1. Deal Structuring John Mullins 2011 © John Mullins 2011

2. Funding Instruments: The Basics Preference/preferred shares –Entail some right (e.g., as below) for the holder Convertible shares –Can be converted to ordinaries (usually at a liquidity event) Redeemable shares –Are simply repaid to the holder, sometimes at some specified premium National Entrepreneurship Network © John Mullins 2011

3. Return Risk Bonds Secured Debt Mezzanine Loan Stock Preferred Equity Ordinary Equity Options or Warrants Which Instruments Should Be Used? National Entrepreneurship Network © John Mullins 2011

4. Return Risk Bonds Secured Debt Mezzanine Loan Stock Preferred Equity Ordinary Equity Options or Warrants What is the VC trying to achieve? National Entrepreneurship Network © John Mullins 2011

5. Return Risk What is the VC trying to achieve? Protect Downside Enhance Upside National Entrepreneurship Network © John Mullins 2011

6. Protecting Downside Preference Share Rights RightsVCs PerspectiveEntrepreneur’s Perspective Liquidation Preference Improves recovery if value declines Increases risk of losing all Makes down rounds tough RatchetSecure more equity if business under performs Focuses team on milestones Deters follow on investors High penalty for slippage Anti DilutionProtects against down round Problematic in follow on rounds Risk of high dilution Risk of VC gaining control Enhanced Voting, control and exit rights Focuses team on plan Ability to address slippage Protects against restructuring Protects exit Who is running the business! Must build strong relationship Risk of being fired National Entrepreneurship Network © John Mullins 2011

7. Protecting Downside Other Options OptionsVCs PerspectiveEntrepreneur’s Perspective Milestone driven drawdownsMuch greater influence if slippage Improves returns Will they really deliver May need to set up alternatives Management share vestingTeam locked into business Have shares to offer replacement execs Will I see the returns Need to commit at least 3 years Diligence!Know what you are getting into Great they understand Don’t take too long National Entrepreneurship Network © John Mullins 2011

8. Enhancing Upside Preference Share Rights OptionsVCs PerspectiveEntrepreneur’s Perspective Preferred Return ( either min IRR or right to repayment and equity) Higher returns on most exit scenarios Maintains returns if exit delayed Very tough to attract other investors High penalty for slippage Warrants (right to additional shares on exit ) Secures additional upside with no additional investment More dilution! Dividends (fixed or participating) Income helps returns But will absorb capital Protects against delayed exit Reduces capital for growth Only have to pay it if I have reserves Transfers value to the investors! National Entrepreneurship Network © John Mullins 2011

9. Delivering Both! Redeemable Instruments OptionsVCs PerspectiveEntrepreneur’s Perspective Redeemable Preference Shares ….and with dividends Combines preferred return rights and liquidation preference! Always get capital back first Get capital returned even if exit delayed Also get income But absorbs working capital Is this really equity? Need to provide for repayment Very tough to attract other investors High penalty for slippage Cash burden Loan StockAll of the above but with security Running yield But increases gearing & reduces borrowing capacity Even less like equity Interest burden Time to adjust the valuation! National Entrepreneurship Network © John Mullins 2011

10. Impact On Returns – An Example M & W Inc. want to raise $5m to fund rapid growth. It is a high risk business which could exit in 3 years for ‘well over $25m’. They have 3 offers on the table. Vanilla PartnersHedge IncLever Ltd $5m for 50% equity stake The Deal Structure: $5m Ordinary shares for 50% equity $5m for 50% stake The Deal Structure: $5m Preferred ordinary shares for 50% equity - 1 x liquidation preference - 5% fixed dividend $5m for 50% stake The Deal Structure: $500k Ordinary Shares for 50% equity $4.5m Redeemable preference shares with 5% fixed dividend National Entrepreneurship Network © John Mullins 2011

11. Impact On Returns – The “Home Run” Scenario Home Run Sales growing rapidly and hit target sale price of $25m National Entrepreneurship Network © John Mullins 2011

12. Impact On Returns – The “Respectable Return” Scenario Respectable Return It works but scale up looks tough. Sell out for $10m National Entrepreneurship Network © John Mullins 2011

13. Impact On Returns – “Fire Sale” Scenario Fire Sale M & W have spotted the right market but run out of cash before technology developed. Manage to recover $2.5m in a fire sale. National Entrepreneurship Network © John Mullins 2011

14. Impact On Returns Which deal structure gives the best return to the VC under a range of exit scenarios? Exit Value $m Return $m National Entrepreneurship Network © John Mullins 2011

15. Summary Structure does make a difference Anything is possible Any preferred share rights transfer value Preferred rights impact the nature of the relationship Always measure the effect on all scenarios National Entrepreneurship Network © John Mullins 2011