[NAME OF COMPANY] SERIES A PREFERRED STOCK FINANCING TERM SHEET _______________, 2009 This Term Sheet summarizes the principal terms with respect to a potential private placement of equity securities (the “Financing”) by [insert name and address of company], a [jurisdiction] corporation (the “Company”), to be sold to a group of investors (the “Investors”). Optional: [Other Company or deal specific terms] Amount of Financing: Up to $__________ in the aggregate [including $[_______] from the conversion of principal [and interest] on bridge notes]. [A minimum of $___________ shall be raised [excluding $[ ________] from the conversion of principal [and interest] on the bridge notes] in the Financing before any money will be transferred to the Company (the “Initial Closing”); any remaining balance to be invested within ninety (90) days after the Initial Closing (the “Subsequent Closing,” and together with the Initial Closing, the “Closing”). Type of Security: Purchase Price: ___________ shares of Series A Preferred Stock (“Series A Preferred”). $__________ per share (the “Purchase Price”), based on the current capitalization of the Company attributing a pre-money valuation to the Company of $_____________. The capitalization of the Company (including all options, warrants, convertible securities and other equity instruments) before and after giving effect to the Financing is set forth on Attachment A. The Initial Closing will take place as soon as practicable following the execution of this Term Sheet by the Company and the Investors, preferably within thirty (30) days after such execution, upon satisfaction of any conditions precedent to such Initial Closing. Any Subsequent Closings will take place within ninety (90) days after the Initial Closing. Rankings: The Series A Preferred will, when issued, rank senior to all other capital stock of the Company.
Capitalization:
Closing:
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Dividend Rights:
The Series A Preferred will be entitled to an annual per share dividend equal to [8%] of the Purchase Price, payable when, as and if declared by the Board of Directors of the Company (the “Board”). Dividends will be cumulative and will be paid prior to payment of any dividend with respect to the Common Stock. After payment of the preferential dividend to the holders of Series A Preferred, any further dividends will be paid pro rata to the holders of Series A Preferred and Common Stock on an as-converted basis. The Series A Preferred also will be entitled to receive any non-cash dividends declared by the Board on an as-converted basis. In the event of any liquidation, dissolution or winding up of the Company, the holders of Series A Preferred will be entitled to receive for each share of Series A Preferred, prior to any distribution to the holders of Common Stock, an amount equal to 100 % of the Purchase Price plus all accumulated but unpaid dividends thereon whether or not declared by the Board of Directors (the “Preference Amount”). After the full Preference Amount on all outstanding shares of Series A Preferred has been paid, any remaining funds and assets of the Company legally available for distribution to shareholders will be distributed pro rata among [the Series A Preferred on an asconverted basis and] the holders of Common Stock. [Note: the bracketed language presents a standard participating preferred, which is the superior alternative. A lesser position that may be presented by the Company is a non-participating preferred, which would be reflected by deleting the bracketed language in the previous sentence. In a non-participating preferred, the Investors must choose between accepting the Preference Amount and nothing else, or converting and sharing on an as-converted basis with no Preference Amount.] If the Company has insufficient assets to permit payment of the Preference Amount in full to all holders of Series A Preferred, then the assets of the Company will be distributed ratably to the holders of Series A Preferred in proportion to the Preference Amount each such holder otherwise would be entitled to receive. A merger or consolidation of the Company in which its shareholders do not retain a majority of the voting power in the surviving corporation, or a sale, lease, transfer or other disposition of all or substantially all the Company’s assets, each will be deemed to be a liquidation, dissolution or winding up of the Company.
