More Related Content Similar to How to Negotiate with Venture Capitalists (19) More from Roger Royse (20) How to Negotiate with Venture Capitalists1. © 2020 Haynes and Boone, LLP
© 2020 Haynes and Boone, LLP
Idea to IPO
How to Negotiate with Venture
Capitalists
#startup #ideatoipo
1
Roger Royse
@rroyse00
2. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
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.
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3. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital
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8. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Are you a candidate for venture
Can the business scale?
Is it a huge market?
Explosive growth
Do you have a top team
Do you have an unfair competitive advantage?
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9. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Should You Take Venture Capital?
Must give up Equity
No near term cash flow
Risky
Illiquid
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10. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Company VC Fit
Large potential market
First Mover or first to market advantage
Long term scale over short term profits
Not able to service debt
Traction!
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11. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Series A is the New Series B
Series Seed
Pre-Seed
Series A-1, A-2
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12. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Types of Funds
Micro VC – angels with other people’s money
Seed Stage Fund – early, first institutional money
Mid Stage – B and beyond
Late Stage
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13. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
A Word About Angels
The Good:
Connections to VC funding
Mentorship
Risk capital
The Bad
Hostage takers
Whiners
Demanders
The Ugly
Potential plaintiffs
Disturbers
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14. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Syndicates
Lead or Co Lead and followers
Party rounds
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15. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Other Parties
Lawyers
CPA
Banker/Broker/Finders
Mentors and Advisors
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16. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital Economics 2/20 Formula
2% management fee on committed capital
20% carried interest
7 to 10 year terms
LPS want 2 1/2 to 3 times investment return
VC fund must earn 3 to 4 times investment to
return that amount
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17. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital Economics – Expected Performance
50% lose money
20% – 30% are singles or doubles
The rest must be home runs (10X to 100X)
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18. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital Management
Partners
Principals or Directors
Associates
Analysts
Entrepreneurs in Residence
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19. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital Economics – Management
Venture capital will participate in management
Board seats
Board Observer
Management rights letter (for VCOC exemption)
Seven to ten year term (and longer)
Precludes small investments
Board meetings
Management
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20. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Venture Capital Metrics
Team
Domain expertise
Technical co-founders
Technology or product
Solve problems, address pain points
Customer validation
Market size
Must be a huge market
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21. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Picking a VC
Reputation
Likelihood of closing
Stage of fund
Size of Fund
How much dry powder?
Is there a fund 2, fund 3 etc.?
Are they litigious? Dificult?
What is their process and timing?
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22. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Structuring For Venture Capital
Business Model
Choice of Entity
Cap Table
Vesting
Debt
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23. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
VC Considerations
1. QSBS
2. VC’s LPA will not allow investment in a
passthrough
1. Tax exempt investors want to avoid UBTI
2. Foreign investors want to avoid ECI
3. VC wants to be able to manage losses
1. No K-1’s showing losses
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24. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Approaching a VC
How much should you ask for?
Staged financings
Next valuation milestone
12 to 18 months
Research
Stage
Sector
Who have they invested in (competitors?)
Litigation, workouts, exits
Multiple Term Sheets
Introductions
Other VCs, Angels
Funded startup entrepreneurs
Industry and service people
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25. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Preparation for Venture
Executive Summary
Team
Product & Market
Technology
Financials
Pitch Deck
Financial Models
Due Diligence
Legal
Technical
Team
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26. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
SAFEs and Convertible Notes
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
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27. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Cap Table
Common Stock
Options
Warrants
Convertibles
Preferred Stock
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28. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Capitalization
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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%
Fully Diluted % Issued %
29. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Effect of Valuation Caps
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Founders 4,000,000 100% 4,000,000 100%
Stock Pool 0 0% n/a
total 4,000,000 100% 4,000,000 100%
Company sells a $1,000,000 SAFE with a $4,000,000 pre money valuation cap
That means that the SAFE will take 20% of the capitalization ($1,000,000/$5.000,000)
Fully Diluted % Issued %
30. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Other Diligence Issues
IP Rights
Patents
Invention Assignments
Licenses and ownership
Data security
Employment Claims (Homejoy)
Tax Claims
Regulatory
Litigation
Claims by prior employer
Entrenched Management
Material Agreements
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31. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Staged Financings
Enough to get to next valuation event
2X
1 to 2 years
Up vs Down rounds
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32. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Pitch Deck
Market Size
Team
Product
Go To Market Strategy
Financials
Financial Plan
NOT VALUATION
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33. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Executive Summary
Team
Projections
Market
Industry
IP and Patents
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34. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Term Sheets
Valuation
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35. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Money –The Priced Round
VC or Institutional Investor
Preferred Stock
Valuation Methods
Score Card
Venture Capital Method
Berkus Method
Cayenne Calculator
Risk Factor Summation
Negotiation
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36. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Money –The Priced Round
More Valuation Methods
(Patents + People) x $1 Million
Comparables
Discounted Cash Flow
Market Multipliers
Discount to Public Companies
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37. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Participation
Participating preferred stock returns its investment and
then shares pro rata in proceeds of a sale
Non-participating convertible preferred stock either gets a
return of its investment or its pro rata share of proceeds
Participation may be capped at a multiple of the
investment
Conversion to common – auto-conversion and majority
vote
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38. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Dividends
Preferred will have a dividend preference.
