Introduction to Venture Capital Financing

Introduction to Venture Capital Financing
Ed Pease
Gary Schall
November 4, 2013

Attorney Advertising

Venture Capital Financing
What is a venture capital transaction?
 Type of private equity capital typically provided for earlystage, high-potential, growth companies in the interest of
generating a return through an eventual realization event such
as an IPO or sale of the company
 Venture capital investments are generally made as cash in
exchange for shares in the invested company
 This session is about traditional venture capital financing, not
new crowdfunding approaches to financing.

Source: Wikipedia

© 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Venture Capital Financing
Securities Law Compliance
 Under federal securities laws, every issuance of a security
must either be registered under the Securities Act or exempt
from registration
 All issuances of securities that are not being registered with
the SEC must also be reviewed for compliance with state
securities laws, or so-called "blue sky" laws

Securities law compliance is not
addressed in this presentation


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Transaction Documents
Pre-Closing
Term Sheet

Certificate of
Incorporation

Signing and
Closing
Operative Documents

Ancillary Documents

• Stock Purchase Agreement

• Management Rights Letters

• Investor Rights Agreement
• Voting Agreement

• Director Indemnification
Agreements

• Right of First Refusal and CoSale Agreement

• Legal Opinion of Company
Counsel


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Term Sheet

 Summarizes the principal terms of the transaction
 Generally not legally binding, except for confidentiality and
exclusivity provisions


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Deal Terms
Term Sheet Offering Terms
 Closing Date
 Investors
 Amount Raised
 Price Per Share
 Pre- and Post-Money Valuation
 Current and Pro Forma Capitalization


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Deal Terms
Term Sheet Binding Provisions
 No-shop / Exclusivity
 Confidentiality
 Expenses


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Stock Purchase
Agreement

 Sets forth the basic terms of the purchase and sale of the

preferred stock to the investors and identifies the other
financing documents
 Typically fully negotiated and approved by the Board and

stockholders but not signed until after the Certificate of
Incorporation is filed


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Deal Terms
Stock Purchase Agreement
 Type and Amount of Shares
 Purchase Price
 Representations and Warranties of Company, Founders and
Investors
 Conditions to Closing/Closing Deliverables
 Counsel and Expenses


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Pre-Closing
Certificate of
Incorporation

 Establishes the rights, preferences, privileges and restrictions

of each class and series of the company’s stock
 Filed with the Secretary of State of the state of the company’s

incorporation


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Deal Terms
Certificate of Incorporation
 Pay-to-Play
– If an investor does not participate in a future financing, its
preferred stock automatically converts to common stock or a
“shadow” series of preferred stock without anti-dilution and/or
other rights

 Redemption Rights
– At election of preferred holders as a class after 3-5 years
– All or portion
– Price can be original purchase price plus dividends or FMV


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Deal Terms
 Dividends
– When, as and if declared or paid on common
– Accruing / cumulative

 Liquidation Preference
– Non-Participating
– Participating


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Deal Terms
 Anti-dilution Provisions
– Weighted average – broad v. narrow (i.e., exclude common stock
equivalents and shares reserved for issuance under incentive
plans)
– Full ratchet


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Deal Terms
 Director Voting Rights
– Right of a class of stock to elect one or more directors

 Protective Provisions
– Right of a class of stock to approve key matters (e.g., equity
issuances, transactions)


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Deal Terms
 Optional Conversion
 Mandatory Conversion
– At a qualifying IPO or upon a class vote


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 Investor Rights Agreement
– Covers ongoing rights and obligations of investors and ongoing
obligations of the company, including registration rights and
company covenants

 Voting Agreement
– Agreement among stockholders, generally investors and founders
to vote shares for various matters, including board designees and
drag-along rights

 Right of First Refusal and Co-Sale Agreement
– Grants rights to the company and investors on sales of stock by
founders and “key holders”
Closing
Operative
Documents

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Deal Terms
Investor Rights Agreement – Registration Rights
 Registrable Securities
 Demand Registration
 Registration on Form S-3
 Piggyback Registration
 Expenses


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Deal Terms
Investor Rights Agreement – Investor Rights and
Covenants
 Management and Information Rights
 Right to Maintain Proportionate Ownership (“preemptive
rights”)
 Matters Requiring Investor Director Approval
 Lock-up in an IPO


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Deal Terms
Investor Rights Agreement – Company Covenants
 Non-Competition and Non-Solicitation and Agreements
 Non-Disclosure and Developments Agreement
 Board Matters
 Employee Stock Options
 Key Person Insurance
 Other Covenants


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Deal Terms
Voting Agreement
 Board size and composition
 Increase common stock to cover conversion of preferred stock
 Drag-along
– Holders of specific percentage of stock can require all holders to
vote for certain matters


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Deal Terms
Right of First Refusal and Co-Sale Agreement
 Right of First Refusal
– Company has primary right of first refusal
– Investors have secondary right of first refusal if company does not
exercise in full

 Right of Co-Sale (“tag along”)
– If company and investors do not exercise their right of first
refusal, investors can sell some of their stock
Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000;
1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors
and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/codeof-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm
Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to
keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP


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Introduction to Venture Capital Financing

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