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Transcript of Venture Capital Deal Terms Joe Hadzima ([email protected]) Managing Director, Main Street Partners LLC...
Venture Capital Deal TermsVenture Capital Deal Terms
Joe Hadzima Joe Hadzima ([email protected])([email protected])
Managing Director, Main Street Partners LLCManaging Director, Main Street Partners LLCSenior Lecturer, M.I.T. Sloan School of ManagementSenior Lecturer, M.I.T. Sloan School of Management
For “Nuts and Bolts of Business Plans” MIT Course 15.S21For “Nuts and Bolts of Business Plans” MIT Course 15.S21(formerly 15.975)(formerly 15.975)
Copyright 2000-2012, Joseph G. Hadzima, Jr., All Rights ReservedThis presentation may be used for academic and teaching purposes with attribution
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 2
Venture Capital Deal TermsVenture Capital Deal Terms
Deal Terms Are A Function Of Many Factors Including:Deal Terms Are A Function Of Many Factors Including:– Type of InvestorType of Investor– The Size Of The Investor’s CheckbookThe Size Of The Investor’s Checkbook– The Economics Of The Investment OpportunityThe Economics Of The Investment Opportunity– The Funding CycleThe Funding Cycle
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 3
» ““Principal” Investors - Institutional or Individual InvestorsPrincipal” Investors - Institutional or Individual Investors» Fund InvestorsFund Investors» Corporate Strategic InvestorsCorporate Strategic Investors
– Not All Money Is EQUAL:Not All Money Is EQUAL:• Money Comes With Different Benefits and “Strings” Including Money Comes With Different Benefits and “Strings” Including
Legal Requirements:Legal Requirements:– Which Apply To Where the Money Comes From- The Ultimate Source Of Which Apply To Where the Money Comes From- The Ultimate Source Of
The FundsThe Funds– Which Derive From The Legal Structure of the Investing EntityWhich Derive From The Legal Structure of the Investing Entity
Deal Terms Are A Function Of Many Factors Including:Deal Terms Are A Function Of Many Factors Including:– Type of InvestorType of Investor
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 4
Determines the Size of Investment NeededDetermines the Size of Investment Needed Determines the Appetite and Ability To Do Follow-on RoundsDetermines the Appetite and Ability To Do Follow-on Rounds Results in Deal Terms Which Protect Initial Investment or Position for Results in Deal Terms Which Protect Initial Investment or Position for
Future InvestmentFuture Investment
Deal Terms Are A Function Of Many Factors Including:Deal Terms Are A Function Of Many Factors Including:– Type of InvestorType of Investor– The Size of Investor’s CheckbookThe Size of Investor’s Checkbook
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 5
Valuation and Attractiveness of the OpportunityValuation and Attractiveness of the Opportunity Business Plan RequirementsBusiness Plan Requirements
– Financial Resources RequiredFinancial Resources Required– Staging of Financing RequirementsStaging of Financing Requirements– Completeness of Team - Additional Equity Pool NeedsCompleteness of Team - Additional Equity Pool Needs
Deal Terms Are A Function Of Many Factors Including:Deal Terms Are A Function Of Many Factors Including:– Type of InvestorType of Investor– The Size of Investor’s CheckbookThe Size of Investor’s Checkbook– The Economics Of The Investment OpportunityThe Economics Of The Investment Opportunity
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 6
For the CompanyFor the Company– Seed Stage – First or Second Rounds – Mezzanine RoundsSeed Stage – First or Second Rounds – Mezzanine Rounds
For the Investor and Its Sources of FundsFor the Investor and Its Sources of Funds– Conditions and Trends in the Financial MarketsConditions and Trends in the Financial Markets
» Venture Capital Fund Raising Has A Cycle TooVenture Capital Fund Raising Has A Cycle Too
Deal Terms Are A Function Of Many Factors Including:Deal Terms Are A Function Of Many Factors Including:– Type of InvestorType of Investor– The Size of Investor’s CheckbookThe Size of Investor’s Checkbook– The Economics Of The Investment OpportunityThe Economics Of The Investment Opportunity– The Funding CycleThe Funding Cycle
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 7
Venture Capital Funding CycleVenture Capital Funding Cycle
Deal Terms Are Influenced By How Much Deal Terms Are Influenced By How Much Venture Capital Is AvailableVenture Capital Is Available
» By Stage of InvestmentBy Stage of Investment» By Industry SectorBy Industry Sector