Liquidation Preference:
Redemption:
Subject to any legal restrictions on the Company’s redemption of
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shares, beginning on the [fifth (5th)] anniversary of the Initial Closing the holders of a majority of the then outstanding Series A Preferred may require the Company to redeem all of the outstanding Series A Preferred. The redemption price (the “Redemption Price”) for each share of Series A Preferred will be the Preference Amount [NOTE: The foregoing provision represents a standard redemption arrangement, and only returns the liquidation preference amount. In some instances, in order to avoid having the entrepreneur make a “lifestyle decision” with respect to liquidity on the Company, you may consider the Preference Amount plus some additional amount above the standard rate of return, or alternatively, a more aggressive provision in lieu of redemption that provides for an appraisal of the Company, and a buyout at the appraisal valuation. Either of these alternatives would be a non-standard provision and would require specific attention of legal counsel.] The Redemption Price will be adjusted proportionally for stock splits, stock dividends, recapitalizations, etc. If on the redemption date, the number of shares of Series A Preferred that then may be legally redeemed by the Company is less than the number of such shares to be redeemed. [Alternative 1: the shares to be redeemed but that may not be legally redeemed will be carried forward and redeemed as soon as the Company has legally available funds therefore or Alternative 2: the redemption amount payable shall be paid in the form of a one-year note to each unredeemed holder of Series A Preferred and the holders of a majority of the Series A Preferred shall be entitled to elect a majority of the Company’s Board of Directors until such amounts are paid in full.] Conversion Price and Rate: The initial conversion rate for the Series A Preferred will be 1:1. The conversion price of the Series A Preferred also will be subject to proportional antidilution protection for stock splits, stock dividends, recapitalizations, etc. The holders of the Series A Preferred will have the right to convert the Series A Preferred into shares of Common Stock at any time at the then current conversion rate. The Series A Preferred automatically will be converted into Common Stock, at the then applicable conversion rate, upon the first to occur of (i) the affirmative vote of 2/3 of the outstanding shares of Series A Preferred and (ii) the closing of a firm commitment underwritten public offering of shares of Common Stock, with subsequent listing on NASDAQ or on a major United States stock exchange, raising a minimum net proceeds of [$30,000,000] with a price per share for the Common Stock equal to or greater than [300% of the Purchase Price] per share (a “Qualified IPO”), as
Conversion Rights:
Automatic Conversion:
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adjusted for stock splits, stock dividends, recapitalization, etc. Antidilution Provisions: The conversion price of the Series A Preferred will be subject to adjustment for issuances of additional securities at a purchase price less than the then-effective conversion price for Series A Preferred on a [full ratchet basis for issuances within 2 years of the Closing and, subsequent to this date, on a] narrow based weighted average basis. [Note: Full ratchet anti-dilution protection is aggressive, and consequently, the bracketed language may need to be eliminated if weighted average anti-dilution protection is agreed upon] The following issuances shall not trigger antidilution adjustment: (i) securities issuable upon conversion of any of the Series A Preferred, or as a dividend or distribution on the Series A Preferred; (ii) securities issued upon the conversion of any debenture, warrant, option, or other convertible security outstanding as of the date of issuance of the Series A Preferred; (iii) Up to [ ] shares of Common Stock (or options to purchase such shares of Common Stock) issued or issuable to employees or directors of, or consultants to, the Company pursuant to any plan approved by the Company’s Board of Directors, including the affirmative vote of the Series A Directors; (iv) shares of Common Stock issued or issuable to banks, equipment lessors pursuant to a debt financing, equipment leasing, or real property leasing transaction approved by the Board of Directors, [including the affirmative vote of the Series A Directors.]* (v) securities issued for mergers and acquisitions as approved by the Board of Directors, [including the affirmative vote of the Series A Directors.]* *The bracketed language is not permissible in California. . Each share of Series A Preferred will carry a number of votes equal to the number of whole shares of Common Stock then issuable upon its conversion into Common Stock. The Series A Preferred generally will vote together with the Common Stock and not as a separate class, except as provided below and as otherwise provided by law. [If a Delaware Corporation: The consent of the majority of the Board of Directors, which includes the affirmative vote of the Series A Directors, will be required in order for the Company to do any of the following; provided, that in the event the Series A Directors
