1、Venture Capital Deal Terms,Joe Hadzima (jghmit.edu)Managing Director, Main Street Partners LLCSenior Lecturer, M.I.T. Sloan School of ManagementFor “Nuts and Bolts of Business Plans” MIT Course 15.975,Copyright 2000-2007, Joseph G. Hadzima, Jr., All Rights ReservedThis presentation may be used for a
2、cademic and teaching purposes with attribution,Venture Capital Deal Terms,Deal Terms Are A Function Of Many Factors Including:Type of InvestorThe Size Of The Investors CheckbookThe Economics Of The Investment OpportunityThe Funding Cycle,“Principal” Investors - Institutional or Individual Investors
3、Fund Investors Corporate Strategic InvestorsNot All Money Is EQUAL:Money Comes With Different Benefits and “Strings” Including Legal Requirements:Which Apply To Where the Money Comes From- The Ultimate Source Of The FundsWhich Derive From The Legal Structure of the Investing Entity,Deal Terms Are A
4、Function Of Many Factors Including: Type of Investor,Determines the Size of Investment NeededDetermines the Appetite and Ability To Do Follow-on RoundsResults in Deal Terms Which Protect Initial Investment or Position for Future Investment,Deal Terms Are A Function Of Many Factors Including: Type of
5、 Investor The Size of Investors Checkbook,Valuation and Attractiveness of the OpportunityBusiness Plan RequirementsFinancial Resources RequiredStaging of Financing RequirementsCompleteness of Team - Additional Equity Pool Needs,Deal Terms Are A Function Of Many Factors Including: Type of Investor Th
6、e Size of Investors Checkbook The Economics Of The Investment Opportunity,For the CompanySeed Stage First or Second Rounds Mezzanine RoundsFor the Investor and Its Sources of FundsConditions and Trends in the Financial MarketsVenture Capital Fund Raising Has A Cycle Too,Deal Terms Are A Function Of
7、Many Factors Including: Type of Investor The Size of Investors Checkbook The Economics Of The Investment Opportunity The Funding Cycle,Venture Capital Funding Cycle,Deal Terms Are Influenced By How Much Venture Capital Is AvailableBy Stage of InvestmentBy Industry SectorCapital Availability AffectsD
8、eal PricingDeal Term Flexibility Where Flexibility Is Possible,The State of Venture Capital,Source: Venture Economics,The State of Venture Capital,The Average Deal Size Doubled In 1999,Source: Venture Economics,$ Invested in Billions,Average $/Deal in Millions,Venture Capital Investment Returns,Seed
9、 Stage Returns Are Up Substantially,Source: Venture Economics Jan 2000,Venture Capital Funding Cycle,SUMMARYToday There Is More Competition For DealsThis Is Reflected In:Valuation of DealsMore Flexibility in Terms Where Flexibility Is Possible,So, What Are The Deal Terms?,Issue: Venture Capital LP (
10、VC) and/or any member of its corporate group (the VC Group) will purchase up to $2,500,000 Series A Convertible Preferred Stock (Series A) newly issued by PCI, Inc. (the Company) at a price per share of $1.00 (the Purchase Price). In addition, other investors shall purchase at least $4,500,000 but n
11、ot more than $7,000,000 of newly issued Series A at the Purchase Price. The shares of Series A will be convertible at any time at the option of the holder into common shares of the Company (Common Stock) on a one-for-one basis, adjusted for future share splits.,VENTURE CAPITAL LPREVISED TERM SHEETPC
12、I, Inc.66 Sutton Business ParkThe Twilight Zone,Major Deal Elements,A Preferred ReturnProtection of Valuation and Position re: Future MoneyManagement of the InvestmentExit Strategies,A Preferred Return,Perception of the VC Investor:When the Investor Writes the Check he has done most EVERYTHING he pr
13、omisedThe Entrepreneur Has Done NOTHING YETResult:The VC wants its money to be paid back BEFORE the Entrepreneur gets his/her return.Instrument: CONVERTIBLE PREFERRED STOCK,Capital Structure Instruments,Capital Structure Instruments,Percentage of Capital Structure By Stage/Type of Company,A Preferre
14、d Return: Dividends,Dividends:The Preferred Stock is entitled to anannual $_ per share dividend,payable when and if declared by theBoard of Directors, but prior to anypayment on Common Stock; dividendsare not cumulative,Dividends:-Paid to Preferred First-Cumulative or Accruing,A Preferred Return: Li
15、quidation Preference,“Straight” Liquidation Preference: The Preferred receives its original investment amount plus accrued dividends (if any) before Common receives anything.Participating (“Double Dip”) Preferred: The Preferred first gets its liquidation preference and then shares any remaining proc
16、eeds with Common. Increasingly subject to a cap of 3X or 4X (including preference).,LiquidationPreference:The Series A Preferred will have a liquidation preference such thatproceeds on a merger, sale or liquidation (including non-cumulative dividends) will first be paid to the Series A and willinclu
