Transcript here. - Rothman & Company, PA

Startup Equity Allocations, Cap Tables, Pricing Negotiations
UCLA Office of Intellectual Property
December 9, 2013
Stephen P. Rothman, Esq.
California
Massachusetts
Florida
www.rothmanandcompany.com
[email protected]
(310) 993-9664
Biographical Information
• 27 years business law practice
• Currently focus on startups from universities and their investors
• 20 university startup formation / financings completed in last two years
• Largest client is super-angel who does multiple university startup
financings each year
• Formerly a partner at Morrison & Foerster and at Irell & Manella
• Now 2-person firm
• Experience as founder and entrepreneur
• Frequent speaker – NCET2 webinars, Children’s Hospital L.A., USC
Stevens Institute, Caltech Office of Technology Transfer, Florida
Innovation Hub at UF Gainesville
• J.D., cum laude Harvard Law School, 1985
• B.A., cum laude, Yale University, 1982
2
Terminology
“Pre-money valuation”
• In the context of an upcoming equity transaction, the value that is
assigned to the company prior to consummation of the financing.
• The earlier the stage, the less objective analysis
• The earlier the stage, the more a product of leverage and negotiation
• Accepted valuation methods for mature companies don’t apply:
• P/E ratios
• Acquisition prices
• Revenue multiples
• For Internet companies with no revenue, unique visitors
• Asset valuation
3
Terminology 2
“Pre-money valuation” 2
• university based startups usually too early-stage for
technical, evidenced based valuation
• Assigned pre-money valuation is a matter of
negotiation and leverage, not a real “valuation.”
4
Terminology 3
“Post-money valuation”
In the context of an upcoming equity financing transaction, the value
that is assigned to the company immediately following consummation
of the financing.
Post-money valuation = Pre-money valuation + Money Invested in Round
5
Simple Initial Capitalization Tables
Example 1
Valuation
Pre-money
Cash in
Post-money
$4,000,000
$3,000,000
$7,000,000
Ownership (disregards
preferences)
Founder %
57.14%
Investor %
42.86%
Example 2
Valuation
Pre-money
Cash in
Post-money
$2,000,000
$3,000,000
$5,000,000
Ownership (disregards
preferences)
Founder %
23.00%
Investor %
60.00%
Employee Pool
15%
University
2%
6
5-Sep-09
Com panyX Consolidated Cap Table
Holder
Com m on Stock
Com m on
Stock
2009 A Price
Bridge dates
Com m on
Options
5/22/2008
Com m on
Warrants
5/29/2008
Series A
Shares
12/15/2008
Series A
Warrants
1/9/2009
Bridge
Warrants
2009 A
Shares
$0.65
Closing date
1/20/2009
As
Converted
%
12,811,666 $1,000,000
Caltech
Early employee
Founder 1
Founder 2
Early employee
Early employee
Early employee
Com m on Options
"2008 Series A options"
Employees 1 -35
XXXXXX Venture XXXXX
Non-founder CEO
Angel
Consultant
Total Pool
Unissued Pool
Com m on Warrants
Attorney
Law firm
Series A Preferred and
Preferred Warrants
_____ _________ Fund LLC
University
Corporate VC Arm
MiYZ Venture Partners
_________________ Bank
Angels w ith converts
Angels w ithout converts
221928
18000
4,000,000
4,000,000
12,308
37,500
170,000
Totals
Total issued from employee pool
(inc exercised options)
8,459,736
5,502,780
Series A total
7,152,643
4,988,060
26.737%
200,000
200,000
165,000
2,544,560
15,000
1,650,000
136,000
40,000
5,502,780
514,720
3,750
11,250
307,692
15,000
521,154
384,615
2,538,462
0
769230
2593921
41,163
0
0
38,465
60756.54873
204876.6092
6,807,382
345,261
9,632
300,000
65,397
3,899,378
0 692307.6923
0 384615.3846
309,632
5,349,391
221,928
18,000
4,200,000
4,200,000
12,308
37,500
170,000
0.83%
0.07%
15.70%
15.70%
0.05%
0.14%
0.64%
165,000
2,544,560
15,000
1,650,000
136,000
40,000
5,502,780
514,720
0.62%
9.51%
0.06%
6.168%
0.51%
0.150%
20.57%
1.924%
3,750
11,250
0.01%
0.04%
307,692
1.15%
562,317
2.10%
459,645
1.72%
6,737,840
25.19%
38,465
0.14%
1522294.241 0.0536947
3183412.994 0.1189986
26,751,682
$17,388,593
99.68%
$200,000
$42,508
$2,534,596
450000
250000
$3,277,104
Current
Series A %
Investm ent
2.40%
$24,017
$200,000
4.39%
$43,891
$338,750
3.59%
$35,877
$292,508
52.59%
$525,914
$4,184,596
0.30%
$3,002
$0
0 0.105635 105635.044
949999.5
0 0.2484777 248477.684
1936048.65
98.68%
$986,814
$7,901,902
7
Before Debt
Class A Common Stock
__________ Inc. Capitalization Table As of December 31, 2013
With Debt
Angel 2 $5M
10,152,361
29.9%
10,152,361
16.5%
7,657,461
8.3%
Founder 1
3,534,575
10.4%
3,534,575
5.7%
2,536,615
2.8%
Founder 2
3,534,575
10.4%
3,534,575
5.7%
2,536,615
2.8%
Founder 3
Pledged by Founders for
Unvest Options for
_____________ Emp
Pledged by Founders for
Key Emp Exit Sales
Bonuses
1,767,287
5.2%
1,767,287
2.9%
1,268,307
1.4%
397,605
1.2%
397,605
0.6%
397,605
0.4%
918,319
2.7%
918,319
1.5%
918,319
1.0%
Option Pool
3,933,333
11.6%
3,933,333
6,428,233
7.0%
Series A (1)
15,000,000
44.2%
15,000,000
24.3%
15,000,000
16.3%
25,593,671
27.9%
6.4%
Anti-Dilution Additional A
Angel 2
4,591,595
