California Massachusetts Florida (310) Stephen P. Rothman, Esq. Startup Equity Allocations, Cap Tables, Pricing Negotiations UCLA Office of Intellectual Property December 9, 2013

2 Biographical Information 27 years business law practice Currently focus on startups from universities and their investors 20 university startup formation / financings completed in last two years Largest client is super-angel who does multiple university startup financings each year Formerly a partner at Morrison & Foerster and at Irell & Manella Now 2-person firm Experience as founder and entrepreneur Frequent speaker – NCET2 webinars, Children’s Hospital L.A., USC Stevens Institute, Caltech Office of Technology Transfer, Florida Innovation Hub at UF Gainesville J.D., cum laude Harvard Law School, 1985 B.A., cum laude, Yale University, 1982

3 Terminology “Pre-money valuation” In the context of an upcoming equity transaction, the value that is assigned to the company prior to consummation of the financing. The earlier the stage, the less objective analysis The earlier the stage, the more a product of leverage and negotiation Accepted valuation methods for mature companies don’t apply: P/E ratios Acquisition prices Revenue multiples For Internet companies with no revenue, unique visitors Asset valuation

4 Terminology 2 “Pre-money valuation” 2 university based startups usually too early-stage for technical, evidenced based valuation Assigned pre-money valuation is a matter of negotiation and leverage, not a real “valuation.”

5 “Post-money valuation” In the context of an upcoming equity financing transaction, the value that is assigned to the company immediately following consummation of the financing. Terminology 3 Post-money valuation = Pre-money valuation + Money Invested in Round

6 Simple Initial Capitalization Tables

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9 Factors Influencing Pre-Money Valuation (i.e. Founder Share) Whether there is competition Overall startup investment climate Negotiation sophistication of founder or founder representative Same factors that investors consider in deciding whether to invest at all: market size; market attractiveness; Investment fads management team / previous startups stage of development; market for exits.

10 Types of Equity Interests in Corporations Common Stock – residual category Straight Preferred Stock – almost like debt priority over common but no upside Convertible Preferred Stock – has the benefits of both common and straight preferred. Participating Convertible Preferred Stock – various level of “double dip”

11 Investor won’t like this scenario. Founder is “making $5 million” and “I just get my money back.” Go back to concept of pre-money valuation and the concept of preferences that we skipped over; did the founders really put in $8 million of value or not.

12 Investor’s response to convertible but not participating scenario – Convertible and participating.

13 Founder’s concern with convertible and participating – the double dip (was founder contribution really worth $8 million?) Partial answer – capped participating convertible preferred

Similar to uncapped preferred stock participation in corporate context. So founder doesn’t like this. 14

Possible Alternatives in LLC “Layer Cake” Profit and Loss Allocations Allocated P&L per percentage interests Distributions on sale per capital accounts Investor has infinite double dip “Target” Profit and Loss Allocations Specify how you would like distributions to come out Allocate P&L however you need to in order to make capital accounts consistent with those distributions Satisfies IRS rule that distributions are pursuant to capital accounts, though only because the capital accounts have been tinkered with to make them equal desired distributions. 15

16 ‘Median pre-money valuation of venture capital seed-stage enterprises has varied over a narrow range between $1.7 million and $2.5 million since 2002.” Kauffman eVenturing The entrepreneur’s trusted guide to high growth. “Valuing Pre-revenue companies.” p.8.

17 Stephen P. Rothman, Esq. Rothman and Company, P.A. Direct Phone: (310) Questions? Sean Brady, Esq. Rothman and Company, P.A. Direct Phone: (626)