NEGOTIATING A SERIES A INVESTMENT TERM SHEET June 18, 2013 Karim - - PowerPoint PPT Presentation
NEGOTIATING A SERIES A INVESTMENT TERM SHEET June 18, 2013 Karim Piguet, LL.M. Page : 1 CONTE ONTENT NT A. INTRODUCTION B. MAIN ISSUES 1. Valuation 2. Option Pool 3. How to split the reward 4. How to allocate control 5. How to align the
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CONTENT AND EFFECT Ø Intent of the parties on the main terms and conditions. NON-BINDING / BINDING PROVISIONS Ø Binding provisions: exclusivity, break-up fee, confidentiality, legal fees, effect of the term sheet, dispute resolution and governing law. Ø Non-binding provisions: main economic terms of the transactions (subject to contract / CP). LEGAL EFFECTS Ø Pre-contractual duties: duty to negotiate in good faith, duty to inform, etc.
WHAT EACH SIDE TRIES TO ACHIEVE? Ø INVESTOR Ø Maximize their return on investment Ø Protect their investment Ø Vetoes over certain company's actions Ø Forced liquidation Ø Founders and key management (stay incentive and aligned interests w/ investors). Ø ENTREPRENEURS Ø Funds until next financing rounds Ø Keeping control over the company’s actions Ø Protect their personal position
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VALUATION Ø PRE-MONEY VALUATION / POST MONEY VALUATION / FULLY DILUTED
VALUATION Ø PRE-MONEY VALUATION / POST MONEY VALUATION / FULLY DILUTED Ø PRE = valuation of the company excluding the capital about to be invested by the investor. Ø POST = valuation of the company including the capital to be invested.
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VALUATION Ø PRE-MONEY VALUATION / POST MONEY VALUATION / FULLY DILUTED Ø PRE = valuation of the company excluding the capital about to be invested by the investor. Ø POST = valuation of the company including the capital to be invested. Ø FD = valuation of the company taking into account all stock options (option pool).
Example:
warrants and other convertible securities of the Company, if any)”.
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Ø MedTech SA is a Swiss limited company with a share capital of CHF 160,000.- divided into 160,000 shares of CHF 1.- each. Ø Investor A wishes to invest CHF 4M and requests 20 % of the company in return. Ø Postmoney valuation implied: CHF 20M. Ø Premoney valuation: CHF 20M – CHF 4M = CHF 16M. Ø Par value of each share: CHF 1.-. Ø Market value of each share: CHF 100.- (16M/160,000). Ø Investor A would receive 40,000 shares for a CHF 4M investment. New capital = CHF 200,000
Ø One year later: Investor B offers to invest 8M for 20% of the company. Ø Postmoney valuation implied: CHF 40M. Ø Premoney valuation: CHF 40M – CHF 8M = CHF 32M. Ø Par value of each share: CHF 1.-. Ø Market value of each share: CHF 160 (32M/200,000). Ø Invest A has achieved a step-up in the value of his shares from CHF 100.- to CHF 160.-. Ø Value creation in one year: 32M (premoney N) - 20M (postmoney N-1) = 12M.
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Initial Stock position Pre- money Initial Ownership Stock position Post- Money Fully Diluted Ownership Founders 6M 8M 100% 6M 8M 80% Investor A 0M 0% 1.5M 2M 20% Total 6M 8M 100% 7.5M 10M 100% Page : 12
Investor’s A term sheet: Ø 8M pre-money valuation for a CHF 2M investment Ø 8M pre-money / 6M existing shares = CHF 1.33/share ? Ø Term sheet : CHF 1 per share !
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Investor’s A term sheet: Ø “The 8M pre-money valuation includes an option pool equal to 20% of the post-financing fully diluted capitalization” Ø Slipping option pool lower the effective pre-money to 6M Ø 8M pre / (6M existing shares + 2M new options) = CHF 1 per share
Initial Stock position Pre- money Initial Ownership Stock position Post- Money Fully Diluted Ownership Founders 6M 6M 75% 6M 6M 60% Investor A 0M 0% 2M 2M 20% Option Pool 2M 2M 25% 2M 2M 20% Total 8M 8M 100% 10M 10M 100%
TIPS TO ENTREPRENEUR
after the investment – this will reduce the dilution experienced by the preexisting shareholders.