Series B Notes, Fully Converted
Series B, Warrants (Vested)
Total
27,713,304
45.0%
27,713,304
14.3%
4,847,639
7.9%
4,847,639
5.3%
33,933,333
100.0%
61,646,637
100.0%
91,831,903
100.0%
Full anti-dilution protection Angel 1 On=1.0
Angel 2 Price
$
Angel 2 converted to Common
2,661,307
Angel 2 Anti-dilution shares
1,930,288
$
0.5459
CP1 B =
$
1.03
4,591,595
4,591,595
11,000,000
Series A Conversion Price
$
Series B Investment
Series B Notes Accrued Int to
December 31, 2013
$ 26,400,000
Series B Conversion Price
$
ESOP Shares
Pre-money Series B35,000,000 CP1 A =
2.5620
1,951,625
Series A Preferred Shares
30.2%
1
Angel 2 Initial Shares
Total Angel 2 Fully Diluted Shares
79.66% Angel 1
5.0%
4,847,639
(1) 11,000,000 shares divided by 0.73333 conversion price
2,494,900
0.73333
$
37,400,000
$
2,500,000
$
2,500,000
700,000
$ 2,184,333
1.03143
1.03143
3,933,333
Total Refinancing of Series B conv$LOC
Series B ESOP Target
New $5M Bridge On=1
7.00%
1
9/30/2013
1,690,583
$
25,000.00
10/31/2013
1,765,583
$
51,750.00
11/30/2013
1,840,583
$
83,750.00
12/30/2013
1,915,583
$
115,750.00
$
147,750.00
Checks for ESOP exericse
$
179,750.00
$
4,781.16
$
211,750.00
$
$
2,860.66
$
268,750.00
$
700,000
$
1,800.00
$
5,000,000
$
1,755.00
$
11,196.82
62,205
Shares issued
8
Factors Influencing Pre-Money Valuation (i.e. Founder Share)
• Whether there is competition
• Overall startup investment climate
• Negotiation sophistication of founder or
founder representative
• Same factors that investors consider in deciding whether to
invest at all:
•
•
•
•
•
•
market size;
market attractiveness;
Investment fads
management team / previous startups
stage of development;
market for exits.
9
Types of Equity Interests in Corporations
• Common Stock – residual category
• Straight Preferred Stock – almost like debt
priority over common but no upside
• Convertible Preferred Stock – has the
benefits of both common and straight
preferred.
• Participating Convertible Preferred Stock –
various level of “double dip”
10
Convertible but not Participating
Cash Invested
$8,000,000
Pre-money valuation
$8,000,000
Preferred as converted %
50%
Common as converted %
50%
Sale Price
Common
$5,000,000
Convertible Preferred
Sale Price
Common
Convertible Preferred
$13,000,000
Proceeds
$0
$5,000,000
Proceeds
$5,000,000
$8,000,000
Investor won’t like this scenario.
Founder is “making $5 million” and “I just get my money back.”
Go back to concept of pre-money valuation and the concept of
preferences that we skipped over; did the founders really put in
$8 million of value or not.
11
Investor’s response to convertible but not participating scenario –
Convertible and participating.
Cash Invested
Pre-money valuation
Preferred as converted %
Common as converted %
Common
Convertible Preferred
$8,000,000
$8,000,000
50%
50%
Sale Price
$5,000,000
Sale Price
Common
Convertible Preferred
$13,000,000
Proceeds
$0
$5,000,000
Proceeds
$2,500,000
$10,500,000
12
Founder’s concern with convertible and participating – the double
dip (was founder contribution really worth $8 million?)
Partial answer – capped participating convertible preferred
$8 million invested, 50/50 as converted, 2X cap
Sale Price
Common
$5,000,000
Convertible Preferred
Sale Price
Common
Convertible Preferred
Common
Convertible Preferred
$13,000,000
Proceeds
$0
$5,000,000
Proceeds
$2,500,000
$10,500,000
Sale Price
Proceeds
>$32,000,000
50/50
13
LLC Capital Accounts
Percentage Interest
Capital Contribution
Investor
50%
$4,000,000
Founder
50%
$0
IRS Rule Distribution According to Capital Accounts
Sale price
$5,000,000
Proceeds Investor $4,500,000
Founder $500,000
Similar to uncapped preferred stock participation in corporate context. So
founder doesn’t like this.
14
Possible Alternatives in LLC
• “Layer Cake” Profit and Loss Allocations
• Allocated P&L per percentage interests
• Distributions on sale per capital accounts
• Investor has infinite double dip
• “Target” Profit and Loss Allocations
• Specify how you would like distributions to come out
• Allocate P&L however you need to in order to make capital
accounts consistent with those distributions
• Satisfies IRS rule that distributions are pursuant to capital
accounts, though only because the capital accounts have
been tinkered with to make them equal desired
distributions.
15
‘Median pre-money valuation of venture
capital seed-stage enterprises has varied over a
narrow range between $1.7 million and $2.5
million since 2002.”
Kauffman eVenturing The entrepreneur’s trusted guide to high
growth. “Valuing Pre-revenue companies.” p.8.
www.eVenturing.org
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Questions?
Stephen P. Rothman, Esq.
Rothman and Company, P.A.
Sean Brady, Esq.
Rothman and Company, P.A.
E-MAIL:
[email protected]
E-MAIL:
[email protected]
Direct Phone: (310) 993-9664
Direct Phone: (626) 993-8424
www.rothmanandcompany.com
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