A cumulative dividend on preferred shares must be paid
before any other dividends on common.
o If the company can't pay out a cumulative dividend in a
year, the amount is carried forward.
o Common in private equity deals, not in venture
Non-cumulative is only paid when as and if declared.
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39. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Liquidation Preference
Who gets paid first and how much?
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40. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Example of Liquidation Preference
1X Preference
$1,000,000 invested for 10%
Ex 1: Exit (sale) of company for $5,000,00; VC gets
$1,000,000
Ex 2: 2X preference
$1,000,000 invested for 10%
Ex 1: Exit (sale) of company for $5,000,00; VC gets
$2,000,000
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41. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Participation Examples
Nonparticipating
Participating capped (e.g 2X, 3X)
Participating uncapped
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42. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Liquidation Preferences and Participation
1X Nonparticipating convertible preferred
$1,000,000 invested for 10% means that VC gets
$1,000, 000 OR 10%
Ex 1: Exit (sale) of company for $5,000,00
Ex 2: Sale for $20,000,000
1X Participating convertible preferred
$1,000,000 invested for 10% means that VC gets
$1,000,000 PLUS 10%
Ex 1: Exit (sale) of company for $5,000,00
Ex 2: Sale for $20,000,000
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43. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Board Representation
Size of board
Founder-friendly boards
Role of the Board
Observers
Indemnification
Insurance
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44. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Board rights
Indemnification
D&O Insurance
Right to designate
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45. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Protective Provisions
Class vote or majority vote
Delaware law
Separate vote for later investors
Do the interests of different
investors diverge?
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46. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Protective Provisions
Standard:
Right to veto or block certain corporate
actions
Sale of the company
Amendment to the company’s certificate or
bylaws so as to adversely alter or change the
rights of preferred stock
Increase or decrease in the number of
authorized shares of preferred or common
Authorization or issuance of equity security
having a preference over, or being on a parity
with, preferred stock
Redemption of shares of preferred stock or
common stock
Declaration or payment of dividends
Change in the authorized number of directors
of the company
Other:
Hiring, firing or change in the compensation of
officers
Any transaction with any director, executive or
employee of the company
Incurrence of indebtedness in excess of
$[____]
Change in the principal business of the
company or the entering into any new line of
business
Any purchase of a material amount of assets
of another entity
Option plan increase
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47. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Information Rights
Financial statements and other information
Thresholds
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48. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Registration Rights
Requires a company to list the shares publicly so
that the investor can sell
Demand rights
Piggyback rights
S-3 rights
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49. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Common restrictions: Co-Sale Rights, ROFR, Drag
Along
Co Sale and Tag-Along Rights – right to participate in a
sale
Right of First Refusal – right of company (first) and
investors (second) to require shares to be offered to each
of them before a third-party sale
Drag Along – right to force shareholders to sell in an exit
Board, common and preferred approvals
Small shareholder carveout
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50. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Founder Vesting
Term, milestones, commencement
Acceleration
Single and double triggers
Fire the Founder
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51. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Vesting
VC will require unvesting shares so vesting period could be 8 years
Fund life can be 7 to 10 years
Most exits are M&A - Fewer and longer IPOs
Extended Option exercise periods
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52. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Transfer Restrictions
Right of First Refusal (ROFR)
Second Tier ROFR
Co-Sale Rights
Lock Ups
Drag Along
Buy Sell
Rule 144
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53. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Pro Rata rights
Right to maintain, right to participate
Major investors
Limited by amount of money company wants to raise
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54. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Option Plan
Increased pre money
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Example: $8 million pre; $2 million investment = $10 million post
Cap Table % ownership
Founder 80%
VC 20%
VC asks for a pre close option pool reserve of 20% post money capitalization
Cap Table % ownership
Founder 60%
Option pool 20%
VC 20%
55. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Redemption Rights
Feature of Preferred Stock
Right to put stock to company, usually after a period of time and
over time
Is effectively a right to force a sale of the company
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56. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Anti-Dilution
Broad-based weighted average
Narrow-based weighted average
Full ratchet
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57. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Exclusivity
No-shop
30 to 60 days
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58. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
NonBinding
30 day no shop
Confidentiality
Is it really nonbinding?
