1. Venture Capital Deal Structure
Prof. Dell, Spring 2011

2. FORM OF TRANSACTION Debt or Equity?
Distinction between the two types of investments
Series A Preferred Stock or Convertible Promissory Note?

3. CONVERTIBLE PROMISSORY NOTE
Still a sale of “security”
No voting rights, dividend distributions or inspection rights - only a creditor of the company with priority on liquidation.
Easy to structure - speed of transaction
Interest Rate
Maturity Date Conversion feature

4. TYPICAL DEAL POINTS Equity Kicker
Amount of warrant coverage, or
Discount upon conversion into next round of equity financing
Conversion feature (e.g., triggered upon next round of financing of at least $1,000,000)
Mandatory or discretionary conversion?

5. TYPICAL DEAL POINTS (CONTINUED)
What if equity financing does not occur?
Board observer?
Information rights (e.g., financials)?

6. SERIES A ROUND EQUITY FINANCING [SOME BUSINESS POINTS]
Valuation of the technology company
Management team
Market space
How much money does the company need (or want)?
Percentage ownership of the company (on a fully-diluted basis, including option pool)

7. PREFERRED OR COMMON?
Attributes of preferred stock (still behind creditors)
Common stock deal prices stock options for employees (ISOs issued for FMV)
Common stock - no negotiation on terms (pari passu with the founders)

8. PREFERRED OR COMMON? (CONTINUED)
No protective provisions for investors
Preferred deal is much more common

9. ATTRIBUTES OF SERIES A PREFERRED
Anti-Dilution Provision
Grant of additional equity to protect your investment
Protection from a down round
Protection from the company granting additional equity to others.
Weighed-Average Anti-dilution (standard)
vs.
Full Ratchet Anti-dilution (harsh)

10. ATTRIBUTES OF SERIES A PREFERRED
Dividend “when, as and if declared”
Noncumulative v. cumulative %
Priority on dividend payments
Liquidation preference
“Participating Preferred”
Money back times 3, or
Money back, then pro-rata with founders

11. ATTRIBUTES OF PREFERRED STOCK
Liquidation Preference
Sale / Merger /
Acquisition /
Liquidation
1st: Debt Holders
2nd: Series B
3rd: Series A
4th: Common

12. MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
Merger or asset sale treated as a liquidation
Consent of Series A Preferred required (50%, 66 2/3%, or more)
Must decide whether to treat merger or asset sale as a liquidation (“cram down”)

13. MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
Redemption (or not)
Beginning year 6, then year 7 and 8
Purchase price + accrued dividends (if any)

14. MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
Conversion
Convertible at any time by dividing Purchase Price by Conversion Price (1:1 basis)
Automatic conversion on IPO
Adjustment to conversion price (“full ratchet”)
excludes options for employees and warrants for service providers
Very lengthy provision but price of new equity issuances is key

15. MORE ATTRIBUTES OF SERIES A PREFERRED STOCK
Pro Rata Investment Rights
Right to maintain ownership levels in future rounds of financing.
If a VC owns 15% of the company, then during a subsequent round of financing, the VC has the “right” to invest up to 15% of the total $s raised in that round.

16. MORE ATTRIBUTES OF SERIES A
Voting Rights - generally 1:1
Protective Provisions
Sale of the company
Create new class of securities
Amend Certificate of Incorporation/Bylaws
Redeem shares
Change number of Board members
Amended and Restated Certificate of Incorporation vs. Certificate of Designation

17. SERIES A TRANSACTION DOCUMENTS
Series A Preferred Stock Purchase Agreement
Reps/warranties from company (capitalization, IP, contracts, etc.)
Rep/warranties from investors (“accredited investor,” no distribution under securities laws, Rule 144, etc.)
Schedule of Investors

18. SERIES A TRANSACTION DOCUMENTS (CONTINUED)
Investors’ Rights Agreement
Demand registration rights
S-3 registration rights
“Piggyback” registration Rights
Financial information rights
Right of First Offer
Right of First Refusal (among Preferred SHs)

19. SERIES A TRANSACTION DOCUMENTS (CONTINUED)
Stockholder Agreement
Includes founders
Right of first refusal for sales by founders (first, to the company and then to the shareholders)
Right of co-sale if ROFR is not exercised
Voting Agreement (for Board seats)
Indemnification Agreement

20. POINTS TO CONSIDER Size of the option pool (20%, 30%??)
Board observer rights?
Stock Restriction Agreements for founders (vesting provisions)
Employment Agreement for founders
Form of investment - individually or through LP?
Tax issues??
Exit strategy

21. Series A (Dilution) 33% 30% 37% Series A – Raise $5m @ $10m pre-money
Pre Money: $10m
Post Money: $15m
Series A Investor bought: 33% of the company
Founders, existing (Angel) investors: diluted by 33%
BUT, Series A required a 30% ISO Pool POST Series A
So….Founders, existing investors: diluted by 63%!
33%
30%
37%

22. Series B (Dilution…Yes More!)
Series B – Raise $30m pre-money
Pre Money: $30m
Post Money: $50m
Series B Investor bought: 40% of the company
Founders, Angel, Series A, ISO: diluted by 40%
Series B: 40%
Series A: 33% x 60% = 19.8%
Founders: 37% x 60% = 22.2%
ISO: 30% x 60% = 18%
40%
22.2%
18%
19.8%