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THE LANGUAGE AND STRUCTURE OF ANGEL AND VENTURE DEALS
JULY 28TH, 2015
©MCCARTHY LAW, LLC 2015
LEGAL ISSUES FOR STARTUPS AND ENTREPRENEURS
FOUR SECTIONS OF THIS PRESENTATION
• Types of Deals
• Common Structure of Deals
• Critical Deal Terms
• Other Key Concepts
SECTION I: TYPES OF DEALS
• Common Equity
• Preferred Equity
• Convertible Notes
• Less Common Deals
COMMON EQUITY
• Common Among Less Sophisticated Investors/Startups
• Simple
• Implies a Valuation
• Pre/Post-Dilution Issues
PREFERRED EQUITY
• Most Common Venture Vehicle/Most Sophisticated Investors
• Varying Levels of Complexity
• Liquidation Preferences
• Huge Variation in Fairness/Characteristics of How Startups Treated
CONVERTIBLE NOTE
• An Investment Vehicle that Has Characteristics of Debt and Equity
• Initially Debt. Upon Triggering Event, Converts into Equity.
• Delays Valuation Question
• Originally Used in Bridge Financing, Now Super Common in Early-Stage Startups
LESS COMMON INVESTMENT VEHICLES
• FACE
• KISS
• Convertible Equity
• ROBS
• Revenue-Based Financing
SECTION II: COMMON STRUCTURE OF DEALS
• Term Sheet
• Disclosure Documents
• Investor Due Diligence
• Accredited Investor Certs
• Final Deal Agreements
• Federal Filings
TERM SHEETS
• Broad Strokes
• Agreement to Agree
• Where You Learn Exactly About Seriousness Level of Your Investors’ Interest
• Not a Binding Document
DISCLOSURE DOCUMENTS
• Securities Laws
• Material Misstatement or Omission
• CYA
• Forward-Looking Statements
INVESTOR DUE DILIGENCE
• You’re Responsible for Having the Documents in Place
• Investors Do the Legwork Here
ACCREDITED INVESTOR CERTIFICATION FORMS
• For Most Startups, Only Let Accredited Investors Invest
• 200k/year Individual, 300k/year Married Couple
• $1,000,000 in Assets Excluding Primary Residence
FINAL DEAL AGREEMENTS
• Stock Purchase Agreement
• Preferred Stock Purchase Agreement
• Convertible Note Agreement
• Fully Fleshed Out, All Legal Concepts
FEDERAL FILINGS
• Form D
• Associated State Filings
• Additional Filings May Be Required – Depends on the Size of the Round
SECTION III: CRITICAL DEAL TERMS
• Liquidation Preference
• Anti-Dilution Provisions
• Representations and Warranties
• Qualified Financing
• Conversion Price
• Valuation Cap
LIQUIDATION PREFERENCES
• Investor Gets Money Back First
• Participating vs. Non-Participating
• Usually a Multiple
• 1x Considered Standard
DILUTION, ANTI-DILUTION PROVISIONS
• Issued vs. Authorized Stock
• Option Pool
• Pro Rata Participation Rights
• Automatic Grant to Maintain Ownership %= Crazy!
REPS & WARRANTIES
• Company Has to Certify It Has Its Excrement Together
• If You Didn’t Set Your Company Up Correctly, Probably In Violation of This
• IP, Authority, Compliance with Laws, Full Information
KEY CONCEPTS, CONVERTIBLE NOTES
Coming Slides
QUALIFIED FINANCING
• Typically, Threshold for Automatic Conversion for a Convertible Note
• Point at Which Investors Convert to Preferred Equity
• $1,000,000 Standard Size
CONVERSION PRICE
• Size of Discount Convertible Note Investors Receive to Later Investors
• 20% Discount Standard
VALUATION CAP
• Provides a Reasonable Estimate of What Convertible Note Investors Think Company Should be Worth Next Round
• $5 MM Cap, $10 MM Raise
SECTION IV: OTHER KEY CONCEPTS
• Regulation D Offering
• Rule 504 vs. 506 Offerings
• Tag-Along/Drag-Along/Co-Sale
• Right of First Refusal
ADDITIONAL READING
• Venture Deals by Brad Feld and Jason Mendelson
• Deal Terms by Alex Wilmerding
THAT’S IT!
• @CoStartupLawyer• www.coloradostartuplawyer.com
Thanks for Coming!