Transcript Why Sign a Term Sheet? - Angel Venture Forum DC

ANGEL VENTURE FORUM –
GEORGETOWN SELECTION DAY
YOU ARE OFFERED A TERM SHEET,
NOW WHAT?
Why Sign a Term Sheet?
• Presented by Angel or VC after initial due diligence
and determination of interest
• Establishes valuation
• Summarizes basic deal terms
• Minimizes area of dispute in definitive
documentation
• Flushes out problems before sunk deal costs grow
large
Angel vs. VC Term Sheet
• Angel Term Sheet (if provided) much simpler
than VC Term Sheet
• Often outlines terms for convertible debt or
Series Seed transaction
– If Convertible Debt, avoids early valuation determination
(although caps are becoming common)
– Usually seeks some form of discount into Series A round
(through discount or warrants)
– Series Seed is short form Preferred Stock financing.
Venture Capital (Series Seed)
Term Sheet – Major Issues
• Economics (dividing the pie on exit)
• Control (who is going to pilot the ship)
• Shareholder Rights (protecting the
investment and getting to the exit)
Economics
• Pre-Money Valuation (% of company
received for the investment).
• Type of security (Preferred Stock vs.
Common Stock).
• Dividends (Cumulative vs. Noncumulative).
Valuation
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Percent of company that VC receives
“Pre-money”
“Post-money”
Impact of options
Type of Security
• Preferred Stock vs. Common Stock
– Fully Participating Preferred (1x or greater),
– Capped Participation (1.5x to 10x),
– Non-participating Preferred.
Example: $5,000,000 Sale
($2,000,000 Pre-Money Vale; $1,000,000 investment)
Non-Participating Preferred
• Founders: $ 3,333,333.33
• Investors: $ 1,666,666.67
Capped Participation at 2X
• Founders: $ 3,000,000.00
• Investors: $
2,000,000.00
Fully Participating Preferred
• Founders: $ 2,666,666.67
• Investors: $ 2,333,333.33
Dividends
• Cumulative
– Similar to interest accruing on a note, the
dividends accrue to the liquidation preference.
– Cumulative dividends erode ownership % over
time (unless only payable in cash).
• Non-Cumulative
– (no dividend rights unless dividends are declared).
Control
• The Board of Directors (Remember the Board
hires and fires the CEO)
– A Voice (1 of 3, or 2 of 5),
– Equality (2 VC directors, 2 founder directors, and
1 independent director, mutually agreed), or
– Control (2 – 2 and 1 independent selected by the
VC).
Control continued…
• Voting of shares (protective provisions):
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–
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changes to organizational documents,
liquidation, recapitalization, re-organization, etc
sale of equity,
incurrence of debt,
sale of the company or material assets,
payment of dividends or redemption of shares,
Hire or fire executive officers or change compensation.
Shareholder Rights
• Protecting the Investment (minority
protections):
– Anti-dilution protections,
– Participation/Preemptive Rights,
– Restrictions on Transfer of Shares:
• Right of first offer/refusal
• Co-sale rights (i.e., the right to “tag along”).
Shareholders Rights
• Getting to the Exit:
– Demand Registrations Rights
– Redemption Rights
– Drag-along Rights
Other Issues
• Founder Employment Agreement
• Vesting of Founder’s Shares through a Stock
Restriction Agreement
• 83(b) elections
Thank you for joining us!
Karl T. Knoll
[email protected]
(703) 394-2279
Dean W. Rutley
[email protected]
(703) 394-2256