How to Split the Pie, Raise Money, and Reward Contributors (Idea To IPO)
•Download as PPTX, PDF•
1 like•852 views
What’s my startup worth? How much equity should founders have? How much equity should I give to employees and consultants? How much should I give to the venture capitalists? Silicon Valley startup attorney Roger Royse of the Royse Law Firm discusses the basic valuation and ownership issues involved in a startup’s life, from formation to financing to exit, including how to value your company and the contributions of stakeholders and investors at each step with a particular emphasis on different models, best practices and traps to avoid.
Report
Share
How to Split the Pie, Raise Money, and Reward Contributors (Idea To IPO)
- 1. Idea To IPO Startup Basics: How to Split the Pie, Raise Money, and Reward Contributors #startup #ideatoipo Roger Royse @rroyse00
- 2. Disclaimer No information contained in this presentation is to be construed as legal advice. No information contained in this presentation is intended or related to any particular factual situation. Nothing herein forms an attorney-client relationship. If legal advice or other expert assistance is required, the services of a competent professional should be sought.
- 5. Splitting Founders Equity • The founder’s first decision • The case of Zipcar • 50/50 handshake deal • Co-Founder 1 (Robin) built the startup, crafted its business plan, and cold called customers. • Cofounder 2 didn’t even quit her day job, and contributed little. • Her rushed negotiation had compromised her team’s longer-term effectiveness by causing her “a huge amount of angst over the next year and a half.”
- 6. Dynamic Split Equal Percentages Subjective Formula Founder’s Equity
- 7. • Traditional fixed-split model: Equity given based on anticipated contributions. • Dynamic-split model: Equity given based on actual contributions. • Inputs to dynamic-split model: The dynamic model assigns a relative FMV weight to various contributions from each participant, and contributions put into model: Time spent working Intellectual property Commissions Cash Facilities Equipment and Supplies • Outputs: Depending on the relative weighted contributions of each team member, that member is allocated a corresponding percentage of outstanding equity. – On “split,” members could return old equity, or be given new equity, to ensure each member gets appropriate percentage of company. Dynamic Split Models – General Concept
- 8. The Founders’ Pie Calculator 1. Created by Frank Demmler, professor, Tepper School of Business at Carnegie Mellon University 2. A founder’s value add is divided into 5 categories: Idea, Business Plan Preparation, Domain Expertise, Commitment and Risk, and Responsibilities. 3. Each category is given a value on a scale of 0-to-10. 4. The value is multiplied by the founder’s score to come up with a weighted score.
- 9. Weight Founder 1 Founder 2 Idea 7 10 3 Business Plan 2 5 1 Domain Expertise 5 3 6 Commitment & Risk 7 4 6 Responsibilities 6 2 3 Founder 1 Founder 2 Idea 70 21 Business Plan 10 2 Domain Expertise 15 30 Commitment & Risk 28 42 Responsibilities 12 18 Total Points 135 113 248 % of Total Founder Equity Pool 54.43% 45.57% 100% Frank Demmler, professor, Tepper School of Business at Carnegie Mellon University Founders’ Pie Calculator Example
- 12. Potential taxation: Stock for services (§83), or taxable repeated contributions of property Partnerships and LLCs – profits interests are non taxable Corporation and capital interests solution: At start of company, all participants are granted a certain number of shares of Restricted Stock. Participants make 83(b) election immediately to recognize ~$0 taxable income, when company worthless. Vesting conditions: You only keep those shares such that you get your appropriate percentage under model. Thanks to §83(b), participants will not need to pay taxes when Grunt Fund “split” occurs at some future date. Dynamic Split Models – Tax Issues and Planning
- 13. • Class F Stock is common stock with super-voting rights. • Series FF Stock is common stock that is convertible into preferred stock in a sale. Founder Protections
- 14. www.startuprounds.com • Who should vest • How long? • Acceleration? • Change of control • Termination without cause • Double and single triggers VESTING Vesting
- 15. • Form of Election • Timing • Whose Obligation? 83 (b)
- 16. FAST Model Valuation Milestones and Deliverables Vesting Stock v. Options Advisors