Voting Rights:
Protective Provisions:
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determine for any reason that it is not appropriate for them to approve any of the following, they shall give written notice to the Corporate Secretary, and thereafter, the approval of the holders of a majority of the Series A Preferred shall be necessary to do any of the following:] [If a California Corporation: The approval of the holders of a majority of the Series A Preferred shall be necessary to do any of the following:] (i) amend or change the rights, preferences, privileges or powers of, or the restrictions provided for the benefit of, the Series A Preferred [approval of Series A Preferred required by California law and Delaware law]; (ii) increase or decrease the size of the Board of Directors; (iii) authorize, create or issue any other security, or security convertible into or exercisable for any shares of any class of stock, having rights, preferences, privileges or powers superior to or on a parity with the Series A Preferred [approval of Series A Preferred required by California law. If the Series A Preferred would be adversely affected by such activity, approval of Series A Preferred is required under Delaware law]; (iv) reclassify any outstanding shares into shares having rights, preferences, privileges or powers superior to or on a parity with the Series A Preferred [approval of Series A Preferred required by California law. If the Series A Preferred would be adversely affected by such reclassification, approval of Series A Preferred is required under Delaware law]; (v) amend the Company’s Articles or Certificate of Incorporation or Bylaws in a manner that adversely affects the rights of the Series A Preferred, or increase the authorized number of shares of Series A Preferred [approval of Series A Preferred required by California and Delaware law to increase the authorized number of shares of Series A Preferred, and also to make amendments to the Articles or Certificate which adversely affect the Series A Preferred]; (vi) materially alter or change the nature of the business of the Company; (vii) redeem or repurchase, any shares of capital stock other than stock repurchased from former employees or consultants in connection with the termination of their employment/services, at the lower of fair market value or cost; (viii) agree to, or consummate, a merger, sale or consolidation of the Company, or effect, approve or authorize any
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(ix)
(x) (xi)
(xii)
liquidation, dissolution, or winding-up or any recapitalization or reorganization of the Company [approval of Series A Preferred generally required by California law and Delaware law]; issue options to directors or officers of the Company, increase the number of shares reserved for issuance to employees, consultants or directors of the Company above __________ shares, or adopt or alter any equity or other incentive or bonus plan for any directors or officers of the Company, or for employees generally; change auditors or effect a material change in accounting practices; sell, license or otherwise transfer to any person or legal entity (a) any of its intellectual property out of the ordinary course of business or (b) any other material assets outside of the ordinary course of business; or incur any indebtedness or issue any bonds, notes or other obligations above the greater of [$200,000] in the aggregate in any fiscal year or creating debt to book value ratio greater than [______].
The foregoing restrictions will terminate upon the closing of a Qualified IPO. [the foregoing restrictions are the most common restrictions imposed upon management of the Company in an early round of financing. Other protective provisions are possible, but may unnecessarily burden management. Please contact us if you are considering the implementation of additional restrictions other than those outlined.] Information Rights: The Company will deliver to each holder of Series A Preferred: (i) annual unaudited financial statements within ninety (90) days following year-end; unaudited quarterly financial statements within forty-five (45) days following quarter-end; and [Note: Consider the following if it makes sense in the context of the Company’s business.] a quarterly narrative business report describing the Company’s progress during the quarter in relation to the business plan.