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59. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Planning for later rounds
Overly favorable terms
Valuation planning and down rounds
Reverse splits
Cap table management
Fire the CEO
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60. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Corporate Venture Capital
Strategic objectives
Less operational involvement
Right of first refusal, right of first offer, right of first look
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61. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Troubled Company Terms
Forced conversion to common
Full ratchet
Uncapped participating preferred
Insider rounds
Low valuations
Down rounds
Trigger anti dilution protection unless waived
Pay to play
requires existing investors to invest on a pro rata basis
in subsequent rounds or they lose preferential rights
(anti-dilution, liquidation preferences, voting rights)
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62. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Successful Exits
IPO
Sale or Acquisition
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63. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Unsuccessful Exits
Zombie Companies
In re Trados Inc. Shareholder Litigation
Bankruptcy or Insolvency Reorganizations
Fire Sales
Management carveouts
Fiduciary duties: shareholders, optionees, preferred and
creditors?
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64. © 2020 Haynes and Boone, LLP© 2020 Haynes and Boone, LLP
Other Unsuccessful Exit Issues
Tax Liability
Personal Liability
Tax
Employment
Fiduciary Claims
Securities Law Claims
Contractual
Pierce the veil and creditor claims
Serial Entrepreneurs and failed companies
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65. AUSTIN
600 Congress Avenue
Suite 1300
Austin, TX 78701
United States of America
T +1 512.867.8400
F +1 512.867.8470
CHARLOTTE
101 S. Tryon Street
Suite 2250
Charlotte, NC 28280
United States of America
T +1 980.771.8200
F +1 980.771.8201
CHICAGO
180 N. LaSalle Street
Suite 2215
Chicago, IL 60601
United States of America
T +1 312.216.1620
F +1 312.216.1621
DALLAS
2323 Victory Avenue
Suite 700
Dallas, TX 75219
United States of America
T +1 214.651.5000
F +1 214.651.5940
DALLAS - NORTH
2505 North Plano Road
Suite 4000
Richardson, TX 75082
United States of America
T +1 972.739.6900
F +1 972.680.7551
DENVER
1050 17th Street
Suite 1800
Denver, CO 80265
United States of America
T +1 303.382.6200
F +1 303.382.6210
FORT WORTH
301 Commerce Street
Suite 2600
Fort Worth, TX 76102
United States of America
T +1 817.347.6600
F +1 817.347.6650
HOUSTON
1221 McKinney Street
Suite 2100
Houston, TX 77010
United States of America
T +1 713.547.2000
F +1 713.547.2600
LONDON
1 New Fetter Lane
London, EC4A 1AN
United Kingdom
T +44 (020) 8734 2800
F +44 (020) 8734 2820
MEXICO CITY
Torre Esmeralda I, Blvd.
Manuel Ávila Camacho #40
Despacho 1601
Col. Lomas de Chapultepec,
DF 11000
Mexico City, Mexico
T +52.55.5249.1800
F +52.55.5249.1801
NEW YORK
30 Rockefeller Plaza
26th Floor
New York, NY 10112
United States of America
T +1 212.659.7300
F +1 212.918.8989
ORANGE COUNTY
600 Anton Boulevard
Suite 700
Costa Mesa, CA 92626
United States of America
T +1 949.202.3000
F +1 949.202.3001
PALO ALTO
525 University Avenue
Suite 400
Palo Alto, CA 94301
United States of America
T +1 650.687.8800
F +1 650.687.8801
SAN ANTONIO
112 East Pecan Street
Suite 1200
San Antonio, TX 78205
United States of America
T +1 210.978.7000
F +1 210.978.7450
SHANGHAI
Shanghai International
Finance Center, Tower 2
Unit 3620, Level 36
8 Century Avenue, Pudong
Shanghai 200120, P.R. China
T +86.21.6062.6179
F +86.21.6062.6347
THE WOODLANDS
10001 Woodloch Forest Drive
Suite 200
The Woodlands, TX 77380
United States of America
T +1 713.547.2100
F +1 713.547.2101
WASHINGTON, D.C.
800 17th Street NW
Suite 500
Washington, D.C. 20006
United States of America
T +1 202.654.4500
F +1 202.654.4501
© 2020 Haynes and Boone, LLP
65
Editor's Notes Founder licensing in
JV contracts
Score card =apply factors to average pre money valuations; VC method =Harvest Value/Anticipated ROI (10x to 30X); Berkus method= 5 characteristics add up to $500k each to valuation; Cayenne calculator=25 question calculator; Risk Factor summation=assess risk factors –+1 or -1 and multiply by $250k;
Score card =apply factors to average pre money valuations; VC method =Harvest Value/Anticipated ROI (10x to 30X); Berkus method= 5 characteristics add up to $500k each to valuation; Cayenne calculator=25 question calculator; Risk Factor summation=assess risk factors –+1 or -1 and multiply by $250k