Anatomy of a Term Sheet July 18, 2002 Starter Fluid, L.P. Robert von Goeben, Managing Director SM

Anatomy of a Term Sheet 1) Vital Parts Shares issued Investors and amounts Capitalization table 2) Operating Terms Board Composition Voting Rights Founders vesting 3) Financial Terms Valuation Liquidation Preferences Antidilution Provisions Dividends & Redemptions Legal Costs

Part One: Vital Parts “Deal at a glance” Designed to save time and limit legal expenses Always have cap table included on term sheets Clearly spell out investors, counsels and amounts invested

Part Two: Operating Terms

Board of Directors Most institutional investors push for board seat, some angels also Typical series A board size is 5 –2 series A –2 common (one must be CEO) –1 outside agreeable to A & common Good practice to name board members on term sheet Strive for “balance of interest”

Founders Vesting Founders typically seek credit for “past work, investors want to tie founders to company 25% of stock can immediately vest depending on past work Remainder on 4-5 year vesting schedule, with 6 month or 1 year cliff Acceleration for termination w/cause or double-trigger for acquisition

Voting Provisions Very important to control factors that affect a class of stock Typical provisions: –Transfer of control or liquidation –Any adverse change in rights to class –Creation of senior security –Change in size of board –Declaration of dividends

Part Three: Financial Terms

Valuation Some say “valuation is all that matters” “All deals are A rounds” –Current market has valuation equal to financing amount –Today seeing 50% dilution to company Q valuation stats* –57% down rounds –10% flat from previous round –33% up-rounds *Source: Fenwick & West LLP

Liquidation Preferences Who gets money in what order New investors are getting in the front of the line Q Stats* –62% of deals had senior liquidation prefs to earlier round –58% had multiple preferences –Of multiple preferences: 66% were 2X 27% were 3X 7% were greater than 3X *Source: Fenwick & West LLP

Antidilution Provisions Two types of antidilution: –Ratchet – “Price protection”, share price reduced to new round price within 6-12 mos. –Weighted Average – Formula on how stock gets repriced Q Stats* –29% ratchet antidilution –69% weighted average antidilution –2% no anti-dilution *Source: Fenwick & West LLP

Dividends & Redemption 2002 stats on redemptions* –36% of the financings provided for mandatory redemption or redemption at the option of the investor Dividends have historically been “when and if declared by board of directors” Non-cumulative, not mandatory *Source: Fenwick & West LLP

“Pay-to-Play” Current trend to “wash out” previous investors over and above dilution New investors pushing tough “pay-to- play” provisions Q Stats* –20% of financings had pay-to-play –56% converted non-participating to common –22% converted to “shadow preferred” –22% blend of common and shadow *Source: Fenwick & West LLP

Legal Costs Company usually pays investor legal expenses Company pushes hard to put cap on expenses Typical seed deals: up to $10K Later stages: up to $25-50K Depends on fees in geography

Other Terms 1.Right of first refusal on new-issue and founders selling shares 2.Information rights is key –Make sure your # shares falls within limits 3.Key-Person insurance on founders 4.Employment, confidentiality and invention agreements with founders 5.Registration, piggy back rights, demand rights: get standard terms through attorneys

Good Terms Sheet Practices Short (2-4 pages) Designed to reduce legal fees Don’t go it alone: get good legal counsel Term sheet is mostly business terms Be aware you’re setting precedent on terms for later investors!

Starter Fluid Starter Fluid is one of the only professionally-managed, institutionally-backed pure seed funds. Closed $32M - June 2000 $ K initial investments, up to $3M total Investors: –Institutions: Univ Chicago, Searle Trust, FLAG Venture Management, Tucker Anthony, Compaq Computers, Crossroads Ventures, and others

Anatomy of a Term Sheet July 18, 2002 SM