- 17. CURRENCY • Options • RSUs • Restricted Stock • Phantom Plan Units Currency
- 18. www.startuprounds.com • How long? • Milestone based vesting • Change of control Acceleration? VESTING Vesting
- 19. www.startuprounds.com • Employee vs Independent Contractor • Wage & Hour Laws • Intellectual Property Issues • Prior Employer’s Facilities • Invention Assignments VESTINGAdditional Considerations
- 20. • Founders • Family & Friends • Angel Investors • Private Equity Funds • Banks • Venture Capital Early Stage Investment Sources
- 21. SAFE Priced roundsConvertible Debt Seed Funding
- 22. • Convertible Notes • Debt obligations that convert to preferred stock • SAFE • Convertible equity • Conversion feature • Valuation Cap • Sets a maximum valuation at which note will convert • Discount • Early investors get a discount to the preferred price • Change of Ownership • Investors convert to common or get a multiple on a sale of the company prior to a priced financing round Terms: SAFEs and Convertible Notes
- 23. • Common Stock • Options • Warrants • Convertibles • Preferred Stock Cap Table
- 24. Founders 5,000,000 38% 5,000,000 45% Stock Pool 2,000,000 15% n/a Series A 3,000,000 23% 3,000,000 27% Series B 3,000,000 23% 3,000,000 27% total 13,000,000 100% 11,000,000 100% Capitalization Fully Diluted % Issued %
- 25. Founders 5,000,000 50% 5,000,000 63% Stock Pool 2,000,000 20% n/a Series A 3,000,000 30% 3,000,000 38% Series B 0% 0 0% total 10,000,000 100% 8,000,000 100% Capitalization
- 26. Founders 5,000,000 71% 5,000,000 100% Stock Pool 2,000,000 29% n/a Series A Series B total 7,000,000 100% 5,000,000 100% Capitalization
- 27. Founders 5,000,000 100% 5,000,000 100% Stock Pool 0% n/a Series A 0% Series B 0% total 10,000,000 100% 5,000,000 100% Capitalization
- 28. Post-Money value = Pre-Money Value + Investment Amount Investor’s ownership = Investment / Post-Money value Pre vs Post Money
- 29. Photo Borrowed From The Full Ratchet Pre vs Post Money
- 30. The company cap table is: Common 1,000,000 shares Convertible Note or SAFE, $1,000,000 with a 20% discount Company does a Series A of $1,000,000 at a pre-money valuation of $4,000,000 We have one $1,000,000 note or SAFE that converts into $1,250,000 of stock ($1,000,000 divided by 0.8). If it come out of the pre money, cap table pre Series A is: Value Shares PPS Percent Common $2,750,000 1,000,000 $2.75 55% Note or SAFE $1,250,000 454,545 $2.75 25% Series A $1,000,000 363,636 $2.75 20% Series A gets 20% and common and SAFEs take dilution SAFE Converting Pre Money
- 31. The company cap table is: Common 1,000,000 shares Convertible Note or SAFE, $1,000,000 with a 20% discount Company does a Series A of $1,000,000 at a pre-money valuation of $4,000,000; Post is $5,000,000 We have one $1,000,000 note or SAFE that converts into $1,250,000 of stock ($1,000,000 divided by 0.8). Value Shares PPS Percent Common $4,000,000 1,000,000 $4.00 64% Note or SAFE $1,250,000 312,500 $4.00 20% Series A $1,000,000 250,000 $4.00 16% Series A gets 20% and common and SAFEs take dilution SAFE Converting Post Money
- 32. Investors will ask that Option Pool be increased pre close, so that founders take full dilution for the option pool Effect of Option Pool
- 33. • VC or Institutional Investor • Preferred Stock • Valuation Methods • Score Card • Venture Capital Method • Berkus Method • Cayenne Calculator • Risk Factor Summation • Negotiation The Priced Round
- 34. www.startuprounds.com • When to mention valuation • Staged Investment • Liquidation Preference • Control • Blocking rights • Drags and tags • Anti-Dilution protection VC Negotiations
- 35. Other Financiers • Private Equity • Crowdfunding • Strategic Investors
- 36. Private Equity • For more mature companies • Deals often leveraged • Usually have cumulative dividend
- 37. Crowdfunding
- 38. • Campaign owner selects crowdfunding platform (e.g., Kickstarter.com, Indiegogo.com, GoFundMe.com). • Differences exist such as whether must hit target to get funds, whether for business or personal, others. • Campaign owner creates a campaign, telling the story of their product, idea, concept or reason for fundraising. • Third-parties “contribute” funds to the campaigns. • Funds raised are distributed to campaign owner less any applicable fees assessed (e.g., by the platform itself, credit card processors, foreign currency conversion, etc.). • Some sites require that “target” be met to get the funds. • Campaign owner, in exchange for this contribution may: • Do nothing, including provide nothing in return to the contributors • Provide a product or ownership interest • Provide a nominal value perk such as a logo tee shirt/tickets to an event Crowdfunding Campaign Overview Slide provided by: Dawn Rhea, Moss Adams Carolyn Lee, Morgan, Lewis & Bockius Annette Nellen, San Jose State University
