Class 7 (Ch. 8

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Class 7 (Ch. 8 9)

• Based on Andrew Metricks Slides

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Term Sheets The Basics

• Expropriation
• Charter
• Investor Rights Agreement
• Rounds
• Series A, Series B, etc.

3
Capitalization Table
4
Investors and Prices

• investment
• Fully diluted share count
• Proposed ownership percentage
• Original purchase price (OPP)
• Aggregate purchase price (APP)
• Tranche

5
Post-Money Valuation

• Post-money valuation price-per-share
  fully-diluted share count
• or
• Post-money valuation investment / proposed
  ownership percentage

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Pre-Money Valuation

• Pre-money valuation post-money valuation -
  investment
• or
• Pre-money valuation price-per-share
  pre-transaction (fully diluted) share count
• (But be careful in down rounds!)

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Liquidation

• Deemed liquidation event
• Liquidation preference (2X, 3X, etc.)
• Qualified public offering (QPO)

8
Dividends

• Dividend Preference
• Cumulative vs. non-cumulative dividends
• Accrued cash dividends
• Simple interest, compound interest
• Stock dividends Payment-in-kind (PIK) dividends

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Restricted Stock Registration Rights

• Registration rights
• Demand
• S-3
• Piggyback
• Redemption rights
• In-kind distributions
• Rule 144, rule 144(k), rule 144A
• Qualified Institutional Buyers (QIBs)
• Lockup restrictions

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Other issues

• Step vesting, cliff vesting
• Right of first refusal, Right of first offer
• Drag-along rights
• Take-me-along tag-along rights
• Anti-dilution rights, down rounds
• Pay-to-Play
• No Shop

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Preferred Stock

• Convertible preferred (CP)
• In our example, conversion point (WA) occurs
  when
• CP (conversion value) 1/3 W
• CP (redemption value) Min (5M , W).
• Conversion Condition 1/3 W gt 5 ? WA
  15.

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Convertible Preferred Payoff Diagram
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Exit Diagram for Convertible Preferred
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Other types of preferred stock

• Redeemable Preferred (RP)
• Participating Convertible Preferred (PCP)
• PCP with cap (PCPC)
• Key threshold for PCP is a qualified public
  offering (QPO)

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Alternatives

• Structure I 5M shares of common
• Structure II RP (5M APP)
• Structure III RP 5M shares of common
• Structure IV PCP with participation as-if 5M
  shares of common, QPO at 5 per share
• Structure V PCPC with participation as-if 5M
  shares of common, with liquidation return capped
  at four times OPP, QPO at 5 per share
• Structure VI RP (4M APP) 5M shares of CP (1M
  APP).

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Structure I
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Structure II
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Structure III
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Structure IV
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Structure V
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Structure V, continued
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Structure VI, RP component
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Structure VI, CP component
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Structure VI, RP CP
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Anti-Dilution Protections

• Down round
• Full-ratchet vs. weighted average
• Broad base vs. narrow base
• Adjusted conversion price, adjusted conversion
  rate

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Broad-base weighted average anti-dilution

• CP2 adjusted conversion price CP1 (AB) /
  (AC)
• where
• CP2 New Series A Conversion Price
• CP1 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
  as-converted basis, and all outstanding options
  on an as-exercised basis does not include any
  convertible securities from this round of
  financing)
• B Aggregate consideration received by the
  Corporation with respect to the new issue divided
  by CP1
• C Number of shares of stock issued in the
  subject transaction

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Narrow-base weighted average anti-dilution

• Everything the same as in the broad-base formula,
  except,
• A (narrow-base) Number of shares of Common
  Stock deemed to be outstanding immediately prior
  to new issue (including all shares of outstanding
  preferred stock on an as-converted basis, but
  excluding all shares of outstanding common stock
  and all outstanding options on an as-exercised
  basis does not include any convertible
  securities from this round of financing)

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• EXAMPLE Suppose that EBV makes a 6M Series A
  investment in Newco for 1M shares at 6 per
  share. One year later, Newco has fallen on hard
  times and receives a 6M Series B financing from
  Talltree for 6M shares at 1 per share. The
  founders and the stock pool have claims on 3M
  shares of common stock.
• Consider the following cases
• Case I Series A has no antidilution protection.
• Case II Series A has full-ratchet antidilution
  protection.
• Case III Series A has broad-base
  weighted-average antidilution protection.
• Case IV Series A has narrow-base
  weighted-average antidilution protection.
• For each of these cases, what percentage of Newco
  (fully diluted) would be controlled by EBV
  following the Series B investment? What would be
  the post-money and pre-money valuations? (See
  Example 9.2 in the textbook.)