Capital Availability AffectsCapital Availability Affects» Deal PricingDeal Pricing» Deal Term Flexibility Where Flexibility Is PossibleDeal Term Flexibility Where Flexibility Is Possible
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 8
The State of Venture CapitalThe State of Venture Capital
The Number of Venture Capital Deals Is Increasing
0
1000
2000
3000
4000
1995 1996 1997 1998 1999 (3Qtrs)Source: Venture EconomicsSource: Venture Economics
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 9
The State of Venture CapitalThe State of Venture Capital
0
5
10
15
20
25
30
$ Invested (Billions) 5.8 9.9 14 19.1 28.6
Avg $/Deal (Millions) 4.24 5.26 5.62 5.54 10.735
1995 1996 1997 19981999
(3Qtrs)
The Average Deal Size Doubled In 1999The Average Deal Size Doubled In 1999
Source: Venture EconomicsSource: Venture Economics
$ Invested in Billions$ Invested in Billions
Average $/Deal in MillionsAverage $/Deal in Millions
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 10
Venture Capital Investment Venture Capital Investment ReturnsReturns
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
1 Yr 3 Yr 5 Yr 10 Yr
Seed Stage
Balanced
Later Stage
All Ventures
Buyouts
Mezzanine
All PrivateEquity
Seed Stage Returns Are Up SubstantiallySeed Stage Returns Are Up Substantially
Source: Venture Economics Jan 2000Source: Venture Economics Jan 2000
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 11
Venture Capital Funding CycleVenture Capital Funding Cycle
SUMMARYSUMMARY Today There Is More Competition For DealsToday There Is More Competition For Deals This Is Reflected In:This Is Reflected In:
– Valuation of DealsValuation of Deals– More Flexibility in Terms Where Flexibility Is More Flexibility in Terms Where Flexibility Is
PossiblePossible
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 12
So, What Are The Deal Terms?So, What Are The Deal Terms?
Issue: Venture Capital LP ("VC") and/or any member of its corporate group ("the VC Group") will purchase up to $2,500,000 Series A Convertible Preferred Stock ("Series A") newly issued by PCI, Inc. (the "Company") at a price per share of $1.00 (the "Purchase Price"). In addition, other investors shall purchase at least $4,500,000 but not more than $7,000,000 of newly issued Series A at the Purchase Price.
The shares of Series A will be convertible at any time at the option of the holder into common shares of the Company ("Common Stock") on a one-for-one basis, adjusted for future share splits.
VENTURE CAPITAL LPREVISED TERM SHEET
PCI, Inc.66 Sutton Business Park
The Twilight Zone
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 13
Major Deal ElementsMajor Deal Elements
A Preferred ReturnA Preferred Return Protection of Valuation and Position re: Protection of Valuation and Position re:
Future MoneyFuture Money Management of the InvestmentManagement of the Investment Exit StrategiesExit Strategies
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 14
A Preferred ReturnA Preferred Return Perception of the VC Investor:Perception of the VC Investor:
– When the Investor Writes the Check he has done most EVERYTHING he promised
– The Entrepreneur Has Done NOTHING YET Result:Result:
– The VC wants its money to be paid back BEFORE the Entrepreneur gets his/her return.
Instrument: Instrument: CONVERTIBLE PREFERRED STOCKCONVERTIBLE PREFERRED STOCK
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 15
Capital Structure InstrumentsCapital Structure Instruments
Company A
Secured Debt
Unsecured Debt
Subordinated Debt
Preferred Stock
Common Stock
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 16
Capital Structure InstrumentsCapital Structure Instruments
0
20
40
60
80
100
120
Startup 1st Round LBO Microsoft
Secured Debt
Unsecured Debt
Subordinated Debt
Preferred Stock
Common Stock
Percentage of Capital Structure By Stage/Type of Company
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 17
A Preferred Return: A Preferred Return: DividendsDividendsDividends: The Preferred Stock is entitled to an
annual $_______ per share dividend,payable when and if declared by theBoard of Directors, but prior to anypayment on Common Stock; dividendsare not cumulative
Dividends:Dividends:
-Paid to Preferred First-Paid to Preferred First
-Cumulative or Accruing-Cumulative or Accruing
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 18
A Preferred Return:A Preferred Return: Liquidation PreferenceLiquidation Preference
““Straight” Liquidation PreferenceStraight” Liquidation Preference: : The Preferred receives The Preferred receives its original investment amount plus accrued dividends (if any) before its original investment amount plus accrued dividends (if any) before Common receives anything.Common receives anything.
