This document provides an overview of key terms and considerations for preferred stock term sheets in venture capital investing. It discusses the most common early-stage securities of convertible debt and preferred stock. Key aspects covered include the economics of equity deals such as pre-money valuation, liquidation preferences, anti-dilution protection, and dividends. It also examines governance issues like board representation and control rights granted to investors.

1. Venture Boot Camp – Term Sheets
June 18, 2013

2. Overview
of
a
Term
Sheet
• Two
most
common
early-­‐stage
securi8es:
– 1)
Conver8ble
Debt
– 2)
Preferred
Stock
• Conver8ble
preferred
stock
• Redeemable
preferred
stock
2

3. What
is
Preferred
Stock?
• Fairly
standard
in
early-­‐stage
investment
• Has
certain
preferences:
– Liquida8on
preference
– Dividends
(maybe)
– Board
representa8on
and
blocking
rights
– An8-­‐dilu8on
protec8on
– Redemp8on
rights
3

4. Preferred
Stock
Term
Sheet
• What
is
a
term
sheet?
– Agree
on
fundamentals
before
legal
draOing
• A
term
sheet
is
generally
non-­‐binding,
but...
– Confiden8ality
– No-­‐shops
– Expense
provisions
4

5. Overview
of
Economics:
Equity
• Price
Terms
– Pre-­‐money
valua8on?
– Op8on
Pool
–
size
and
8ming
of
addi8on
• Treatment
of
Dividends
– Cumula8ve
dividends
• Liquida8on
Preferences
– Par8cipa8ng
vs.
Non-­‐Par8cipa8ng;
dollar-­‐capped
– The
effect
on
“Ownership
Percentage”
• Price
Protec8on
–
An8-­‐Dilu8on
– Full
vs.
weighted
average
• Redemp8on
Features
– Timing
and
consequences
5

6. Equity
Pricing:
Terms
to
Understand
• Pre-­‐Money
– What
the
investor
believes
the
company
is
worth
prior
to
their
investment
• Post
Money
– Simply
the
pre-­‐money
valua8on
plus
the
investment
amount
6

7. Equity
Pricing:
Terms
to
Understand
• Op8on
Pool
– Given
to
incen8vize
employees
– Feel
ownership
in
company
– How
does
it
impact
Founder
economics/ownership?
– Who
benefits?
• Considera8ons
– When
does
it
get
added?
– How
big
should
it
be?
– What
is
the
ves8ng
schedule?
– Is
there
accelera8on
on
a
liquidity
event?
7

8. Equity
:
Liquida8on
Preferences
• Preferred
–
First
out
in
“liquida8on
event”
– Liquida8on
event:
• Merger,
acquisi8on,
change
of
control,
true
liquida8on
– Return
of
investment
before
common
stock
then...
– Is
it
Par8cipa8ng
Preferred
or
Non-­‐Par8cipa8ng?
• With
Par8cipa8ng
Preferred,
the
investor
gets
its
liquida8on
preference
and
then
par8cipates
in
all
residual
distribu8ons
on
an
as
converted
basis
• With
Non-­‐Par8cipa8ng
Preferred,
the
investor
is
only
en8tled
to
its
liquida8on
preference
8

9. Equity:
Par8cipa8ng
Preferred
vs.
Non
• An
example:
• 10M
shares
of
common
stock
outstanding
(assuming
exercise
of
all
op8ons
in
pool)
• Investors
hold
10M
shares
of
preferred
purchased
for
$1.00
per
share
• Preferred
convert
to
common
on
a
1-­‐for-­‐1
basis
• Preferred
has
a
1X
liquida8on
preference
9

10. Equity:
Par8cipa8ng
Preferred
vs.
Non
10
Common Shareholders Share of Sale $
Sale Price Participating Non-Participating
$10M $0 $0
$15M $2.5M $5.0M
$25M $7.5M $12.5M
$50M $20M $25M
$100M $45M $50M

11. An8-­‐Dilu8on
• Allows
investors
to
“re-­‐price”
• Two
types:
– 1)
Weighted
Average
– 2)
Full
Ratchet
11

12. Governance
• Board
of
Directors
– Who
chooses?
How
chosen?
– Observa8on
rights
–
who,
how
monitored
– Skills
needed
to
fill
out
team
– Audit,
Compensa8on
Commiiees
– Fiduciary
du8es
• Financial
and
Repor8ng
Requirements
– Financial
statements
–
monthly,
quarterly,
annual
–
audited
or
not?
– Who
gets
these?
• Other
Informa8on
Rights?
– What
informa8on
and
who?
– Visita8on
rights?
12

13. Control
– Vo8ng
• Ability
of
board,
stockholders,
or
class
holders
to
block
certain
ac8ons
• Who
elects
the
board?
– Vo8ng
on
“as
if”
Converted
Basis
– Class
Vo8ng
and
Protec8ve
Provisions
– Nega8ve
Covenants
• What
you
can
and
can’t
do
without
investor
approval
13

14. Stockholders
Rights
• Transfer
Rights
– Right
of
First
Refusal
• Par8cipa8on
in
future
financings
• Founder
restric8ons
– Reverse
ves8ng
of
stock
– Non-­‐compe88on
– Founder
representa8ons
in
purchase
agreement
14

15. Stockholders
Rights
• Registra8on
Rights
• Drag
along
• Right
of
Co-­‐sale
• Redemp8on
15