Terms and Trends in Venture Financings from across WilmerHale

Terms and Trends in Venture Financings– from across WilmerHale

Daragh Murphy

Attorney Advertising

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Venture Capital Financing – the Basics

What is a venture capital transaction? Type of private equity capital typically provided for early-stage, high-potential,

growth companies in the interest of generating a return through an eventual

realization event such as an IPO or sale of the company

Venture capital investments are generally made as cash in exchange for

shares in the invested company

© 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Transaction Documents

Term Sheet Certificate of Incorporation

Operative Documents • Stock Purchase Agreement • Investor Rights Agreement • Voting Agreement • Right of First Refusal and Co-

Sale Agreement

Ancillary Documents • Management Rights Letters • Director Indemnification

Agreements • Legal Opinion of Company

Counsel

Signing and Closing

Pre-Closing


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Deal Terms

Stock Purchase Agreement Type and Amount of Shares

Purchase Price

Representations and Warranties of Company, Founders and Investors

Conditions to Closing/Closing Deliverables

Counsel and Expenses


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Deal Terms

Certificate of Incorporation Pay-to-Play

– If an investor does not participate in a future financing, its preferred stock automatically converts to common stock or a “shadow” series of preferred stock without anti-dilution and/or other rights

Redemption Rights – At election of preferred holders as a class after 3-5 years

– All or portion

– Price can be original purchase price plus dividends or FMV


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Deal Terms Certificate of Incorporation Dividends

– When, as and if declared or paid on common

– Accruing / cumulative

Liquidation Preference – Non-Participating

– Participating

Anti-dilution Provisions – Weighted average – broad v. narrow (i.e., exclude common stock

equivalents and shares reserved for issuance under incentive plans)

– Full ratchet


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Deal Terms

Certificate of Incorporation Director Voting Rights

– Right of a class of stock to elect one or more directors

Protective Provisions – Right of a class of stock to approve key matters (e.g., equity

issuances, transactions)

Optional Conversion

Mandatory Conversion – At a qualifying IPO or upon a class vote


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Transaction Documents

Investor Rights Agreement

– Covers ongoing rights and obligations of investors and ongoing obligations of the

company, including registration rights and company covenants (management and

information rights, preemptive rights, matters requiring investor director approval)

Voting Agreement

– Agreement among stockholders, generally investors and founders to vote shares for

various matters, including board designees and drag-along rights

Right of First Refusal and Co-Sale Agreement

– Grants rights to the company and investors on sales of stock by founders and “key

holders”


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Trends We’ve Observed

More Founder Leverage in Early Stage (Seed) Financings

More Focus on Key Provisions (more flexibility at the margins for Founders)

More Acceptance of Founder Liquidity terms

Significant Founder Investment at the Outset


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More Founder Leverage in Early Stage (Seed) Financings Founders may be able to negotiate that Seed Investors do not

get a board seat, or any protective provisions in the charter – Seen more frequently by our Palo Alto office.

R&D Company in Palo Alto was able to negotiate a separate voting agreement with a founder veto on M&A; – Caveat: rights had to be unwound in next financing 6 mos later

Two companies out of Boston doing Series A rounds where Investors wanted Series A director approval to hire/fire/change compensation for executive officers: – One financing died over this disagreement;

– One ended with a compromise where Series A Director vote was required for decisions regarding CEO, but not other execs.


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More Focus on Key Provisions (more flexibility at the margins for Founders)

Because of high volume of VC financings, lawyers are focusing on negotiating key terms (future voting/control, financial terms), leaving more wiggle room for favorable founder terms in smaller matters – Registration rights for founder shares;

– Carve-out from ROFR provisions for up to 5% of founder shares;

– Founder voting rights not limited to founders providing services to the Company (e.g. on amendment s to key agreements, consent required for a company sale);


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More Acceptance of Founder Liquidity

In later stage (Series C or D) financing, VCs are becoming more amenable to giving Founders liquidity – More visible trend in Palo Alto, partly in recognition of high cost of

living and serial entrepreneurship of many founders

Conversation is shifting to more about how much they can sell than whether they can sell at all.

VCs are cognizant that they won’t be able to keep a founder happy if he/she has working for 2-3 years to build a company but not able to pay the rent.


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More Acceptance of Founder Liquidity

One quirky trend: “Series FF” Preferred Stock (Palo Alto) – Founder issues himself 80% Common Stock and 20% Series FF

Preferred Stock (acts like common, but with conversion feature)

– When purchased by a Preferred Investor in connection with a Preferred Financing, the FF Preferred automatically flips to the series of Preferred Stock being purchased

– E.g. If Company is raising a $10M Series B, and Founder wants to sell $2M of his “FF” Preferred Stock, Investor pays $8M to the Company, and $2M to the Founder, and ends up with $10M worth of Series B Preferred Stock, as the FF flipped into Series B.

– This is a way to get founders some liquidity while solving for the problem that Preferred Investors do not want to buy Common Stock, and a high priced Common Stock sale could affect future 409A valuations.


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Significant Founder Investment at the Outset Founders who put in a significant amount of their own cash up front looking for a creative way to structure that investment; want to be “at the table” with preferred investors

– Separate class of founder preferred stock with its own rights (unlikely to be able to keep this for long)

– Convertible notes that will convert into the next round of institutional investment (we recommend this approach)

Founder’s participation in preferred round can lead to very high pro-rata depending on how the IRA is written

– E.g. One NY company had one of two-person founding team invest in preferred; IRA was written such that pro-rata was based on total shares held, not just preferred shares held. Other founder was NOT HAPPY (one founder no longer with the company)


Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP

Terms and Trends in Venture Financings from across WilmerHale

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