17、de a 10% per annum compounding guaranteed returncalculated on the total amount invested.,Comparison of Straight vs. Participating Preferred,WHICH IS THE BETTER DEAL FOR THE FOUNDERS?Case A: Founders sell 40% of the Company for 5m of Convertible Preferred Stock with a $5m Liquidation preference but n
18、o participating rights. ($7.5M pre-money valuation)Case B: Founders sell 33% of the Company for $5m of Participating Preferred Stock ($10m pre-money),Valuation and Participating Preferred,Valuation and Participating Preferred,A Preferred Return: Liquidation Events,Liquidation, dissolution, sale of a
19、ssetsmoney comes into corporationmoney paid out to stockholders to redeem stock“Deemed liquidation”-merger or other positive eventconsideration may be stock or cashconsideration may go directly to stockholders,Major Deal Elements,A Preferred ReturnProtection of Valuation and Position re: Future Mone
20、yManagement of the InvestmentExit Strategies,Antidilution ProtectionApproval Rights,Protection of Valuation and Position re: Future Money,Protection of Valuation:Conversion and Antidilution,Conversion:A holder of the Series A Preferred shall have theright to convert the Series A Preferred at theopti
21、on of the holder, at any time, into shares ofCommon Stock. The total number of CommonShares into which the Series A Preferred may beconverted initially will be determined by dividingthe Original Purchase Price by the “ConversionPrice”. The initial Conversion Price shall be theOriginal Purchase Price
22、.,Protection of Valuation:Conversion and Antidilution,Conversion Events: When Does Preferred Convert Into Common?VoluntaryForced: often some % of Preferred can force conversion of all Automatic-upon “Qualified IPO”minimum total offering; minimum share price (usually 3 to 5 times initial purchase pri
23、ce)Conversion Ratio-initially 1:1Adjustments-stock splits, etc; price antidilutionExceptions-option pool, conversion of preferred, outstanding warrants, other existing conditions, other special exceptions,Protection of Valuation:Conversion and Antidilution,Anti-Dilution:Series A shall have weighted
24、average anti-dilution, based on a weighted averageformula to be agreed, for all securities purchased as part of this transaction(excluding shares, options and warrantsissued for management incentive and smallissues for strategic purposes of under 100,000 shares),Antidilution Adjustment increases the
25、 number of shares received on conversion of PreferredWhat Triggers Antidilution Adjustment?Issuance or “deemed issuance” of Common at less than preferred issuance price“Deemed issuance”-adjust upon issuance of derivative security; if common never issued, readjust lateroptions, warrantsconvertible se
26、curities,Protection of Valuation:Conversion and Antidilution,Protection of Valuation: Antidilution,Conversion Ratio: Original Purchase Price/Conversion PriceInitially OPP=CP so Conversion Ratio =1“Full ratchet”: Conversion Price reset to equal price at which diluting security is sold“Weighted averag
27、e”: CPnew=CPold*RWhere R = (N + M/CPold)/(N+S)N = old shares outstanding (fully diluted)S = new shares to be issuedM = new money ($),Antidilution,Protection of Valuation and Position:,Approval of Investors Pre-Emptive RightsRight of First Refusal,Protection of Valuation and Position:Approvals,Approv
28、al of Investors Required ForNew Financings Merger or Sale of CompanyIncrease in Option Plan,Negative Covenants:Approval by holders of Preferred Stock oforganic changes outside normal course ofbusiness and sale, liquidation or merger,increase in board seats or change electionprocedures, new shares se
29、nior to or on parwith and all distributions (dividends,repurchases).,Protection of Valuation and Position: Pre-Emptive Rights,Pre-Emptive Rights:Holders of the Preferred Stock will begranted rights to participate in future equity financings of the Company basedupon their pro-rata, as-if-converted,ow
30、nership of the Company.,Protection of Valuation and Position: Pre-Emptive Rights,Permits Investors to participate pro rata in future financings, to preserve their percentage ownershipSubject to exclusions: option pool issuances strategic alliances & licenses“Pay to Play”,Protection of Valuation and
31、Position: Rights of First Refusal; Tag Along,Rights of FirstRefusal;Tag-AlongThe Company and the Investors will have a right offirst refusal with respect to any employees sharesproposed to be resold. Alternatively, the Investorswill have the right to participate in the sale of anysuch shares to a th
32、ird party (co-sale rights), whichrights will terminate upon a public offering.,Protection of Valuation and Position: Rights of First Refusal; Tag Along,Granted by Founders/other InvestorsFirst Refusal: Gives Investors the right to acquire shares offered by the grantor, pro rataMay be partial or “all
