Transcript Document

8/10/2007
Morocco Day 1
July 2008
Agenda Day 1 - Valuation
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Introductions
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Valuation introduction
The difficulties of early stage valuation
The art and science of valuation
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Ted Anderson
Jeff Karras
Multiples analysis
VC or DCF Model
Beyond the numbers
Valuation Examples
Case Study
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Ted Anderson
Managing General Partner
Ventures West Management Inc.
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Ventures West -Firm Overview
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Recognized nationally as a premier early stage technology investor – currently investing 8th fund
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Largest and oldest private Canadian venture capital firm - Venture capital manager since 1973
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Established team, in key cities (Montreal, Toronto, Ottawa, Vancouver)
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Prior funds total over $700 million; VW4-8 total $600 million (since 1993)
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90 technology company investments in Ventures West 4-8
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Established, stable team plus recent additions
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7 Partners—average of 14 years of VC experience and 11 years at Ventures West
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Investors represent almost all of the large private equity investors in Canada
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36 exits (Ventures West 4-8)—26 acquisitions and 10 IPOs (NASDAQ, TSX, AIM)
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Example exits—Angiotech (19X, 88% IRR), AudeSi (3.5X, 67% IRR), Chantry (2.4X, 59% IRR),
LinkAge (5.2X, 324% IRR), Pivotal (18X, 109% IRR)
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VW Investment Strategy
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Venture capital investments - Primarily in Canada
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Approximately 20-25 investments in a US$200 million fund
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Early stage investments
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High potential sectors (biotech, cleantech, communications)
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Lead the “A” round, initial position > 20%
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Active investor, board seat
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Syndication (often with US funds) in later rounds
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Extensive partnering
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Exit by IPO or strategic sale
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Jeff Karras
General Partner
Levensohn Venture Partners
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Levensohn Venture Partners -Firm Overview
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Established presence in Silicon Valley since 1996
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$193 million in total committed capital
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$334 million in distributions to date since inception
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Investment Team of five together since 2002
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Focused, selective strategy  fewer investments and more time per
portfolio company
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Hands-on investment style with proven ability to identify, build, and
harvest winning companies
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30 investments since 1996
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16 exits to date
23% IPO
30% M&A
30% Remain private
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LVP Investment Strategy
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Early stage investor emphasizing companies that have
completed initial technology development
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Thematic team-based approach to technology investing with
California focus
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Lead deals and require board seat, with subsequent active role
on boards
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Proactive engagement in operating and strategic projects
across portfolio companies
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VALUATION
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The Stages
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Expansion Stage- Revenues increase, low or negative earnings,
limited operating history, some but few comparables, value based
mostly on future growth
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High Growth- Rapidly growing revenues and earnings,
meaningful operating history, large number of comparables,
value in both assets and future growth
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Mature Growth- Revenue growth slows but operating income still
growing, lots of operating history, lots of comparables, value
driven more from existing assets than future growth
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Declining- Revenue and operating income begins to decline,
substantial operating history, declining number of mostly mature
comps, value driven by existing assets.
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Early Stage
If everything was Ideal,
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There would be historical financials
An entrepreneur’s financial projections would be accurate
VCs would know the timing and exit value
A company would know exactly how much cash was require to breakeven
There would be no competition for deals
The challenge with early stage startups
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Non existent or low revenue
Negative operating income
Little operating history
Few if any true pure play comparable companies
Value based entirely on future growth- value relies on the ability of
managers to turn a promising idea into commercial success
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Art and Science
From a practical standpoint, valuation tends to be both
Art and Science
Typically more Art than Science
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The Science of Early Stage Valuation
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Public market comparables and M&A comparables
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Requires applying trading or transaction multiples of earnings or cash flow i.e. P/E or
P/CF associated with comparable companies to the current and future performance of
the target business
The “VC” or DCF model
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Requires forecasting the future cash flows of the business to a terminal value and
discounting those cash flows back to the future at a an appropriate discount rate
The earlier the company is in its development, the more
difficult it is to use financial models
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Public Comparable Analysis
Composite Valuation
Components
Supply Chain
CRM
ERP
Analytics
Average
Ent. Val./
2004 Sales
1.9x
1.3x
3.3x
2.2x
2.2x
Composite Multiple
2.1x
Revenue Scenario
High Case
Low Case
Actual Forecasat
2003E
Revenue
$12,000
$8,000
$10,000
Implied Enterprise Value (2004)
less Marketability Discount
plus Cash
Recommended Valuation
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Mix of
Business
50%
10%
10%
30%
100%
2004E
Revenue
$25,000
$12,000
$16,000
Beginning
Cash (1Q03)
$1,000
$1,000
$1,000
Low
$24,761
(30.0%)
$1,000
$18,333
Actual
$33,015
(30.0%)
$1,000
$24,110
High
$51,585
(30.0%)
$1,000
$37,110
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M&A Analysis
Universe of Software Acquisitions 2002
Acquirer
IBM
Microsoft
Fair Isaac & Company
Veritas Software
Microsoft
BMC Software
Cadence Design Systems
NetIQ
Adobe Systems
Business Objects
Inktomi
PeopleSoft
Syngistix
Borland Software
Borland Software
ASG Corporation
Intuit
Aspen Technology
Cognos Software
Maptics
SSA Global Technologies
Lawson Software
Itron
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Acquiree
Rational Software
Navision
HNC Software
Precise
Rare Ltd.