(ii)
(iii)
Employee Matters:
Upon the Closing of the Financing, and included as part of the premoney valuation, there will be [____________] shares of issued and outstanding Common Stock held by the founders of the Company
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(the “Founders”) and an additional [_________] shares of Common Stock reserved for future issuance to key employees. [Note: Typically, 10%-15% of the aggregate issued and unissued stock on a post-financing basis is allocated to company employees. This proportion may be higher, however, if the company needs to hire additional key personnel.] Registration Rights: If, at any time after [the earlier of (i)] six months following the Company’s initial public offering [or (ii) the [three/five]-year anniversary of the Initial Closing [Note: this clause (ii) is very aggressive, and you should anticipate substantial resistance to the concept that the Investors can cause the IPO to occur 3-5 years out. You should be prepared to scale back to only option (i)]], Investors holding at least [25%-50%] of “Registrable Securities” request that the Company file a Registration Statement for such Registrable Securities, the Company will use commercially reasonable efforts to cause such Registrable Securities to be registered. “Registrable Securities” will mean the shares of Series A Preferred (or Common Stock issuable upon conversion of Series A Preferred) issued in the Financing. The Company will not be obligated to effect more than [3] registrations hereunder, and the Company shall not be obligated to effect a registration hereunder unless the aggregate net proceeds exceed [$10,000,000]. The holders of [25%] of Registrable Securities will have the right to require the Company to file unlimited Registration Statements with respect to its Common Stock on Form S-3 (or any equivalent successor form), if available to the Company, if the anticipated aggregate offering price to the public would exceed [$1,000,000], provided that the Company shall not be obligated to file more than [1-3] Form S-3 registration statements in any 12-month period. The Investors will be entitled to unlimited “piggyback” registration rights on registrations by the Company and on any demand registrations subject to the right, however, of the Company and its underwriters to reduce the number of Registrable Securities proposed to be registered to a minimum of [25%] on a pro-rata basis and to complete reduction on an IPO at the underwriters discretion. In all events, the shares to be registered by holders of Registrable Securities will be reduced only after all other stockholders shares are reduced. The Investors’ registration rights may be transferred to a transferee who acquires Registrable Securities. The registration expenses (exclusive of stock transfer taxes,
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underwriting discounts, and commissions) will be borne by the Company. The Company shall also pay the reasonable fees and expenses[, not to exceed [$50,000],] of one special counsel to represent all participating Investors. No Investor holding more than 1% of the Company will sell shares within 120 days of the effective date of the Company’s initial public offering if all officers, directors, and other 1% shareholders are similarly bound. The registration rights granted to the holders of Registrable Securities shall terminate at the earlier of (i) [five] years after a Qualified IPO (ii) upon a deemed liquidation event as defined in the “Liquidation Preference” section above, or (iii) when all Registrable Securities held by a holder thereof are eligible to be sold under rule 144k. Preemptive Rights: At any time on or prior to the consummation of a Qualified IPO, holders of shares of Series A Preferred will have the opportunity to purchase their pro rata portions of any future private placements by the Company of equity or equity-linked securities (assuming the conversion of all outstanding Series A Preferred into Common Stock and the exercise of all options, warrants and other convertible securities outstanding), excluding those issuances listed in the “Antidilution Provisions” section of this Term Sheet, and further excluding securities issued in connection with acquisitions by the Company that have been approved by the Board of Directors which includes the affirmative vote of the Series A Directors. In the event an unaffiliated third party makes a bona fide offer for all or substantially all of the stock or assets of the Company and the Board of Directors and holders of a majority the Common Stock and holders of a majority of the Series A Preferred approve the transaction, the remaining stockholders shall sell their shares and/or vote for the transaction to sell the assets of the Company. The aforementioned rights will terminate upon the closing of a Qualified IPO. [Note: This is an optional provision, and can be used to bridge a difference in valuation between the investors and the Company] The Investors also will receive [7-10]-year Warrants to purchase one (1) share of Common Stock for each __________share of Series A Preferred (___% warrant coverage). The Warrants will be exercisable for Common Stock at $______ per share. The Warrants will contain a cashless exercise feature and customary antidilution and other provisions.
