Subject: VCEF

Textbook Chapter 9 + Term Sheet in Appendix

Summary

Term Sheet & Negotiating with investors

• Term Sheet
  • Outlines key financial aspects

  • and price of shares

  • also known as Letter of Intent (LOI), Memorandum of Understanding (MoU) or Agreement in Principle
• Term sheet does not closed round until final document is signed
• Post-term sheet negotiation, a "Subscription Agreement" and "Shareholders' rights agreement" has to be signed
  • Subscription agreement
    • Contains details of investment round

    • and class of shares subscribed

    • Payment terms
    • Reps & Warranties
  • Shareholder's rights agreement
    • Contains investor rights and protection
• Investor's interest in term sheet
  • Protect from poor operations and management
  • Ensure commitment from team and key personnel
  • Handle divergence inn opinion on timing of value creation (LT vs ST)
  • Protect from entrance and conflict from other shareholders
• Entrepreneur's interest in term sheet
  • Ensure involvement and commitment from investors (network, knowledge)
  • Handle entrance of new shareholders in future
  • Protect from exist at wrong time
• Terms / Covenants
  • Positive Covenants - agreement to do
  • Negative Covenants - limit detrimental behaviour
  • Ratchets - agreements with option to change duties or rights upon specified conditions
  • Economic Rights
    • Liquidation Preference
      • For preference stocks
      1. Non-participating - pay up to invest value
      2. Participating Capped - pay up to value + cap (upper limit of share)
      3. Participating Non-capped - pay first and then treat like common stock
    • Anti-Dilution Provision
      • Adjust number of shares upwards if firm gets financing at lower valuation
    • Transfer of Shares
      • Right of first refusal - can refuse new shareholders, but must acquire outgoing shares per buyer terms
      • Right of first offer - shareholder must offer to holder first
      • Tag along right - allow minority shareholder to sell with majority with their terms
      • Drag along right - allow minority shareholder to "force" others to sell to same buyer, creating a new majority
      • Call & Put options - current shareholders can buy from PE/VC and vice versa
  • Political Rights
    • Asset sales covenants - restrictions on assets above set value
    • Merger or sale covenants - prevent merger or sale without approval
    • Asset purchase covenant - restrictions on purchase of assets above set value
    • New securities restrictions
  • Information rights
  • Team Commitment
    • Stock options - motivate and align interests
    • Lock up - prevent sales of stock to third parties for lock-up period
    • Permitted transfer clause - required approval before sales of shares from either party
    • Earn Out Agreement
    • Exit Ratchet - incentive for managers upon exit
  • Staging
    • Investment in staged instalments
    • Based on business targets
  • Exclusivity and confidentiality

Negotiation

• Challenges
  • Type of shares
    • Typically piggy-back off terms from previous rounds
    1. Common Shares
    2. Preferred stock - no rights, dividend and liquidation priority
    3. Convertible preferred stock
    4. Participating convertible preferred stock - can take face value and equity participation if company sold
    5. Shares with embedded option - provide rights to buy stocks at predefined price
    6. Tracking stock - security related to results of subsidiary of business (usually to separate high growth division from parent)
  • Use of funds
    • Also known as "paying policy"
    • Basic questions to allocate funds
      • Source of money
      • Reasons for issuing shares
      • Relationship with existing shareholders
  • Post-Investment Rules
    • Related to creating and measuring value → Contractual rules for liquidity and performance
    • Ensure investors and entrepreneur can coexist as a team → Behaviour and mechanism to offer to venture

Biz Angel Term Sheet

• Typically common shares, convertible preferred shares, convertible debt
• Preferred returns - amount to return before distribution to other stakeholders
• Accruing returns - dividend on shares that accrue and are converted to equity at time of loan principal
• Board structure and reporting
• Due Diligence