be put in place before the investment. One way to make the case is to establish the list of individuals to be recruited over the next 12-18 months (the investment horizon of the investor) and the number
Title Range % CEO 5-10 COO 2 -5 VP 1 - 2 Independent Board Member 1 Director 0.4 – 1.25 Lead Engineer 0.5 – 1 5+ years experience Engineer 0.33 – 0.66 Manager or Junior Engineer 0.2 – 0.33 Page : 15
HOW TO CREATE AN OPTION POOL FROM A HIRING PLAN?*
*Source : www.venturehacks.com
TERMS FOR SPLITTING THE REWARD Ø WHAT THE INVESTORS TRY TO ACHIEVE (reminder) Ø Maximize their return on investment Ø Protect their investment Ø Founders and key management (stay incentive and aligned interests w/ investors)
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TERMS FOR SPLITTING THE REWARD Ø WHAT THE INVESTORS TRY TO ACHIEVE (reminder) Ø Maximize their return on investment Ø Protect their investment Ø Founders and key management (stay incentive and aligned interests w/ investors) Ø METHODS Ø Exit preferences Ø Dividend preferences (pro memoria) Ø Staging of investment against milestones Ø Option to invest more money at a defined price per share Ø Antidilution
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TERMS FOR SPLITTING THE REWARD EXIT PREFERENCES Ø LIQUIDATION PREFERENCE Ø Liquidity event
« In the event of a voluntary or non-voluntary liquidation, a dissolution or winding up or a Sale
A “Sale” means the sale, transfer or other disposal of shares in the Company that result in a change of control or the sale of all or substantially all of the Company’s assets. »
TERMS FOR SPLITTING THE REWARD EXIT PREFERENCES Ø LIQUIDATION PREFERENCE Ø Liquidity event Ø Types of LP : single / multiple ; Participating / Capped Participating / Non-Participating
In the event of a Deemed Liquidation, (…) each Preferred A Shareholder shall be entitled to receive an amount equal to 1 time (1x) the aggregate of his invetsment before any net assets or funds be distributed to other Shareholders (the « Preference A Amount »)
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TERMS FOR SPLITTING THE REWARD EXIT PREFERENCES Ø LIQUIDATION PREFERENCE Ø Liquidity event Ø Types of LP : single / multiple ; Participating / Capped Participating / Non-Participating
After the payment of the Preference A Amount to the holders of the Preferred A Shareholders, the remaining assets shall be distributed on a pro rata basis to the holders of Common Stock and the Preferred A Shareholders.
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TERMS FOR SPLITTING THE REWARD EXIT PREFERENCES Ø LIQUIDATION PREFERENCE Ø Liquidity event Ø Types of LP : single / multiple ; Participating / Capped Participating / Non-Participating
After the payment of the Preference A Amount to the holders of the Preferred A Shareholders, the remaining assets shall be distributed on a pro rata basis to the holders of Common Stock and the Preferred A Shareholders, provided that the Preferred A Shareholders will stop participating once they have received a total liquidation amount per share equal to [x] time their investment (…).
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Ø Single (1x) Non Participating Liquidation Preference:
Investor A invested CHF 3M with a 10% coupon rate. The company is sold three years after.
Investor A will receive CHF 3.9M. The remaining will be shared among common shareholders.
If the company is sold for less than CHF 3.9M, all the proceeds go to Investor A.
0 1 2 3 3.9 4 5 6 7 8
Ø Multiple (2x) Participating Liquidation Preference:
Investor A invested CHF 2M for a 30% shareholding.
Sale price = CHF 10M. Investor gets his/her CHF 2M back plus 2M plus 30% of the remaining CHF 6M.
Best solution from investor’s perspective (see SECA template).
0 1 2 3 4 5 6 7 8 9 10
TERMS FOR SPLITTING THE REWARD STAGING OF INVESTMENT AGAINST MILESTONES
TIP TO ENTREPENEURS
sure that you are extremely confident of meeting the milestones.
being renegotiated with the entrepreneur in a very weak position.
TERMS FOR SPLITTING THE REWARD OPTIONS TO INVEST MORE MONEY AT A DEFINED PRICE PER SHARE
TIP TO ENTREPENEURS
value, and entrepreneurs can often underestimate the value of the option granted. Also, always set a time period for the option.
