1. Silicon Valley Term Sheets
Brad Rock
DLA Piper LLP (US)
650-833-2111
brad.rock@dlapiper.com
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2. Structure of Typical Start Up
• Founders: Partly vested common stock
• Employees: Common stock options with vesting over
4 years
• Investors: Convertible preferred stock
• C corporation: DE or CA
• In practice, no variation permitted
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3. Framework of Analysis
• Like a Prenuptial Agreement?
• Which terms matter
• Which don’t matter
• Attributes of Ownership Rights
• Economic
• Political
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4. Which Terms Don’t Matter - Economics
• Dividends (that are not automatic or cumulative)
• Conversion rights (always starts 1:1)
• IPO
• By choice
• Antidilution (if “broad based” not “ratchet”)
• Registration rights
• Demand
• S-3
• “Piggy-back”
• Lock up (180 days)
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5. Which Terms Don’t Matter – Economics
(cont.)
• Information Rights
• Indemnification
• D&O Insurance
• Management Rights Letter
• Proprietary Rights Agreements
• Deal expenses (within range)
• Right of Co-sale and First Refusal (as to founders and
their stock)
• Redemption
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6. Terms that Matter - Economics
• Valuation (and which shares are “pre-money”)
• Liquidation Preferences
• Participating/Non-participating
• “Deemed liquidation” – mergers
• Founder vesting
• Up-front vesting?
• Acceleration if terminated without cause?
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7. Key Political Terms
• Raw Percentage Ownership
• “Protective” provisions
• Always part of deal – boundaries
• Class versus Series rights – veto powers
• Board Composition
• Determines strategic direction; termination of management
• “Drag along” terms
• Who decides to sell company?
• CA vs. Delaware
• Contractual provisions
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8. Terms Mostly About the Investors
• Right of First Refusal on future financing
• “Pay to Play”
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9. “Cap Table” for Valuation of High Tech, Inc.
Pre-Money % Post-Money %
Outstanding 3,000,000 shares 75.00% 3,000,000 shares 50.0%
Common Stock
Outstanding 0 shares -- 2,000,000 shares 33.33%
Preferred Stock
Outstanding Stock 200,000 shares 5.00% 200,000 shares 3.33%
Options
Reserved Options 800,000 shares 20.00% 800,000 shares 13.33%
100.00% 100.00%
4,000,000 shares 6,000,000 shares
Valuation:
(Series A $8.0 million $12.0 million
Preferred
Purchase Price =
$2.00 per share)
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10. Anti-Dilution Protection
• Antidilution
• Weighted Average: Most common
• Ratchet: decreasing
• None: rare (generally, investor policy)
• Exclusions
• Option pool
• Warrants for banks/leasing companies
• Pay to Play provisions
• Lose future investment rights and preferences
• Harsher terms: Convert to common rather than a “shadow”
series of preferred stock
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11. Basic Protective Provisions
• Authorize more of that series
• Authorize series with more senior rights
• Change rights of that series
• Merger / sale of assets
• Limits on changes to number of members of Board of
Directors
• Many others possible
• Limits on borrowing, exclusive licenses, dividends,
redemption of shares
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12. Documents for Funding
• Stock Purchase Agreement
• Schedule of Exceptions
• Due Diligence
• Articles (Certificate) of Incorporation
• Investor Rights Agreement
• Registration Rights Agreement
(often combined with Investor Rights Agreement)
• Voting Agreement (with “drag along”?)
• Co-sale and rights of first refusal
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13. Due Diligence: Common Start-Up
IP Problems
• Hidden founder
• Missing IP assignments to company
• Prior employer rights
• Trademark issues
• Exclusive licenses
• Tradeshow display before the patent is filed
• Unplanned use of Open Source software
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14. Effect of Liquidation Preference in Merger
Assumed Total Liquidation or Sale
Amount (options expire or assumed): $9.0 million $15.0 million $20.0 million $25.0 million
Example A: Non-Participating Preferred (per share): $0.80 $1.25 $1.67 $2.08
Preferred Common (per share): $0.725 $1.25 $1.67 $2.08
Example B: Fully Participating Preferred (per share): $1.28 $1.78 $2.20 $2.62
Preferred (assuming Common (per share): $0.48 $0.98 $1.40 $1.82
1 times preferred)
Example C: Participating Preferred (per share): $1.28 $1.78 $2.00 $2.08
Preferred up to $2.00 Common (per share): $0.48 $0.98 $1.50 $2.08
per share
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