1. ALTERNATIVE FINANCING
OPTIONS FOR
UNCERTAIN TIMES
Anthony Millin
Lerch, Early & Brewer, Chtd.
www.lerchearly.com November 17, 2011

2. Overview
Convertible Note – Friends and Family,
Angel Round
Preferred Stock – Angel Round, VC Round
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3. A Convertible Note
 A convertible note is a debt instrument, with interest that usually
accrues
 Frequently issued to angel investors (sometimes used with friends
& family)
 Frequently unsecured
 Is usually convertible into a company’s preferred stock:
 Automatically, at the time the company closes on its next qualified round
of equity financing
 If no such round occurs, at pre-agreed upon terms
 Anytime prior to maturity, upon a vote of a majority of the convertible
note holders
 If there is no automatic conversion, and no election to convert is
made, the convertible note is repayable along with accrued, but
unpaid interest upon its maturity
© Lerch, Early & Brewer 2011

4. Benefits Of A Convertible Note Structure
 Relatively simple legal structure, and enables a lower
transaction cost
 Note Purchase Agreement and Promissory Note
 Provides the investor with priority status over common
and preferred shareholders with respect to the assets of
the company.
 Provides investor with a discount to the next
round/warrants/Cap
 Bypasses the need for the parties to agree on the
current value of the company
© Lerch, Early & Brewer 2011

5. A Convertible Note With A “CAP”
 The cap ensures that if the issuing company is very successful, the
convertible note investors still will own a material percentage of the
company
 Offers protection in situations when there is:
 A significant jump in the value of the company for the first preferred
round and/or a considerable amount of capital is raised.
 Investor will usually have the option to convert at either:
 A negotiated discount (i.e., 20%) to the next preferred round
 The agreed-upon valuation cap.
 Investor is compensated for investing during a period when market
risk, execution risk, technology/product risk and financing risk are
usually the highest.
© Lerch, Early & Brewer 2011

6. EXAMPLE
 A company with 1 million shares of common stock outstanding
 Issued a $500,000 convertible note, with a conversion discount of
20% and a conversion cap of $6 million.
 The start-up was able to raise $15 million at a pre-money valuation
of $45 million in its first preferred round of financing.
$ 6 million 20% No Cap or
Cap Discount Discount
Valuation $6 million $36 million $45 million
# of Shares 83,333 13,889 11,111
% Of Company 5.9% 1.0% 0.8%
(Post)
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7. Preferred Stock
 Is a security that represents an equity ownership interest in a
corporation.
 Comes with a set of rights and preferences (priorities) over the
common stock related to the assets and profits of a company.
 Comes with a set of protective provisions that limit actions that can
be taken by the Company without preferred shareholder approval.
 The first preferred round is called Series A Preferred, the second
preferred round is called Series B Preferred, followed by Series C
Preferred, etc.
 Typically issued on pre-money fully diluted basis.
 Agreements typically include:
 Stock Purchase Agreement
 Investor Rights Agreement
 Right of First Refusal and Co-Sale Agreement
 Voting Agreement
 Amended and Restated COI
© Lerch, Early & Brewer 2011

8. Three Key Levers of Negotiation
 Value of the Company
 Pre-Money, Fully Diluted Value placed on Company
 $5 million/1 million=$5/share vs. $5 million/1.5 million =
$3.33/share
 Rights
 Liquidation Preference (Participating vs. Non Participating),
Dividend Rights (Cumulative vs. Non-Cumulative), Preemptive
Rights, Co-Sale Rights, Information Rights, Right of First Refusal
 Protection
 Require the approval of a majority of the preferred stock before
an action is taken by the company
 Amending the COI, Redemptions, change in business, size of
board, dissolving company, issuance of new superior securities

9. For more information
Lerch, Early & Brewer, Chtd.
3 Bethesda Metro Center, Suite
460
Bethesda, MD 20814
(301) 986-1300
www.lerchearly.com
Thank you for your participation
© Lerch, Early & Brewer 2011