Peregrine
Simplex Systems
PentaSafe
Accelio Corporation
Acta Technology
Quiver
Calico Commerce
Ecometry Corporation
Starbase Corporation
Togethersoft Corporation
Landmark Systems
Blue Ocean Software
Hyprotech
Adaytum Software
Frontstep
Infinium Software
Armature Holdings
Regional Economic Research
Purchase Price
$2,100,000,000
$1,300,000,000
$810,000,000
$537,000,000
$375,000,000
$350,000,000
$300,000,000
$255,000,000
$71,287,000
$65,000,000
$12,000,000
$5,000,000
$36,250,000
$24,000,000
$185,000,000
$59,100,000
$170,000,000
$99,000,000
$160,000,000
$50,100,000
$94,500,000
$7,750,000
$14,000,000
Revenue Multiple
3.2x
6.4x
3.6x
7.5x
NA
1.4x
6.2x
7.1x
1.1x
2.6x
4.8x
0.3x
1.4x
0.6x
3.6x
1.0x
3.4x
1.4x
2.8x
0.6x
1.4x
1.4x
1.8x
Average
High
Low
Stripped Mean
2.9x
7.5x
0.3x
2.8x
Software Sectors
Business Intelligence/Analytics
Content Management
Consumer Relationship Management
Document Management
E-Learning
EAI/Milddleware
Engineering/CAD/CAM
Large Cap ERP
Gaming
Human Resource
Infrastructure
Internet Pure Plays
IT Service
Network/Systems Management
Security
Software Development Tools
Storage
Supply Chain Management
Wireless
Average
Source: Corum Mergers & Acquisitions
Median Price/Sales
2.0x
1.9x
0.7x
1.5x
1.2x
1.3x
2.2x
3.0x
1.2x
1.7x
3.3x
2.6x
0.7x
2.4x
2.9x
1.7x
1.5x
1.5x
1.0x
1.8x
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The “VC” or DCF Method
Objective: Determine the number of shares a VC
needs to receive for a given level of investment in
order to achieve investment return objective.