- 39. • Crowdfunding (Title III of the JOBS Act) o Allows companies to raise a limited amount of funds from the general public (Effective as of May 16, 2016) o Investment must be through an intermediary broker or funding portal • General Solicitation (Title II of the JOBS Act) o The SEC has extended the exemption for private offerings under Rule 506 to allow for general solicitation providing certain requirements are satisfied o Can only issue securities to accredited investors and there are additional filing requirements • New Regulation A, nicknamed “Regulation A+” (Title IV of the JOBS Act) o Preempts state registration, allow for what some call a “mini-IPO” JOBS Act – Key Provisions
- 40. Exemption from Registration • The private company issuer (aggregated with predecessors and companies under common control) may sell up to $1.07 million of securities in a 12-month period [adjusted for inflation] • Individual investments in all crowdfunding issuers in a 12-month period are limited to: o If either their annual income or net worth is less than $107,000, then the greater of: $2,200 or 5 percent of the lesser of their annual income or net worth o If both their annual income and net worth are equal to or more than $107,000, then 10 percent of the lesser of their annual income or net worth (up to a maximum of $107,000) o Issuer may rely on intermediary’s calculation of investor limits, unless issuer knew it was or would be wrong • Process is likely to prove expensive and overly burdensome • Effective as of May 16th, 2016 Crowdfunding
- 41. Utility • Use of Token • Secondary Trading • Scarcity • Voting + Democratized Issuer Law • Securities Law • Regulatory • Tax • AML/KYC • Anti Fraud $ Step 2: Build Platform Step 1: Pre-Sale $orCrypto SAFT Investors Step 3: ICO Tokens Investors The ICO: Crowdfunding on Steroids
- 42. • Community supported crowd sale of cryptocurrency tokens issued by startups based on private Blockchain technology • Creates liquidity and growth equity without giving up equity in a company • Tokens are sold in exchange for Bitcoin, Ether, and government fiat • No clear tax guidance Initial Coin Offering (“ICO”)
- 43. • In certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the SEC or pursuant to an exemption from registration • Will depend on the facts and circumstances including the economic realities of the transaction • Tokens can have different utilities and rights • Regulation A, Regulation D, or Regulation CF can be used • Potential CFTC and FinCEN Compliance • US vs. Offshore Offering ICOs (cont.)
- 44. • Tokenized Stock • Token tied to asset or revenue stream • Treated as security STO - Security Coin Offering
- 45. Advantages: 1. It’s not an ICO, which are not doing well due to regulations and bad press 2. Liquidity, can be traded 3. Removes middleman, speeds up process 4. Broad access to investors Disadvantages: 1. Stigma due to ICO fallout 2. Regulatory uncertainty 3. Lack of governance STO – Pros and Cons
- 46. • Stock with tokens attached • Stock with right to future tokens • Stock convertible into tokens • Tokens with rights of stock • Asset backed tokens or centralized stable coins Security Tokens - Implementation
- 47. • Taking Money Off the Table • Earnouts and contingencies • Acqui- Hires The Exit
- 48. 1. Investor buys preferred shares from company and common shares from founders 2. Alternatively, investors buys preferred from company and company redeems common from founder 3. Founders common priced at above market 4. Tax issues for founder Target Target Shareholders PEG Target Shares Cash Cash Taking Money Off the Table
- 49. • Purchase price based on performance (earnouts) should be baked into formation documents • Can structure for capital gains tax instead of ordinary income Earnouts and contingencies
- 50. • Acquiring a company to recruit its employees • The Marvell case • Management carveouts Acqui- Hires
- 51. PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 SANTA MONICA 520 Broadway Suite 200 Santa Monica, CA 90401 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw ORANGE COUNTY 135 S. State College Blvd Suite 200 Brea, CA 92821