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Conquering the Term Sheet
Everything You Need to Know About Deal Terms
Part 2
David StarkPartner, OurCrowd
@starkupnation
Zack MillerPartner, OurCrowd
@newrulesinvest
OurCrowd
Leading equity crowdfunding platform with 8000+ investors
from over 100 countries
Quick ReviewLesson 1 - Equity
Valuation Liquidation preferences
ESOP
Key takeawayNeed to look at the
WHOLE term sheet to see the full
picture
Mailbox: Liquidation preferences
preferred shares automatically convert to common in a
qualified IPO
Q: What happens to liquidation preferences in
the event of an IPO?
Mailbox: Investment amount
Warrants are the rights to invest X amount at $Y for a period of Z
months.
Q: Can you explain how warrants work?
Real life example: Currently funding company on OurCrowd.com with 15% warrant coverage at current
price (for 2 years)
Today’s agenda
Pre-emptives Anti-dilution provisions
Board of Directors Information Rights
Veto Rights Right of first refusal Drag along rights Registration rights
Pre-emptive (Pro-rata) Rights
Pro-rata right is the right to invest in later rounds in
order to maintain your ownership
–Fred Wilson, Union Square Ventures
“I think pro-rata is the single most important term anyone can negotiate for in a venture
capital investment.” (Source)
Because returns in early stage investing come from a small portion of
your portfolio and therefore, you want to own as much as you can in the winners
Let’s illustrate
Ownership % in the company * new investment amount = pro-rata right
Invest $100k at $10M post, you own 1% Say the company raises $5M at $20M premoney They are selling 20% of the company and you would be diluted to 0.8% (without pro-rata)
Formula
Example
If you want to maintain 1% holding, then you would invest 1% of the $5M (or, $50k)
Implications for upround, downround scenarios
Individual angels rarely get “the most important right” (prorata) —>
institutional investors (like OurCrowd and VCs) do
Current''Ownership'
Total'New'Investment'
Post'Money'Ownership'
1%'1%' ?'
100%'of'the'company'
25%'being'sold'to'new'investor'
25%'
.75%'
.25%'1%'
25%$99%$ 74%$
Current''Ownership'
Total'New'Investment'
Post'Money'Ownership'
1%'1%' ?'
100%'of'the'company'
25%'being'sold'to'new'investor'
25%'
.75%'
.25%'1%'
25%$99%$ 74%$
Current''Ownership'
Total'New'Investment'
Post'Money'Ownership'
1%'1%' 1%'
100%'of'the'company'
25%'being'sold'to'new'investor'
25%'
.75%'
.25%'1%'
25%$99%$ 74%$
Anti-dilution provision
protection from dilution resulting from later issues of stock at lower price than investor originally paid
Definition
Weighted Average
Full Ratchet Broad-based Narrow-based
if company issues shares at a lower
price, earlier price is effectively reduced
to price of new shares
NCP = OCP * ((CSO + CSP) / (CSO + CSAP))
NCP = new conversion price OCP = old conversion price CSO = common stock outstanding CSP = common stock purchasable with consideration received by company (i.e. “what the buyer should have bought if it hadn’t been a ‘down round’ issuance”) CSAP = common stock actually purchased in subsequent issuance (i.e., “what the buyer actually bought”)
CSO = ALL shares of stock outstanding, including
options, ESOP, convertible securities
CSO = Only the number of shares of the series of Preferred that is being
adjusted
Anti-Dilution Provision
Without Anti-Dilution
Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
Full Ratchet
Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
Broad-Based Weighted
Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
Narrow-Based weighted
Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
Anti-dilution Cheat Sheet
Investor A invests $2M at $8M pre (20% ownership) Investor B invests $5M at $7.5M pre (40% ownership)
Vesting
Key here is to ensure management’s commitment
What’s a cliff?
Typical Schedule
?
Board representation
• Liquidation preference • Right to participate pro-rata in future rounds • Right to a board seat
–Fred Wilson, Union Square Ventures
The 3 terms you must have in a venture investment (other than price):
Typical Board Composition
Investors, Founders, Industry Expert
What does a BOD do?• corporate governance • approving annual budgets • accounting to the stakeholders for the organization's
performance • selecting, appointing, supporting and reviewing the
performance of the chief executive; • ensuring the availability of adequate financial resources • setting the salaries and compensation of company
management
director vs.
observer
Information rights
Starting point: Entrepreneurs want happy investors and owe them communication. How much, though?
Veto rights
Protective and Control
Right of first refusal / Co-saleIf common holders want to sell stock, investors
have a right of first refusal on purchasing the stock or they have the right to participate in the
proposed sale
Bring along/Drag alongMajority shareholders
can force minority to sell
Registration rights
• an investor’s right to force a company to list shares publicly so investor can sell them
• demand registration, piggyback rights, S-3
Next step?
Join us next week for Lesson 3Other common investment structures:
Convertible Notes SAFEs
OurCrowd.com
Check out our real-life term sheets by
accrediting on our website