TERMS FOR SPLITTING THE REWARD ANTIDILUTION Ø PROTECTION AGAINST DOWN ROUND Ø ALTERNATIVE ANTIDILUTION APPROACHES Ø PAY TO PLAY
TERMS FOR SPLITTING THE REWARD ANTIDILUTION Ø PROTECTION AGAINST DOWN ROUND Ø ALTERNATIVE ANTIDILUTION APPROACHES: Ø Full ratchet / Narrow-band weighted average / Broad-band weighted average Ø PAY TO PLAY
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Ø Round B, investor B agrees to invest CHF 500,000 for 50% of the company
Investment Price per share Shares % Post financing value Founders 600,000 60% 600,000 Investor A 400,000 1 400,000 40% 400,000 Anti-dilution protection 0%
400,000 40% Investor B 0% Investors’ subtotal 400,000 100% 400,000 Total 1M 100% 1M
Ø Round B, investor B agrees to invest CHF 500,000 for 50% of the company
Investment Price per share Shares % Post financing value Founders 600,000 30% 300,000 Investor A 400,000 1 400,000 20% 200,000 Anti-dilution protection 0%
400,000 20% Investor B 500,000 0.5 1,000,000 50% 500,000 Investors’ subtotal 1,000,000 100% 400,000 Total 2M 100% 1M
Ø Round B: Investors B agrees to invest CHF 500,000 for 50% of the company. Ø Investor A has the rights to that number of shares as if he paid the current round’s lower price
Investment Price per share Shares % Post financing value Founders 600,000 10% 100,000 Investor A 400,000 400,000 6.67% 66,666 Anti-dilution protection 2,000,010 33.33% 333,334 Investor A subtotal 2,400,010 40% 400,000 Investor B 500,000 0.1667 3,000,012 50% 500,000 Investors’ subtotal 5,400,012 90% 900,000 Total 6,000,022 100% 1M
Ø WA anti-dilution protection gives consideration to the relationship between the total shares
Investment Price per share Shares % Post financing value Founders 600,000 25.38% 253,846 Investor A 400,000 400,000 16.92% 169,231 Anti-dilution protection 0.6875 181,818 7.69% 79,923 Investor A subtotal 581,818 24.62% 246,154 Investor B 500,000 0.42231 1,181,818 50% 500,000 Investors’ subtotal 1,736,636 74.62% 746,154 Total 2,323,636 100% 1M
TIP TO ENTREPRENEUR
to an investor who is unable to invest much more capital in the company.
protection clause
average)
+ Have it accompanied by a pay-to-play clause
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TERMS FOR SPLITTING THE REWARD ANTIDILUTION Ø PROTECTION AGAINST DOWN ROUND Ø ALTERNATIVE ANTIDILUTION APPROACHES: Ø PAY TO PLAY
ALLOCATING CONTROL BETWEEN FOUNDERS / MANAGEMENT AND INVESTORS SHARE TRANSFER Ø PREEMPTIVE RIGHTS Ø LOCK-UP Ø RIGHT OF FIRST REFUSAL Ø TAG-ALONG / DRAG ALONG Ø FORCED SALE Ø CALL OPTIONS / PUT OPTIONS / CLAWBACK SHARES
ALLOCATING CONTROL BETWEEN FOUNDERS / MANAGEMENT AND INVESTORS CORPORATE GOVERNANCE Ø BOARD OF DIRECTORS Ø Composition Ø Chairman (casting vote) Ø Independent member(s) Ø PROTECTIVE PROVISIONS (qualified majority / veto rights) Ø List of Restricted Transactions Ø Who gets the vetoes? (Limit the number of vetoes / avoid to grant the veto to a small investor unable or unwilling to invest more capital in the company) Ø INFORMATION RIGHTS
ALIGNING THE INTERESTS OF FOUNDERS / MANAGEMENT AND INVESTORS Ø PURPOSES / MECHANISMS Ø Reward founders for value creation / option pool Ø Motivating the key people to stay around / vesting of stock and options Ø Ensure that the founders and key executives do not try to sell the company before the investors are ready / prohibition to sell without investors’ consent + tag-along Ø Ensure that the full energy of the founders and key executives is commited to the venture rather than other activities. Risk that the founders might think about starting a new company or joining a competitor / non-compete & IP assignment
ALIGNING THE INTERESTS OF FOUNDERS / MANAGEMENT AND INVESTORS Ø REPRESENTATIONS AND WARRANTIES Ø Personal liability of the founders Ø Limitation: scope, amount (cap, de minimis, threshold/deductible, etc.), time, knowledge of parties Ø Indemnification