Determining Key Inputs:
• Terminal value be at time of exit
• Time to Exit
• Discount Rate
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VC Model
V= terminal value at time of exit= $25 million
T=time to exit=4 years
I= amount of investment by VC= $3 million
R= discount rate used by investor=50 percent
X= number of existing shares owned by entrepreneur = 1 million
-note options should be treated “as if exercised’
Step 1:
Determine the post money valuation ie. the present value of the company after
the initial investment has been made
NPV of the terminal value
= V/ (1+R)t
= $25 million/ (1.5)4
= $4,938,272 Post
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VC Model
V= terminal value at time of exit= $25 million
T=time to exit=4 years
I= amount of investment by VC= $3 million
R= discount rate used by investor=50 percent
X= number of existing shares owned by entrepreneur= 1 million
-note options should be treated “as if exercised’
Step 2:
Determine the pre- money valuation
PRE
= Post – investment cost
= $4,938,272 - $3 million
=$1,938,272
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VC Model
V= terminal value at time of exit= $25 million
T=time to exit=4 years
I= amount of investment by VC= $3 million
R= discount rate used by investor=50 percent
X= number of existing shares owned by entrepreneur = 1 million
-note options should be treated “as if exercised’
Step 3:
Determine the ownership fraction required to achieve required rate of return
Ownership Fraction = $3 million/ $4,938,272
=60.75%
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VC Model
V= terminal value at time of exit= $25 million
T=time to exit=4 years
I= amount of investment by VC= $3 million
R= discount rate used by investor=50 percent
X= number of existing shares owned by entrepreneur = 1 million
-note options should be treated “as if exercised’
Step 4:
Calculate the number of shares
If x = founders shares and
y = # of shares required
y/ (1,000,000 +y) = ownership fraction or 60.75%
y
= 1,000,000 [(0.6075 / (1-0.6075)]
=1,547,771 shares
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8/10/2007
VC Model
V= terminal value at time of exit= $25 million
T=time to exit=4 years
I= amount of investment by VC= $3 million
R= discount rate used by investor=50 percent
X= number of existing shares owned by entrepreneur = 1 million
-note options should be treated “as if exercised’
Step 5:
Calculate the Price Per Share
$3 million / 1,547,771= $1.94 per share
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The Art
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Beyond the numbers, countless other factors influence valuation
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Market pressures of a deal
Prior investor or management expectations
Recent data on comparable financings
Level of comfort with company including
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Business plan
Executive team
Stage in the market
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Beyond valuation, there are many tools used to mitigate risk (Option
pool, Liquidation Preferences, Participation, Drag-along) – This is Day
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Often we will use the financial model as a part of the negotiation and
share the models with the entrepreneurs. This take some of the
emotion out of the process
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Case Study: Shotspotter
• Shotspotter Gunshot Location system
– Combination of themes: wireless technology, mesh networks,
GPS technology, and acoustic algorithms
• Met CEO at conference
• Company had history of successful field deployments in public
Safety
• Well suited to multiple markets
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Case Study: The Process
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Initial meetings to understand company and meet team
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Subsequent meetings to understand the technology, business model,
customers, traction, etc…
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Customers are important part of our diligence. Spoke with existing and
potential customers. Looking to hear commitment and believe that SS is
relieving a pain
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Technology Demonstration
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Intellectual property – Hired IP attorney to review the portfolio
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Deployment process and costs
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Pipeline review
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Case Study: Key Findings
• Public safety market progressing, but less certainty around military
– Worked through strategy to penetrate military market
– Bottom line, Military remained a risk and was factored into valuation
• Revenue Forecast was too aggressive
– Discounted as a part of the valuation exercise
• No immediate competitive threat, but patent portfolio important
– IP Attorney helped company identify areas of weakness and plan put in
place
• Margins were too low for the business
– Worked with company to understand plan to bring them in line
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Case Study: The Valuation
• We were pre-emptive and the company was not out officially raising
money
• We did not want to overpay, but understood that if we were too low,
they would talk to other VCs for a higher valuation
• Worked on a comp analysis, M&A analysis, and even a DCF.
Modeled the round and the returns for all of the investors
• Disagreed over the revenue forecast and got creative with the
valuation
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Agenda Day 2 – The Deal
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The deal
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Basic Terms in the term sheet
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Proper due diligence
Forecasting
Relationships with team and other investors
The other terms beyond price
Preferred vs Common stock
The offer
The charter
Stock purchase agreement
Investor’s rights agreement
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Case Study
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Managing the deal after the investment
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Deal Negotiation
• Experienced VCs and Entrepreneurs understand that
valuation alone is a small part of the investment process
• Critical elements to a deal
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Proper due diligence
Working relationship with team
Relationship with existing investors
Term Sheet
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Proper Due Diligence
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The management team
– Personal reference checks
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Technology (if applicable)
– Consultants that can help to validate
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Business model
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Pipeline review
– Customer reference checks
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Financials including forecast
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Legal due diligence
– Intellectual property review