Participating (“Double Dip”) Preferred:Participating (“Double Dip”) Preferred: The Preferred The Preferred first gets its liquidation preference and then shares any remaining first gets its liquidation preference and then shares any remaining proceeds with Common. Increasingly subject to a cap of 3X or 4X proceeds with Common. Increasingly subject to a cap of 3X or 4X (including preference).(including preference).
LiquidationPreference: The Series A Preferred will have a liquidation preference such that
proceeds on a merger, sale or liquidation (including non-cumulative dividends) will first be paid to the Series A and willinclude a 10% per annum compounding guaranteed returncalculated on the total amount invested.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 19
Comparison of Straight vs. Comparison of Straight vs. Participating PreferredParticipating Preferred
Preferred Investment Amount 5,000,000$ Percentage purchased 30%Sale Price of Company 25,000,000$
ParticipatingPreference Only Converted Preferred
Sales Price 25,000,000$ 25,000,000$ 25,000,000$ Amount to PreferredLiquidation Pref 5,000,000$ 5,000,000$
--------------- --------------- ---------------Amount after Preference 20,000,000$ 25,000,000$ 20,000,000$ Percentage of Balance 30% 30%As Converted 7,500,000$ 6,000,000$
--------------- --------------- ---------------Total to Preferred 5,000,000$ 7,500,000$ 30% 11,000,000$ 44%
Common Stock 20,000,000$ 17,500,000$ 70% 14,000,000$ 56%
Non Participating Preferred
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 20
WHICH IS THE BETTER DEAL FOR THE FOUNDERS?WHICH IS THE BETTER DEAL FOR THE FOUNDERS?
Case A:Case A: Founders sell 40% of the Company for 5m of Founders sell 40% of the Company for 5m of Convertible Preferred Stock with a $5m Liquidation Convertible Preferred Stock with a $5m Liquidation preference but no participating rights. ($7.5M pre-money preference but no participating rights. ($7.5M pre-money valuation)valuation)
Case B:Case B: Founders sell 33% of the Company for $5m of Founders sell 33% of the Company for $5m of Participating Preferred Stock ($10m pre-money) Participating Preferred Stock ($10m pre-money)
Valuation and Participating PreferredValuation and Participating Preferred
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 21
Valuation and Participating PreferredValuation and Participating Preferred
Payout Schedule for Case A: 40% of the Company for $5m of Nonparticiating Preferred
Exit Valuation ($M) 5 10 12.5 20 35 100Investors Payout ($M) 5 5 5 8 14 40Founders Payout ($M) 0 5 7.5 12 21 60
Payout Schedule for Case B: 30% of the Company for $5m of Particiating Preferred
Exit Valuation ($M) 5 10 15 20 35 100Investors Payout ($M) 5 6.5 8 9.5 14 33.5Founders Payout ($M) 0 4.5 7 10.5 21 66.5
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 22
A Preferred Return:A Preferred Return: Liquidation Events Liquidation Events
Liquidation, dissolution, sale of assetsLiquidation, dissolution, sale of assets– money comes into corporation– money paid out to stockholders to redeem stock
““Deemed liquidation”--merger or other positive eventDeemed liquidation”--merger or other positive event– consideration may be stock or cash– consideration may go directly to stockholders
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 23
Major Deal ElementsMajor Deal Elements
A Preferred ReturnA Preferred Return
Protection of Valuation and Protection of Valuation and Position re: Future MoneyPosition re: Future Money
Management of the InvestmentManagement of the Investment Exit StrategiesExit Strategies
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 24
Antidilution ProtectionAntidilution Protection
Approval RightsApproval Rights
Protection of Valuation and Protection of Valuation and Position re: Future MoneyPosition re: Future Money
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 25
Protection of Valuation:Protection of Valuation:ConversionConversion and Antidilution and Antidilution
Conversion: A holder of the Series A Preferred shall have theright to convert the Series A Preferred at theoption of the holder, at any time, into shares ofCommon Stock. The total number of CommonShares into which the Series A Preferred may beconverted initially will be determined by dividingthe Original Purchase Price by the “ConversionPrice”. The initial Conversion Price shall be theOriginal Purchase Price.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 26
Protection of Valuation:Protection of Valuation:ConversionConversion and Antidilution and Antidilution
Conversion Events: When Does Preferred Convert Into Conversion Events: When Does Preferred Convert Into Common?Common?
