1. Venture Capital Deal Structure Prof. Dell, Spring 2009

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 3 rd : Series A 2 nd : Series B 1 st : Debt Holders 4 th : 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) 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%! 30% 33% 37%

22. Series B (Dilution…Yes More!) Series B – Raise $20m @ $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% 22.2% 40% Series B: 40% Series A: 33% x 60% = 19.8% Founders: 37% x 60% = 22.2% ISO: 30% x 60% = 18% 18% 19.8%