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Speaker: Seffi Kaminitz
Join us www.IgniterSV.com
Igniters MeetupHacking the Startup Finance
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Introduction
I. General Intro on Equity
II Series Seed Funding
III. Convertible Notes
IV. Preferred Stock
V. Anti-Dilution Provisions
I. Incorporation
When to incorporate
Timing of issuances, 409A considerations
Founders Vesting Vesting Schedules: Four Year with One Year Cliff. If a founder leaves the company or is terminated before the founder’s shares are vested, the
founder will only be entitled to those shares that have already vested under the schedule. Retroactive Start Date. Typically required by investors in connection with a Series A financing, Series Seed financing
or a convertible loan deal. Investors want to see that founders are committed to staying with the company and are incentivized to grow the company during the vesting period.
Delaware The industry standard. VCs prefer to invest in Delaware C corps General Corporation Law is designed to provide maximum flexibility in the structuring of
business entities. Courts have a large body of case law dealing with corporate governance. Anonymity for directors and officers
II. Series Seed Funding
• What is Series Seed Funding? Like Series A, but with fewer requirements, leading to faster
negotiation and preparation. Postpones a few key features of Series A, including: :
registration rights, anti-dilution clauses, and veto rights.• When Should you use Series Seed Funding?
• Best for very early stage startups. • Later, when valuation is higher and round bigger, better to do a regular Series A.
• Who is a Good Candidate for Series Seed Funding?• Good for investors reluctant to do a convertible note, as it gives Equity, not debt.
III. Convertible Note
What is a convertible note? An affordable and quick way for early stage startups to raise funds. Converts short-term debt into equity over a defined period of time. Process: (1) Take a ‘loan’ from VC or angel investor, without negotiation for
issuance of preferred stock. (2) When the startup raises its next round of funding, that debt converts to equity, and investor is rewarded for early investment with a discount on the share price in such round.
How does a convertible note differ from convertible debt? No real expectation that loan will be repaid. Designed to delay the
conversion of the debt into equity until after the company is able to secure a Series A financing.
Conversion discount (20-30%) from the price of the Series A, which compensates the early investors for the greater risk they take by investing before a Series A is secured.
Convertible notes with a cap Cap applies to protect investor in case Company is very successful and
raises a Series A at a high valuation. Encourages both parties to aim for high valuation.
III. Convertible Note
When should a convertible note “mature”? 1-2 yrs; enough time to secure Series A. If fail to raise Series A, extent
date.
Do convertible noteholders have control over the company? No. Debt converts to preferred at the discount. Rarely angel investors may
ask for control mechanism, such as a board member or other “veto” rights.
Dilution of Convertible Notes Normally stock is issued on a “fully diluted basis”; any issuance of stock
thereafter dilutes ALL shareholders in the company at that stage. However, in a convertible note, the investor was not yet issued stock, and
will not be diluted for any issuances of stock that occurred after he made his convertible note investment, even if that investment was prior to the subsequent stock issuances.
Note: Avoid by drafting the note such that the conversion will not take into account all of the Outstanding Common Stock in the applicable definition.
IV. Preferred Stock
What is preferred stock? Preferred stock defines a particular class of stock that carries
certain rights and privileges for investors above and beyond what common stock offers. Holders of preferred stock are paid before holders of common
stock in the event the company is sold in a merger or acquisition (or other liquidation events).
Also get anti-dilution rights. Should a startup offer preferred stocks?
Good for VCs. Allows VC to give funds to the startup while positioning them favorably in the case of widespread success or, in the alternative, liquidation. It enables VC’s to take risks on startup companies and gives startup entrepreneurs some bargaining chips in determining the conditions of receiving funding.
V. Anti-Dilution Provisions
Ensures Investor is not diluted by subsequent stocks issued at a price below the original purchase price (i.e. as part of subsequent round of financing in a down round situation).
Two main mechanisms: 1. Weighted Average. [Industry Standard]
Gives Investor more shares down the line, at no extra cost, to compensate for a down round.
Takes into consideration how much money was invested as part of the down round, and based on that allows for a partial price adjustment.
2. Full Ratchet. Allows for a full correction of the price paid; stronger for investors and less
favorable to founders. Example: If an investor bought a share at a price of $10 per share, and, in a
later down round, the price is determined to be $5, and such investor will be entitled to receive more shares as if she originally invested at a price of $5.