–Voluntary–Forced: often some % of Preferred can force conversion of all –Automatic--upon “Qualified IPO”
» minimum total offering; minimum share price (usually 3 to 5 times initial purchase price)
Conversion Ratio--initially 1:1Conversion Ratio--initially 1:1–Adjustments--stock splits, etc; price antidilution–Exceptions--option pool, conversion of preferred, outstanding warrants, other
existing conditions, other special exceptions
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 27
Protection of Valuation:Protection of Valuation:Conversion and Conversion and AntidilutionAntidilution
Anti-Dilution: Series A shall have weighted average anti-dilution, based on a weighted averageformula to be agreed, for all securities purchased as part of this transaction(excluding shares, options and warrantsissued for management incentive and smallissues for strategic purposes of under 100,000 shares)
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 28
Antidilution Adjustment Antidilution Adjustment increasesincreases the number of shares the number of shares received on conversion of Preferredreceived on conversion of Preferred
What Triggers Antidilution Adjustment?What Triggers Antidilution Adjustment?– Issuance or “deemed issuance” of Common at less than
preferred issuance price– “Deemed issuance”--adjust upon issuance of derivative
security; if common never issued, readjust later» options, warrants» convertible securities
Protection of Valuation:Protection of Valuation:Conversion and Conversion and AntidilutionAntidilution
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 29
Protection of Valuation:Protection of Valuation: AntidilutionAntidilution
Conversion Ratio:Conversion Ratio:– Original Purchase Price/Conversion PriceOriginal Purchase Price/Conversion Price
» Initially OPP=CP so Conversion Ratio =1 ““Full ratchet”: Conversion Price reset to equal Full ratchet”: Conversion Price reset to equal
price at which diluting security is soldprice at which diluting security is sold ““Weighted average”: CPWeighted average”: CPnewnew=CP=CPoldold*R*R
– Where R = (N + M/CPWhere R = (N + M/CPoldold)/(N+S))/(N+S)» N = old shares outstanding (fully diluted)» S = new shares to be issued» M = new money ($)
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 30
AntidilutionAntidilutionSeries A Series B Series C
Amount Invested 7,000,000$ 13,500,000$ 5,000,000$ Round Stock Price $1.00 $5.00 $2.00Number of Shares 10,000,000 7,000,000 2,700,000 2,500,000 Normal DilutionCommon 100.00% 58.82% 50.76% 45.05%Series A 41.18% 35.53% 31.53%Series B 13.71% 12.16%Series C 11.26%
----------------- ----------------- ----------------- -----------------100.00% 100.00% 100.00% 100.00%
Percentage Ownership After Series C RoundCommon Series A Series B Series C
Normal Dilution 45.05% 31.53% 12.16% 11.26%Weighted Average 44.65% 31.26% 12.93% 11.16%Full Ratchet 38.10% 26.67% 25.71% 9.52%
Rounds of Financing
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 31
Protection of Valuation Protection of Valuation and Positionand Position::
Approval of Investors Approval of Investors Pre-Emptive RightsPre-Emptive Rights
Right of First RefusalRight of First Refusal
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 32
Protection of Valuation Protection of Valuation and Positionand Position::ApprovalsApprovals
Approval of Investors Required ForApproval of Investors Required For– New Financings New Financings – Merger or Sale of CompanyMerger or Sale of Company– Increase in Option PlanIncrease in Option Plan
Negative Covenants: Approval by holders of Preferred Stock oforganic changes outside normal course ofbusiness and sale, liquidation or merger,increase in board seats or change electionprocedures, new shares senior to or on parwith and all distributions (dividends,repurchases).