– Existing company documents around governance
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Forecasting in Venture Capital
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It is the responsibility of the entrepreneur to provide a well thought analysis
of the market opportunity and the cost structure needed to properly to
execute on the opportunity
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A VC must pay attention to a number of factors including
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Product development
Margins on product
Cash burn and cash out date
Critical milestones
Validation of near term sales forecasts
Fixed costs such as office space and other contractual money owed (in case of
shut down)
A sensitivity analysis is a critical tool for evaluating the risks in a forecast
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Board Dynamics
• Critical to have aligned interests among board members and
entrepreneurs
• Prior to any investment, must speak with each member of the board
and the management team to
• White papers with best practices for Board Participation
– A Simple Guide to The Basic Responsibilities of VC-Backed Company
Directors
– After the Term Sheet: How Venture Boards Influence the Success or
Failure of Technology Companies
– Rites of Passage: Managing CEO Transition in Venture-Backed
Technology Companies
• http://www.levp.com/news/whitepapers.shtml
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The Term Sheet
• Starting point for a good faith negotiation/ few binding
provisions
• Structure contracts to protect investment from
negligence or malice
Four Sections of a Term Sheet
1. The basic description of the offer
2. The Charter
3. Stock Purchase Agreement
4. Investor Rights Agreement
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Preferred vs Common Stock
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Common Stock
– The basic stock held by founders, employees, and public shareholders
upon IPO
– In general, provides basic voting privileges
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Preferred Stock
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Preferred shares give holders preference over Common shares
Seniority in liquidation (i.e. preferred shareholder paid first)
Seniority in payment of dividends
Special privileges documented in the Shareholders agreement including
Board Seat, voting rights on additional capital, right to participate in future
financings, and ability to veto the choice of CEO
– Right to approve spending
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VCs almost always take Preferred Stock
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Basic Offer
• Fully Diluted Ownership- assumes all preferred stock is converted
and options are exercised
• Original Purchase Price- price paid per share
• Capitalization Table- lists all securities in the capital structure before
and after the deal -typically includes common, preferred, options
pool
• Aggregate Purchase Price- price paid for all shares of a security
• Post-money Valuation= price per share*fully diluted share count analogous to market cap for a public company
• Pre-money Valuation= post money valuation-$ investment
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The Charter
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The Charter establishes the rights, preferences, privileges and restrictions of each class and
series of the company’s stock
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Dividend Preference- restricts the payment of dividends to common stock unless first paid to
preferred
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Deemed Liquidation Event- sale, merger or shut down
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Liquidation Preference- determines where an investor stands in the investor hierarchy in the case of a
liquidation event
pari passu means all (or some) preferred investors are treated equally
3X liquidation preference means an investor get back triple their investment before any other equity claims
are satisfied
Preferred Stock
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cumulative dividends accrue even if not paid
non cumulative dividends do not accrue except in the final period prior to payment
Non- participating Preferred Stock- receives only Original Purchase price plus any accrued dividends
Fully Participating Preferred Stock- receives Original Purchase price plus accrued dividends and then
participates with commons stockholders on an as-converted basis.
Cap on Preferred Stock Participation Rights- receives Original Purchase Price plus accrued dividends and
participates with common stock up to an agreed multiple of the Original Purchase Price
Protective Provisions- give minority investors a laundry list of protections against possible
expropriation by managers or other investors
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The Charter - Continued
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Anti-dilution Protection- protect investors stakes if future rounds of financing are
done at a lower price ie. “a down round” by adjusting the original conversion price
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Adjusted Conversion Price = Original conversion price* ((fully diluted # of shares
outstanding prior to new issue + new money received / original conversion price)) /
(fully diluted shares outstanding prior to new issue + number of new shares issued in
subsequent transaction)
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“full ratchet reduces conversion price to the lowest price of any later stock sale
weighted average reduces conversion price by the weighted average price impact of the
subject transaction
Formula for Weighted Average Conversion Price
Mandatory Conversion- convertible preferred is typically convertible at the option of the
holder but may be required to be converted in the event of a qualified public offering
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Pay-to-Play- requires all investors to participate to the full extent of their participation
rights in any “down round” or lose their anti-dilution rights
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Redemption Rights- the right to require the company to redeem (pay back) the
investors investment
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Stock Purchase Agreement
• Contains company reps and warranties
• Conditions to closing and
• Outlines responsibilities for fees and expenses.
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Investor Rights Agreement
• Matters pertaining to a company going public
• Matters Requiring Investor Approval- give minority
investors a laundry list of protections against possible
expropriation by managers or other investors.
• Employee Stock Options- shares or options set aside for
employee compensation and incentives - cliff vs. step
vesting
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Case Study – McLean Watson/Media Synergy Inc
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After the Investment
• Due diligence and reviews on valuation continue after
the investment
• Follow-on investments
• On-going portfolio valuation
• The exit
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