per annum, non-compounding No voting rights or control over the Company Mandatory Conversion

Automatically converts into subsequently issued equity securities Conversion price at a discount to price paid by new investors - 10% is a typical discount

Automatically converts into subsequently issued equity securities Conversion price at a discount to price paid by new investors -

10% is a typical discount Investor may convert to Common Stock at any time Conversion price at an agreed future valuation of the Company

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Example (Convertible Notes)

Investment of $1 million Founders: Bill Gatesly and Steve Casey each own

150,000 shares of Common Stock of Slushy Software, Inc.

Investors: Warren Buffer and Donald Trumpet each invest $500,000 into Slushy Software, Inc. Purchase convertible notes at 8% per annum, non-compounding, with an optional conversion price based on a Company valuation of $10 million

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Example (Convertible Notes)

Post-closing capitalization Warren and Donald together hold convertible notes in

the aggregate principal amount of $1 million Bill and Steve together own 300,000 shares of

Common Stock (100%) The sale of Convertible Notes does not establish a

valuation for Slushy Software, Inc.

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Example (Convertible Notes – Successful Exit)

Sale for $20 million after two years Warren and Donald elect to convert their notes into

39,366 shares of Common Stock (outstanding principal and interest / per share conversion price) OR ($1,160,000 / ($10,000,000 / # shares of Common Stock following conversion))

Warren and Donald receive approximately $2.32 million ($20,000,000 x (39,366 shares of Common Stock / 339,366 shares of Common Stock))

Bill and Steve receive $17.68 million

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Example (Convertible Notes – Unsuccessful Exit)

Sale for $2 million after two years

Warren and Donald do not convert their notes Warren and Donald receive $1.16 million in principal

and interest Bill and Steve receive $0.84 million

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Common Stock vs. Convertible Notes

Sale for $20 million after two years

$15,000,000

$5,000,000

$17,680,000

$2,320,000

$0

$4,000,000

$8,000,000

$12,000,000

$16,000,000

$20,000,000

Common Stock Convertible Notes

Security Purchased

Founders

Investors

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Common Stock vs. Convertible Notes

Sale for $2 million after two years$1,500,000

$500,000

$840,000

$1,160,000

$0

$400,000

$800,000

$1,200,000

$1,600,000

Common Stock Convertible Notes

Security Purchased

Founders

Investors

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Preferred Stock

Typical security offered to Angel Groups, Venture Capitalists and other sophisticated Investors

Dividends at 8% per annum, non-compounding

Convertible into Common Stock Automatic Conversion

Consent of the holders of Preferred Stock IPO

Optional Conversion

Liquidation preference over Founders set forth in charter documents

Double Dip Double Dip, subject to a cap Single Dip

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Example (Preferred Stock)

Investment of $1 million

Founders: Bill Gatesly and Steve Casey each own 150,000 shares of Common Stock of Slushy Software, Inc.

Investors: Warren Buffer and Donald Trumpet each purchase 50,000 shares of Series A Preferred Stock for $10 per share, for a total investment of $1 million

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Example (Preferred Stock)

Post-closing capitalization

Warren and Donald own 100,000 shares of Series A Preferred Stock (25%)

Bill and Steve own 300,000 shares of Common Stock (75%)

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Example (Preferred Stock – Double Dip – Successful Exit)

Sale for $20 million after two years Warren and Donald receive $1.16 million in liquidation

preference, including dividends Warren and Donald receive an additional $4.71 million

in pro rata distribution (25% x ($20 million - $1.16 million))

Warren’s and Donald’s total proceeds equal $5.87 million

Bill and Steve receive $14.13 million in pro rata distribution (75% x ($20 million - $1.16 million))

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Example (Preferred Stock – Single Dip – Successful Exit)

Sale for $20 million after two years

Warren and Donald convert their Preferred Stock to Common Stock 1:1

Warren and Donald receive $5 million Bill and Steve receive $15 million

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Comparison of Securities – Successful Exit

Sale for $20 million after two years

$15,000,000

$5,000,000

$17,680,000

$2,320,000

$14,130,000

$5,870,000

$15,000,000

$5,000,000

$0

$4,000,000

$8,000,000

$12,000,000

$16,000,000

$20,000,000

CommonStock

ConvertibleNotes

PreferredStock (Double

Dip)

PreferredStock (Single

Dip)

Security Purchased

Founders

Investors

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Example (Preferred Stock – Double Dip – Unsuccessful Exit)

Sale for $2 million after two years Warren and Donald receive $1.16 million in liquidation

preference, including dividends Warren and Donald receive an additional $0.21 million

in pro rata distribution (25% x ($2 million - $1.16 million))

Warren’s and Donald’s total proceeds equal $1.37 million

Bill and Steve receive $630,000 (75% x ($2 million - $1.16 million))

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Example (Preferred Stock – Single Dip – Unsuccessful Exit)

Sale for $2 million after two years

Warren and Donald do not convert their Series A Preferred Stock

Warren and Donald receive $1.16 million in liquidation preference, including dividends

Bill and Steve receive $840,000 ($2 million - $1.16 million)

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Comparison of Securities - Unsuccessful Exit

Sale for $2 million after two years$1,500,000

$500,000

$840,000

$1,160,000

$630,000

$1,370,000

$840,000

$1,160,000

$0

$400,000

$800,000

$1,200,000

$1,600,000

CommonStock

ConvertibleNotes

PreferredStock (Double

Dip)

PreferredStock (Single

Dip)

Securities Purchased

Founders

Investors

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Additional Terms for Series A Preferred Stock

There are many more protections available to holders of Preferred Stock than for holders of Common Stock

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Additional Terms for Series A Preferred Stock

Anti-dilution protection Stock splits, stock dividends and recapitalizations Dilutive issuances

Redemption rights

Election of Board Members

Voting rights Voting on an as-converted basis

Separate statutory voting rights

Separate vote for significant actions (negative covenants)

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Additional Terms for Series A Preferred Stock

Information rights

Registration rights

Rights of First Refusal

Co-Sale Rights

Drag Along Rights

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Additional Terms for Series A Preferred Stock

Many of these rights usually appear in contracts separate from the Company’s organizational documents

Investor Rights Agreement Registration Rights Agreement Voting Agreement Right of First Refusal and Co-Sale Agreement

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Founder and Employee Matters

Option Pool and Restricted Stock New option grants for employees, directors and

consultants subject to vesting Previously issued Founder stock subject to vesting Acceleration of Vesting

Proprietary Information and Inventions Agreement

Restrictions on Founder Stock Sales

Key-Man Insurance

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Other Matters

No Shop Agreements

Indemnification protection for directors and officers

Assignment by Investors

Investors’ legal fees and expenses

Due diligence

Budget

Finder fees

Confidentiality

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Conclusion

Any Questions?