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 33
Protection of Valuation Protection of Valuation and Positionand Position:: Pre-Emptive RightsPre-Emptive Rights
Pre-Emptive Rights: Holders of the Preferred Stock will begranted rights to participate in future equity financings of the Company basedupon their pro-rata, as-if-converted,ownership of the Company.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 34
Protection of Valuation and Position:Protection of Valuation and Position: Pre-Emptive RightsPre-Emptive Rights
Permits Investors to participate Permits Investors to participate pro ratapro rata in future in future financings, to preserve their percentage financings, to preserve their percentage ownershipownership
Subject to exclusions: Subject to exclusions: – option pool issuances option pool issuances – strategic alliances & licensesstrategic alliances & licenses
““Pay to Play”Pay to Play”
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 35
Protection of Valuation and Position:Protection of Valuation and Position: Rights of First Refusal; Tag AlongRights of First Refusal; Tag Along
Rights of FirstRefusal;Tag-Along The Company and the Investors will have a right of
first refusal with respect to any employee's sharesproposed to be resold. Alternatively, the Investorswill have the right to participate in the sale of anysuch shares to a third party (co-sale rights), whichrights will terminate upon a public offering.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 36
Protection of Valuation and Position:Protection of Valuation and Position: Rights of First Refusal; Tag AlongRights of First Refusal; Tag Along
Granted by Founders/other InvestorsGranted by Founders/other Investors First Refusal: Gives Investors the right to acquire shares First Refusal: Gives Investors the right to acquire shares
offered by the grantor, offered by the grantor, pro ratapro rata– May be partial or “all or nothing”– Exclude: VC partnership distributions, estate planning
Tag Along (Co-Sale): Gives Investors the right to sell shares Tag Along (Co-Sale): Gives Investors the right to sell shares pro rata if a Founder sells shares to otherspro rata if a Founder sells shares to others– Rarely invoked– Helps lock in Founders
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 37
Major Deal ElementsMajor Deal Elements
A Preferred ReturnA Preferred Return Protection of Valuation and Position re: Protection of Valuation and Position re:
Future MoneyFuture Money
Management of the InvestmentManagement of the Investment Exit StrategiesExit Strategies
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 38
Management of the Management of the InvestmentInvestment
Board Seat(s)Board Seat(s) Business ApprovalsBusiness Approvals Information RightsInformation Rights
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 39
Management of the Investment:Management of the Investment:Board SeatsBoard Seats
Board Seat(s)Board Seat(s)– Importance of the “Independent Director(s)”
Board of Directors: The Board will consist of ___ members. Theholders of the Preferred Stock will have theright to designate __ directors, the holders ofthe Common (exclusive of the Investors) willhave the right to designate ___ directors, andthe remaining ___ directors will be unaffiliatedpersons elected by the Common Stock and thePreferred Stock voting as a single class.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 40
Management of the Investment:Management of the Investment:Business ApprovalsBusiness Approvals
Business ApprovalsBusiness Approvals– Capital Expenditures etc.– Approval of Annual Budget and Operating Plans
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 41
Management of the Investment:Management of the Investment:Information RightsInformation Rights
Information Rights: Monthly actual vs. plan and prior year. Annualbudget 60 days before beginning of fiscal year.Annual audit by national firm. All recipients offinancial statements to execute non-disclosureagreement acceptable to Company counsel. Theaforementioned information rights shall beavailable to each holder of Preferred Stock foras long as such holder owns 220,000 shares ofPreferred Stock or shares of Common Stockissued upon conversion of shares of PreferredStock
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 42
Management of the Investment: Management of the Investment: CarrotsCarrots and Sticks and Sticks
Option Pools:Option Pools:– Traditionally 12% to 18% at Round One– Two Year Pool
Option Pool: Simultaneously with this transaction, onemillion new shares shall expand the Company'smanagement incentive stock option pool -bringing the total number of shares issued andstock incentives (awards and options)authorized to 6,100,000.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 43
Management of the Investment: Management of the Investment: Carrots and Carrots and SticksSticks
Vesting of Founders/Key Management StockVesting of Founders/Key Management Stock
Stock RestrictionAgreement: All present holders of Common Stock of the Company
who are employees of, or consultants to, the Companywill execute a Stock Restriction Agreement with theCompany pursuant to which the Company will have anoption to buy back at cost a portion of the shares ofCommon stock held by such person in the event that suchstockholder's employment with the Company isterminated prior to the date of employment. 25% of theshares will be released each year from the repurchaseoption based upon continued employment by theCompany.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 44
Management of the Investment: Management of the Investment: Carrots and Carrots and SticksSticks
Non-Competition and Invention AgreementsNon-Competition and Invention Agreements
Non-competition, ProprietaryInformation andInventions Agreement: Each officer and key employee of the
Company designated by the Investors willenter into a non-competition, proprietaryinformation and inventions agreement in aform reasonably acceptable to theInvestors
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 45
Major Deal ElementsMajor Deal Elements
A Preferred ReturnA Preferred Return Protection of Valuation and Position re: Protection of Valuation and Position re:
Future MoneyFuture Money Management of the InvestmentManagement of the Investment
Exit StrategiesExit Strategies
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 46
Exit StrategiesExit Strategies
IPOs and Registration RightsIPOs and Registration Rights Sale/AcquisitionSale/Acquisition Redemption of StockRedemption of Stock
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 47
Exit Strategies:Exit Strategies: Registration Rights Registration Rights
Shares cannot be freely sold without filing a Registration Shares cannot be freely sold without filing a Registration Statement with the SECStatement with the SEC– Only the CompanyCompany can file
So the Investors negotiate for certain Registration Rights So the Investors negotiate for certain Registration Rights to insure a contractual ability to exit into the public marketsto insure a contractual ability to exit into the public markets
Registration Rights: Two U.S. demand registrations, subject to $3million and 500,000 share trigger, unlimitedpiggybacks, and evergreen S-3 if requestedand possible all at company expense.
