Dynamics of Term Sheets in Venture Financing
Denny S. Roja, Esq. Acuity Ventures, LLC
denny@acuityventures.com
Background
Managing Partner, Acuity Ventures Corporate attorney, Enterprise Law Group Investment banker (M&A), NewCap Partners and Harris Roja Corporation Director of Corporate Development - Pacific Telesis; General Foods MBA, Stanford; JD, Fordham Law President, ACG Silicon Valley
Understand the Needs of the Players
The Company
The Founders The Investors
The Company needs...
Capital Value-added investors
Relevant business experience Knowledge of the industry Ability to recruit key personnel Ability to establish important relationships
The Founders need...
To develop and commercialize “idea” Some degree of control to execute the Business Plan To be clear and realistic on their personal objectives A clear, well-negotiated Term Sheet
The Investor needs...
THE INVESTORS BILL OF RIGHTS Right to a high ROI Right to reduce risk (shift them to founders?) Right to have enough control to protect their interests Right to liquidate the investment
Considerations in Angel/VC Financing - Founder Viewpoint
Think ahead to next financing rounds Terms must be acceptable to reasonable future venture investors and fit seamlessly Do not extract anything unusual that will need to be undone in later rounds
limit upside of the business reduces value
Examples of Terms to Avoid
No “ratchets.” Weighted average will do. No inordinate number of board seats No special rights to Angel or corporate partner No right to sell Company to Angel at most favored nation price No right of first refusal
Other Considerations
Fewer rather than more Angel investors Choose sophisticated people who understand the business Pay attention to securities compliance and other legal formalities. Watch out for “Blue Sky” issues Choose Preferred Stock vs. Common avoid tax issues ability to give options at lower price
Other Considerations
Pay attention to reputation of Angels Pick Angels who have good contacts/strong networks, i.e. valueadded Distinguish between Angels and Finders Be wary of “side” agreements Understand capital structure of the Company
Other Considerations: Angel Viewpoint
Angel round should be properly documented. No excuse to be sloppy.
Stock Certificates properly issued Proper legends Securities compliance
Know what commitments for stock have been made by founders Don’t invest until stock books cleaned up
Key Features
Features that reduce Risk Features that provide Liquidity Features that relate to Control
Features that Reduce Risk
Liquidation Preference Price-based Anti-Dilution Merger Protection Right of First Refusal/Participation Restrictions on New Securities
Liquidation Preference
Sale or Liquidation of the Company Founders bear first risk of loss Investors recover their investment and minimum return before founders Participating preference - the “double dip”
Anti-dilution Protection
In a “down round”
Founders bear disproportionate share of dilution Conversion ratio of Preferred adjusted or issue more shares to Preferred
“Ratchet” most onerous - Adjust price of old investors to new round. “Weighted average” middle ground.
Other Risk Reducers
Treat Mergers as liquidations New issues of Securities require consent of existing shareholders Right of participate in new round of financing - may prevent bringing in attractive, new investors
Features that provide Liquidity
Registration Rights Demand Piggyback Redemption - force the Company to buy back investor shares if no IPO or M&A. Right to control board if Company goes sideways. Co-Sale - include investor shares in a private sale of founder shares
Features that Relate to Control
Restrictions on Founder Stock vesting, repurchase at low price Board of Directors voting agreements Observation rights right to observe but not vote or participate Information rights - receive financials Limits on Employee Stock Ownership - to reduce dilution and preserve voting control