33、 or nothing”Exclude: VC partnership distributions, estate planningTag Along (Co-Sale): Gives Investors the right to sell shares pro rata if a Founder sells shares to othersRarely invokedHelps lock in Founders,Major Deal Elements,A Preferred ReturnProtection of Valuation and Position re: Future Money
34、Management of the InvestmentExit Strategies,Management of the Investment,Board Seat(s)Business ApprovalsInformation Rights,Management of the Investment:Board Seats,Board Seat(s)Importance of the “Independent Director(s)”,Board of Directors:The Board will consist of _ members. Theholders of the Prefe
35、rred Stock will have theright to designate _ directors, the holders ofthe Common (exclusive of the Investors) willhave the right to designate _ directors, andthe remaining _ directors will be unaffiliatedpersons elected by the Common Stock and thePreferred Stock voting as a single class.,Management
36、of the Investment:Business Approvals,Business ApprovalsCapital Expenditures etc.Approval of Annual Budget and Operating Plans,Management of the Investment:Information Rights,Information Rights:Monthly actual vs. plan and prior year. Annualbudget 60 days before beginning of fiscal year.Annual audit b
37、y national firm. All recipients offinancial statements to execute non-disclosureagreement acceptable to Company counsel. Theaforementioned information rights shall beavailable to each holder of Preferred Stock foras long as such holder owns 220,000 shares ofPreferred Stock or shares of Common Stocki
38、ssued upon conversion of shares of PreferredStock,Management of the Investment: Carrots and Sticks,Option Pools:Traditionally 12% to 18% at Round OneTwo Year Pool,Option Pool:Simultaneously with this transaction, onemillion new shares shall expand the Companysmanagement incentive stock option pool -
39、bringing the total number of shares issued andstock incentives (awards and options)authorized to 6,100,000.,Management of the Investment: Carrots and Sticks,Vesting of Founders/Key Management Stock,Stock RestrictionAgreement:All present holders of Common Stock of the Companywho are employees of, or
40、consultants to, the Companywill execute a Stock Restriction Agreement with theCompany pursuant to which the Company will have anoption to buy back at cost a portion of the shares ofCommon stock held by such person inthe event that suchstockholders employment with the Company isterminated prior to th
41、e date of employment. 25% of theshares will be released each year from the repurchaseoption based upon continued employment by theCompany.,Management of the Investment: Carrots and Sticks,Non-Competition and Invention Agreements,Non-competition, ProprietaryInformation andInventions Agreement:Each of
42、ficer and key employee of theCompany designated by the Investors willenter into a non-competition, proprietaryinformation and inventions agreement in aform reasonably acceptable to theInvestors,Major Deal Elements,A Preferred ReturnProtection of Valuation and Position re: Future MoneyManagement of t
43、he InvestmentExit Strategies,Exit Strategies,IPOs and Registration RightsSale/AcquisitionRedemption of Stock,Exit Strategies: Registration Rights,Shares cannot be freely sold without filing a Registration Statement with the SECOnly the Company can fileSo the Investors negotiate for certain Registrat
44、ion Rights to insure a contractual ability to exit into the public markets,Registration Rights:Two U.S. demand registrations, subject to $3million and 500,000 share trigger, unlimitedpiggybacks, and evergreen S-3 if requestedand possible all at company expense.,Exit Strategies: Registration Rights,E
45、nables Investors to sell shares publicly by means of a registered offeringSales prior to end of 1-year holding period;Avoid compliance with volume limitations of Rule 144Registration paid for by the CompanyAre Founders included?,Exit Strategies: Demand Registration Rights,Exercisable after the IPO o
46、r within 3-7 years of investmentCan be exercised 1 to 3 times;Can be exercised by holders of 20-50% of the registrable shares, with value of $,Exit Strategies:Incidental (“Piggyback”) Registration Rights,Investors “piggyback” on another registrationCan they participate in other shareholders demand r
47、ights?Subject to underwriter “cutback”S-3 Registrations generally unlimited,Exit Strategies: Redemption,Redemption: The Companys repurchase of Preferred Stock at the demand of the InvestorsWhen Used: When the Company hasnt gone public Because Founders Dont Want ToBecause Business Doesnt Develop Into an IPO Type,Redemption:If not previously converted, the Series A is tobe redeemed in three equal successive annualinstallments beginning January 20, 2005.Redemption will be at the purchase price plusa 10% per annum cumulative guaranteedreturn,