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 48
Exit Strategies:Exit Strategies: Registration Rights Registration Rights
Enables Investors to sell shares publicly by Enables Investors to sell shares publicly by means of a registered offeringmeans of a registered offering– Sales prior to end of 1-year holding period;– Avoid compliance with volume limitations of Rule 144
Registration paid for by the CompanyRegistration paid for by the Company Are Founders included?Are Founders included?
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 49
Exit Strategies:Exit Strategies: Demand Registration Rights Demand Registration Rights
Exercisable after the IPO or within 3-7 years of Exercisable after the IPO or within 3-7 years of investmentinvestment
Can be exercised 1 to 3 times;Can be exercised 1 to 3 times; Can be exercised by holders of 20-50% of the Can be exercised by holders of 20-50% of the
registrable shares, with value of [$$$]registrable shares, with value of [$$$]
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 50
Exit Strategies:Exit Strategies:Incidental (“Piggyback”) Registration RightsIncidental (“Piggyback”) Registration Rights
Investors “piggyback” on another registrationInvestors “piggyback” on another registration Can they participate in other shareholders’ Can they participate in other shareholders’
demand rights?demand rights? Subject to underwriter “cutback”Subject to underwriter “cutback” S-3 Registrations generally unlimitedS-3 Registrations generally unlimited
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 51
Exit Strategies:Exit Strategies: Redemption Redemption
Redemption: The Company’s repurchase of Preferred Redemption: The Company’s repurchase of Preferred Stock at the demand of the InvestorsStock at the demand of the Investors
When Used: When the Company hasn’t gone public When Used: When the Company hasn’t gone public – Because Founders Don’t Want To– Because Business Doesn’t Develop Into an IPO Type
Redemption: If not previously converted, the Series A is tobe redeemed in three equal successive annualinstallments beginning January 20, 2005.Redemption will be at the purchase price plusa 10% per annum cumulative guaranteedreturn
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 52
Exit Strategies:Exit Strategies: Redemption Redemption When Does Redemption Kick In?When Does Redemption Kick In?
– Typically after Five (5) years– Often phased over Three (3) years
TriggerTrigger– Automatic– Upon vote of Preferred
PricePrice– Initial Purchase Price paid plus accrued dividends– Sometimes additional return
Different classes of preferred--later classes won’t let Different classes of preferred--later classes won’t let earlier investors out firstearlier investors out first
Copyright 2000-2012 Joe Hadzima, All Rights ReservedCopyright 2000-2012 Joe Hadzima, All Rights Reserved 53
ConclusionConclusion Understand the Major Deal ElementsUnderstand the Major Deal Elements
– A Preferred ReturnA Preferred Return– Protection of Valuation and Position re: Protection of Valuation and Position re:
Future MoneyFuture Money– Management of the InvestmentManagement of the Investment– Exit StrategiesExit Strategies
Focus on Proving Your ValuationFocus on Proving Your Valuation
Joe HadzimaJoe HadzimaManaging Director, Main Street Partners LLCManaging Director, Main Street Partners LLC
[email protected]@mit.edu