Drag-along Rights:
Warrants:
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Board of Directors:
The Board will consist of 5 members. 2 directors will be nominated by the holders of a majority of the outstanding Common Stock [, one of which shall be the C.E.O. of the Company], 2 directors will be nominated by the holders of a majority of the outstanding Series A Preferred, and 1 director will be nominated mutually by the holders of a majority of the outstanding Common Stock and by the holders of a majority of the outstanding Series A Preferred, voting as separate classes. At least one of the directors nominated by the holders of Series A Preferred will be on each committee of the Board. The Board of Directors will establish a compensation committee that shall be responsible for determining management compensation and administering the granting of options pursuant to the Company’s option plan. The Company will not use the proceeds from the Financing to repay any outstanding debt obligations but will instead use the proceeds from the Financing for the following purposes: [general working capital needs, hiring of additional employees, purchase of PPE or other capital expenditures, marketing/sales/promotional activities, inventory purchase etc.] All existing shareholders (including the Founders) who proposes to sell all or a portion of his or her shares in the Company to a third party must permit the holders of the Series A Preferred, at their option, to: (i) purchase such shares on the same terms as the proposed transferee, or (ii) sell a proportionate part of their shares on the same terms offered by the proposed transferee. The foregoing rights will terminate upon the closing of a Qualified IPO. The Company and each Investor will enter into a Stock Purchase Agreement reasonably acceptable to the Company and the Investors, which will contain, among other things, appropriate representations and warranties of the Company and the Investors, covenants of the Company reflecting the provisions set forth in this Term Sheet and appropriate conditions to closing which will include, among other things, qualifications of the shares to be sold under applicable federal and state securities laws, and the filing of Amended and Restated [Certificate/Articles] of Incorporation, and satisfactory completion of financial and legal due diligence. Counsel to the Investors shall draft the closing documents. [Note: Fallback position is that Company counsel drafts, but this should be resisted, and only agreed to if the Investors’ counsel is familiar with and approves Company counsel.] Each officer and employee of the Company, as well as consultants
Use of Proceeds:
Series A Preferred Right of First Refusal and Co-Sale Agreement:
Stock Purchase Agreement:
Confidential
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Information and Invention Assignment Agreement: NonCompetition and NonSolicitation:
with access to Company confidential information/trade secrets will enter into an acceptable Confidential Information and Invention Assignment Agreement in a form acceptable to the Investors.
Each Founder and key employee will enter into a [one] year noncompetition and non-solicitation agreement in a form reasonably acceptable to the Investors. [Note: This provision should be discussed with counsel, and may not be appropriate if the Company and/or any such Founder is located in California or other jurisdictions] On or prior to the Initial Closing, the Company shall procure D&O insurance with coverage of not less than [$1,000,000], with an insurer reasonably acceptable to the Investors, and shall maintain such insurance in full force and effect so long as there shall be any Series A Directors. [Note: If there is something unique or special about the Founders, consider the following insurance provision.] As soon as reasonably possible after the Closing, the Company shall procure a key man insurance policy for the following individuals employed by the Company with a death benefit in the amount of [$2 to $3 million], naming the Company as beneficiary; provided, however, that at the election of holders of a majority of the outstanding Series A Preferred, such proceeds shall be used to redeem shares of Series A Preferred: [key management person 1], [key management person 2], etc
Insurance:
Small Business Stock Provision Under Section 1244 of the IRC:
Prior to the Initial Closing, the Company shall determine whether it qualifies to issue the Series A Preferred as “small business stock” pursuant to Section 1244 of the Internal Revenue Code. If the Company satisfies the criteria to issue the Series A Preferred as “small business stock” as outlined in Section 1244 then, on and after the Closing, the Company shall take all action reasonably necessary to make the benefits of Section 1244 available to the Investors. [Note: Section 1244 provides a benefit to Investors if there is a loss on 1244 stock at the time it is sold. Normally, such a loss would be treated as a loss from the sale or exchange of a capital asset. Section 1244 permits such loss to be treated as an ordinary loss. The benefits of Section 1244 of the Code are available only to Investors that are individuals (corporations, trusts, and estates are excluded from the benefits of the section). Please contact Stubbs Alderton & Markiles, LLP if you have questions in relation to the applicability of Section 1244 in the Financing.]
