Pre-Series A Funding Vehicles

© Copyright 2016 by K&L Gates LLP. All rights reserved.

Presented by Stan [email protected] 650.798.6743September 22, 2016

Silicon Valley Startup: Idea to IPO

Pre-Series A Funding Vehicles

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INTRODUCTIONS§ Stan Lewandowski, Esq., Partner (Emerging

Growth/Corporate/M&A)

§ Works primarily in the Silicon Valley and SF offices of K&L Gates in Palo Alto but often works from other locations

§ Advised clients (issuers and investors) in more than 100 closed angel and venture capital financings

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OVERVIEW OF COMMONLY USED VEHICLES§ Friends, Family and … (FFF)

§ Convertible Promissory Notes (Notes)

§ Simple Agreements For Equity (SAFEs)

§ Keep It Simple Agreements (KISSes)

§ Other Options (crowdfunding, grants, etc.)

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CONVERTIBLE PROMISSORY NOTES§ Debt instruments with a conversion into equity feature

§ Features

§ Maturity date

§ Interest

§ Mostly, automatic conversion into equity in a qualified financing

§ Conversion discount (~20%) or a valuation cap (max. pre-money valuation), or…

§ Premium on acquisition (1X+)

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CONVERTIBLE PROMISSORY NOTES§ Conversion Options – Automatic Conversion

§ Upon Qualified Financing

§ What is a Qualified Financing?

§ Discount

§ Valuation Cap

§ Fully Diluted Capitalization

§ What if the valuation cap in the note is lower than that agreed by the company and the investors?

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CONVERTIBLE PROMISSORY NOTES

§ Conversion Options – Automatic Conversion

§ If No Qualified Financing or Acquisition Before Maturity Date

§ Conversion into Common Stock at a Pre-Agreed Valuation Cap on a Fully Diluted Basis

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SAFE (CONVERTIBLE EQUITY)

§ Convertible equity instrument

§ No debt features

§ Interest

§ Maturity

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§ Four available versions

§ Price cap, no discount (no minimum amount for conversion)

§ Discount, no price cap (no minimum amount for conversion)

§ Price cap and discount

§ Most favored nation (MFN) provision (no price cap or discount but MFN treatment, minimum amount for conversion)

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§ Price Cap, no Discount (no minimum for conversion)

§ Price cap = valuation cap

§ Conversion into Standard Preferred Stock or Safe Preferred Stock

§ Same or different price per share

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§ Discount, no Price Cap (no minimum for conversion)

§ Discount rate = [100 - the discount]%

§ Conversion into shares of Standard Preferred Stock based on principal amount divided by price of Standard Preferred Stock sold in Equity Financing

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§ Price Cap and Discount

§ Conversion into number of shares of Preferred Stock equal to:

§ The principal amount divided either by:

§ Safe Price (valuation cap/capitalization of company), or

§ Discount Price (standard price of stock sold in Equity Financing x discount rate), whichever results in a greater number of shares

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§ Most Favored Nation (MFN) provision§ (no price cap or discount but MFN treatment, minimum

amount for conversion)

§ What’s the benefit?

§ Amendment of existing documents to reflect better terms offered to investors purchasing issuer’s convertible securities in the future

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§ Now, what if:

§ Company is acquired by another person before conversion of your principal amount into preferred stock?

§ You can elect to:

§ Receive your money back, or

§ Automatically receive shares of common stock equal to the principal amount divided by FMV of company’s common stock, if you fail to elect receipt of cash

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§ Now, what if:

§ Company terminates its operations, liquidates, dissolves or winds up before conversion of your principal amount into preferred stock?

§ You will:

§ It depends

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§ Now, what if:

§ Your investor asks for participation rights as part of its investment?

§ Few options are available

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KISS DOCUMENTS

§ Two versions

§ Debt

§ Equity (more favorable to the issuer)

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KISS DOCUMENTS

§ Comparison of Debt and Equity Versions (substantially similar, except for interest and maturity)

§ Treatment in financing

§ Conversion into preferred stock in a qualified financing round (~$1M, for instance) at a price that’s lesser of cap or discount

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KISS DOCUMENTS


§ Treatment in acquisition

§ You elect to either convert principal into shares of common stock at a valuation cap or multiple of investment plus interest (2X)

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KISS DOCUMENTS


§ Treatment at maturity

§ If not converted in equity financing or part of an acquisition, then, on or after maturity, the majority in interest will elect to either convert into Series Seed Preferred Stock at a cap OR demand repayment from issuer

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KISS DOCUMENTS


§ Most favored nation treatment

§ Right to exchange the existing instrument for one issued subsequently to other investors on terms more favorable than the terms of the instruments issued to existing investors if such subsequent issuance occurs before conversion or repayment of the existing instrument

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KISS DOCUMENTS


§ Information and participation rights

§ Rights for “Major” Investors? Who is Major Investor?

§ What are the rights?

§ Information§ Participation (pro rata, 1X+ investment amount)

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OTHER OPTIONS TO SECURE CAPITAL

§ Crowdfunding (www.kickstarter.com)

§ Factoring (selling AR)

§ Customer financing

§ Grants

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THANK YOUFor Further Questions Please Contact:

Stan LewandowskiPartner, K&L Gates LLP

(650) 798-6743E-mail: [email protected]

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Pre-Series A Funding Vehicles