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Published byZakary Goodspeed Modified over 9 years ago
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Private Equity Financings Downside Protection: What’s Important, What’s Not & Why
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Down-Side Protection Liquidation Preference Right of Redemption Price-based Anti-Dilution Protection
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Liquidation Preference The “New” Standard: participating Issues: Participating vs Non-Participating Disincentivize management team, if LP too large Negotiation Ideas: Repay Preferred, then pay common, THEN share upside –Balances investor protection with management incentive
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Liquidation Preference Negotiation Ideas cont’d Balance downside protection with upside benefit –Different LP for M&A vs Liquidation –LP subordinated to retention bonuses – Fixed return for investors for greater downside protection
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Liquidation Preference The New Standard: Priority Issue: Priority vs Pari Passu Non-Issue: – Generally, an investor issue -- potential conflict between classes, but money controls – Cal. Corp. Code (§903(b) - Some class protection – Some protection through board/observer rights
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Redemption The New Standard: More common, but not “standard” Issues: – Jeopardize company if insufficient $$ to repay – Gives investors inordinate bargaining power – Makes company less attractive acquisition candidate
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Redemption – Old CW: Non-issue Push off for 5 years, which was a long time Within 5 years, company will either exit or fold Corporations code protection, if company cannot not afford redemption
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Redemption – New CW: Issue? Longer liquidity path - 5 years is “shorter” Corporations code protection, but Obligation still affects company’s attractiveness for merger
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Redemption Negotiating Points – Disincentive to Management – fully vest and then diminish value of shares – Essentially converts equity into debt – so use it to bargain on valuation – Push off as far into future as possible, and redeem over time – Might deter future investors – whose proceeds are used to pay redemption – Permit Company to delay redemption for cause – Require “call”, if must have redemption
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Anti-Dilution Protection The “New” Standard: Weighted Average Issues: – Broad vs Narrow-based – Full Rachet Negotiation Points – Push hard against full rachet Disincentive to additional investors See example – Recommend limited rachet – tied to reduction of risk (e.g., hitting milestones)
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Founder Vesting & Acceleration Issues: – if Founder can’t get liquid, valuation is secondary Negotiate V&A in context of valuation – Removal by Board for “convenience” Acceleration on termination “without cause” Include Constructive Termination Double Trigger
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TERM SHEETS 101 Thursday, march 15, 2001 8:30am- 12:00pm Software Development Forum
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