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Common Stock Repurchase Right:
Each Founder shall enter into a Stock Repurchase Agreement whereby shares of Common Stock held by the Founders will be subject to a repurchase right upon termination of such Founder’s employment pursuant to which the Company will have the right to repurchase [60%-75%] of such shares, at the Founders’ actual cost of such shares. The repurchase right shall expire in equal increments over a period of [forty-eight (48)] months. This proposal is specifically subject to: 1) Completed due-diligence reviews satisfactory to the Investors and Investor’s counsel. 2) Customary stock purchase and related agreements satisfactory to the Investors and Investor’s counsel, including stock option plan. 3) Confidential Information and Invention Assignment Agreement in a form acceptable to the Investors and Investors’ counsel. 4) [Optional: Conversion of all outstanding convertible securities (e.g. convertible notes or preferred stock issued prior to the date of this Series A financing).] 5) [Optional: the receipt of an opinion of counsel to the Company in form and substance acceptable to the Investors.]
Conditions Precedent:
Definitive Documents: Confidentiality:
Upon completion of the Investors’ due diligence investigation, the Investors will instruct their legal counsel to prepare definitive documents on the terms contained herein. Unless specifically agreed to in a separate written agreement, there shall be no expectation that any information and/or documents provided to the Investors in connection with the proposed transactions shall be confidential or proprietary to the Company. The parties agree to negotiate in good faith the terms and conditions to the definitive documents. Except for this section, and the sections entitled “Confidentiality” and “Expenses” which are intended to be binding, the parties agree that this Term Sheet is not intended to be a binding agreement between the parties but merely an expression of their intent with regard to the transactions described herein. Without limiting the foregoing, it is the intent of the Company and the Investors that, until such definitive documents are in place, no agreement shall exist among them and there shall be no obligations whatsoever, including an obligation to invest, based on such things as parol evidence, extended negotiations, “hand shakes,” oral understandings or courses of conduct.
Binding Effect and Termination:
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Expenses:
The Company will reimburse [all or up to $[____________]] of the actual out-of-pocket legal and administrative expenses of the Investors incurred in connection with the investigation, due diligence and documentation related to the Financing (including, without limitation, fees and expenses of counsel and consultants), concurrently upon the earlier to occur of (i) the Initial Closing and any Subsequent Closing, as applicable, and (ii) the termination of negotiations relating to the Financing. This Term Sheet shall expire on [_____________________] if not accepted by the Company by that date.
Expiration
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IN WITNESS WHEREOF, this Term Sheet is executed as of the date first above written: The Company: [Name of Company]
By: Its:
The Investors: [List Each]
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ATTACHMENT A PRE AND POST-FINANCING CAPITALIZATION TABLE
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Sample Anti-Dilution Provisions In the event that the Company issues additional securities at a purchase price less than the current Series A conversion price, such conversion price may be adjusted in accordance with any of the following three techniques: Method 1: Broad Based Weighted Average (this method is most favorable to the company): New = Old * (A+B) / (A+C) New = New Series A conversion price Old = Series A conversion price in effect immediately prior to new issue A = Number of shares of Common Stock deemed to be outstanding immediately prior to new issue (includes all shares of outstanding common stock, all shares of outstanding preferred stock on an asconverted basis, and all outstanding options and warrants on an asexercised basis). B = Aggregate consideration received by the Company with respect to the new issue divided by Old C = Number of shares of stock issued in the subject transaction.
Method 2: Full ratchet (this method is most favorable to the Series A investors) In this method, the conversion price is reduced to the price at which the new shares of stock are issued (regardless of the number of shares of stock that are issued).
Method 3: Narrow Based Weighted Average (this is the middle ground) New = Old * (A+B) / (A+C) New = New Series A conversion price Old = Series A conversion price in effect immediately prior to new issue A = Number of shares of Common Stock deemed to be outstanding immediately prior to new issue (includes all shares of outstanding common stock, and all shares of outstanding preferred stock on an asconverted basis).* B = Aggregate consideration received by the Company with respect to the new issue divided by Old C = Number of shares of stock issued in the subject transaction. *there are variations on this formula to include options. Please contact Stubbs Alderton & Markiles, LLP if you are considering an alternative definition.
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