This document summarizes key terms in a Series A term sheet for financing. It discusses control terms such as board composition, investor protective provisions, and voting rights. It also discusses economic terms such as valuation, liquidation preferences, anti-dilution, and registration rights. The document provides an overview of major issues to consider for each term and emphasizes negotiating favorable terms for founders like limiting investor control and liquidation preferences.
1. Negotiating Series A Term Sheets
Richard M. Lucash
rlucash@mccarter.com
617.449.6568
@RickLucash
10/1512
2. What is a Term Sheet
♦ Control Terms and Economic Terms
♦ For Sale of Preferred Stock
– Liquidation PREFERENCE
– Conversion & Antidilution
3. Documents to implement Term Sheet
♦ Stock Purchase Agreement
♦ Charter
♦ Bylaws
♦ Investor Rights Agreement
♦ Voting Agreement
♦ Right of First Refusal and Co-Sale Agreement
4. Part I: Control Terms
Voting Rights and Board Seats
Investor Protective Provisions
Information Rights
Vesting of Founders’ Equity
Right of First Refusal and Co-Sale
Drag-Along
5. Voting Rights and Board Seats
♦ On most matters Series A votes with Common
♦ Typically 5 Directors (3 for smaller financings)
– 2 Investor Directors
– 1 Founder Director
– CEO
– 1 Independent Director
6. Investor Protective Provisions
♦ Investor Approvals:
– Significant corporate events (ex. sale)
– Actions that could adversely impact Series A
– More $$ More Protections
♦ Series A Director Approvals
– Lending/Borrowing
– Insider transactions
– Hiring/Firing Key Employees
♦ Key Issues
– Stockholder v. Series A Director approval
– % of stockholders required to approve
7. Information Rights
♦ Right to receive periodic reports
♦ Management Rights Letter
♦ Key Issues
– Which investors have rights to information
– Frequency (quarterly or monthly)
– Consequences for failure
– Confidentiality
♦ Nobody ever complies with information rights!
8. Vesting of Founders’ Equity
♦ Right to repurchase shares if Founder leaves
♦ Term: 3-4 years; 25% after 1 yr, then monthly
♦ Key Issues
– Credit for time served before the financing?
– Repurchase of vested shares in some situations?
– Acceleration on:
Change of Control (single/double trigger)
Termination without Cause
Leaving for Good Reason
9. Right of First Refusal and Co-Sale
♦ ROFR:
– Right to buy shares offered for sale by others
– Usually company has first right; investors second
– May be “all or none”
– May be applied to investors as well
♦ Co-Sale (aka Tag Along):
– Right to sell alongside (subject to ROFR)
– May be applied to investors as well
10. Drag-Along
♦ Compels subject stockholders approve a sale
♦ Facilitates exit where interests differ
♦ Key Issues
– Threshold for exercising
– Is consent of common or founders required?
– Is Board approval required?
11. Control Terms: Key Takeaways
♦ Board composition and director election
determines who controls the company
♦ Obtaining approval of actions from directors is
simpler than obtaining consent from investors
♦ Limit investor right to “drag” other stockholders
♦ If founders’ equity is subject to vesting, get credit
for time served
12. Part II: Economic Terms
Valuation and the Option Pool Shuffle
Dividends
Liquidation Preference
Anti-dilution
Pre-emptive Rights and Pay-to-Play
Redemption Rights
Registration Rights
13. Valuation and the Option Pool Shuffle
♦ Valuation
– Just one of several the economic terms
– Need to consider terms as a package
– Model outcome in various exit scenarios
♦ Option Pool Shuffle
– Option pool is typically 15-20% of post
– If included in pre-money:
reduces the effective valuation
“phantom” increase to the post-money valuation
shifts dilution to existing stockholders
14. Dividends
♦ Range from 5-10%
♦ Typically convert when Series A converts
♦ Key Issues
– Try to eliminate/delay accruing dividends
– Fight cumulative dividends
– Strongly resist compounding dividends
♦ Value of dividends can add up
– Most important in middle-of-the-road exit
15. Liquidation Preferences
♦ Most important economic term after valuation
♦ 3 Types
– Non-participating – Founder favorable
– Full Participating – Very Investor favorable
– Capped Participating – Investor favorable
♦ Investors get 1-3x (plus dividends) before others
♦ Participating preferred also shares with Common
♦ Applies to any exit, not just liquidation (ex. sale)
16. Anti-dilution
♦ Conversion Ratio = Conversion Price / Sale Price
♦ Adjusts conversion price for “down” rounds
♦ Weighted Average:
– Proportionate to size and price of down round
♦ Full Ratchet:
– Adjusts conv. price to equal price in down round
– Red Flag: investor is aggressive on terms
♦ Exceptions for certain share issuances
17. Pre-emptive Rights and Pay-to-Play
♦ Types of Pre-emptive Rights
– Right to maintain %
– Right to purchase a multiple of %
– Right to purchase (collectively) 100%
♦ Over-Allotment Right
♦ Limitations
– Major Investors
– Pay-to-Play
– Use or Lose (Pay-to-Play Lite)
18. Redemption Rights
♦ Right to force redemption after ~5 years
♦ Creates an “exit” option, but rarely (never?) used
♦ May create leverage to force other exits
♦ Key Issues
– Optional v. Mandatory
– Time before right matures
– Length of time allowed for payout
– Consequences of failing to redeem
19. Registration Rights
♦ Demand: Usually limited to 1 or 2
♦ Generally not worth negotiating; underwriters will
rule
♦ S-3: Usually limited to 1 or 2 per year
20. Economic Terms: Key Takeaways
♦ Dividends and liquidation preferences can have
significant impact on economics
♦ Option pool should be sufficient for near future
♦ Understand if option pool is in pre-money
♦ Full ratchet anti-dilution is very investor favorable
♦ Pay-to-Play helps mitigate anti-dilution in down-
round financing
♦ Pre-emptive Rights should not prevent the
company from raising more money
♦ Don’t sweat Registration Rights
21. Other Terms
♦ Tranches and Milestones
♦ Conditions to Closing
♦ Reps & Warranties
♦ Payment of Investor Expenses
– Should be contingent on closing
– Cap (typically $35K-$50K)
Series Seed and other downward pressure on prices
22. McCarter & English LLP
Questions?
Richard M. Lucash
rlucash@mccarter.com
617.449.6568
@RickLucash