Shmalo - 2015-Convertible Note Paper and Exhibits - FINAL

Page 2 of 23 KISS’S, SAFE’S AND CONVERTIBLE NOTES ICLEGA October 22, 2015

360 Venture Law (Shmalo Turner) LLP 270 Carpenter Drive, Suite 225 Atlanta, GA 30328 Mailing Address: PO Box 12306 Atlanta, Georgia 30355 www.360vLaw.com Daniel A. Shmalo, Esq. 404.575.4360 office 404.664.5196 mobile 404.719.4284 fax [email protected]

TO: ICLEGA – Growth Companies: Business and Legal Considerations FROM: Daniel A. Shmalo DATE: October 22, 2015 RE: KISS’S, SAFE’S AND CONVERTIBLE NOTES

The Latest Startup Financing Tools __________________________________________________________________________________ Introduction Some say we are in the golden age of seed financing. Others say we continue to pump air into the latest tech bubble. Regardless, it is certainly true that venture capital funds, seed funds, super angels, micro-VC’s, angel groups, incubators, accelerators and “friends and family” are all playing the seed financing game and investing in, or at least talking about investing in, early stage startups. Newbie investors are trying to land the next Facebook, Snapchat or Twitter, or locally, the next Yik Yak, Kabbage, or CloudSherpas. Lately, for at least the last 5-10 years, the convertible note has been an increasingly popular tool used by founders of startups and early stage investors to consummate an investment with arguably fewer initial terms to negotiate and fewer legal documents to draft and execute. In this paper, we will explore the convertible note as typically used in growth company investment scenarios. We will cover topics including:

What, how and why for the convertible note:

• what is a convertible note? • why are convertible notes issued instead of shares of common or preferred stock? and • what are the advantages of issuing convertible notes?

The main economic levers in connection with the issuance of convertible notes:

• interest rate • valuation cap • conversion discount • (and how they interrelate)

4

4/58


Convertible note issues more interesting to lawyers, such as: • what happens if the startup is acquired prior to the note’s conversion to equity? • what happens if the maturity date is reached prior to the note’s conversion to equity? and • what securities laws do founders need to worry about in connection with the issuance of

convertible notes?

Spin Room – Points of View from a founders’ perspective and from an investors perspective Next generation – Convertible Securities that are NOT promissory notes – e.g. KISS’s and SAFE’s What is a Convertible Note?

In the context of a seed stage financing of a small or startup business, a convertible note is short-term debt instrument that is designed to (almost always) later convert into the equity securities of the issuer (a “Convertible Note”). This debt is embodied by a promissory note contract that, typically automatically, converts into shares of preferred stock upon the closing of a qualified financing. The term “Qualified Financing” is defined in the Convertible Note as an issuance of new stock that raises enough money at a high enough valuation with certain minimum investor rights (more on Qualified Financing below). If and when the Qualified Financing happens, the Convertible Note converts into the equity security issued in that round. Unlike a normal loan (mortgage, car loan, SBA loan), the Convertible Note “lender” does not really want his money back at the end of the short term. He or she wants to own a piece of equity in a business that will grow and ultimately make the owners 2x, 3x or more on their initial investment. Usually, Convertible Note investors loan money to a startup as its first round of funding, or first post friends and family round; and then rather than get their money back with interest, the investors receive shares of preferred stock as part of the startup’s initial preferred stock financing. A Convertible Note is used by seed/angel investors and the founders of the business being financed (“Founders”) who wish to delay establishing a valuation for that startup until a later round of funding or other milestone. It also defers the more complex discussion of the exact legal and business terms of the new preferred equity securities. In order to compensate the seed investor for the additional risk of investing in the earlier round, Convertible Notes will usually have additional terms to sweeten the deal for investors, such as ValCaps, and or Discounts. These terms and others will be explored in depth herein. See the example term sheet marked as Attachment 2.

Before the Seed Round Convertible Note and other uses of convertibles

Originally, the concept of convertible debt in the world of VC and growth company finance was used to “bridge” companies that needed financing in between distinct rounds of professional equity financing — such as between Series A and Series B. The company needed the bridge to enable it to stay solvent or fund capex necessary to reach the next business milestone, raise new financing or sell the company. This is why convertible debt was originally referred to as a “bridge loan.” The startup finance Convertible Note that we are discussing here is similar but not the same as a bridge loan. With the old school bridge loan, if the company didn’t raise a new round of financing, or get to an exit event, the convertible debt would convert into the last round of financing (i.e. Series A) or mature to be repaid in cash. However, with the startup finance Convertible Note we are referring to here, there is no Series A preferred available to fall back on, and the investors do not want common which is one of the reasons a Convertible Note is used in the first place. It is important to say, a Convertible Note is a far more speculative investment than the name implies. This is not your grandparents’ AAA insured bond investment.

5

5/58


Another use case. Some VC’s will also use Convertible Notes after they have participated in the last preferred round (e.g. Series A). They use the Convertible Note as a bridge to the Series B that they also intend to fund. They use it as a down payment to get cash into the company quickly usually because the company desperately needs the cash, but also because the VC may need extra time to solidify a syndicate to raise a larger round then they are capable of, or comfortable, doing alone. These notes usually do not have a Discount or ValCap (both defined below).

Boil it down, why do startups raise investment capital using convertible notes?

People who use Convertible Notes typically do so because they believe the notes offer a simple, cheap, and fast method for startup funding as compared to traditional priced preferred equity rounds.

Defined Terms – the following terms are necessary for the discussion below:

“Priced Round” for purposes of this paper means the parties have have placed a value on the company as a whole and thus can calculate the price per share of the stock that would be issued to the investor. In other words, they have calculated how much each share of stock would cost if sold today. “Qualified Financing” is a concept used in most (if not all) Convertible Notes to determine when an automatic conversion of the convertible debt into equity is triggered. The Qualified Financing is typically defined as an equity financing by the startup, for the purpose of raising capital, in which the aggregate of, for example, $2,000,000 (this amount varies per deal) of Qualified Securities (defined below) is purchased by outside investors. Again, the Qualified Financing event is the trigger by which the convertible debt will automatically convert to equity. The conversion is considered “automatic” because it does not require the vote, or any other action, of either the company or the investor/holder. “Qualified Securities” is the concept used in most (if not all) Convertible Notes to describe what type of stock must be issued in the round of funding to allow it to meet the definition of Qualified Financing (and thus trigger the automatic conversion. This is usually a Series A Preferred Stock type class to be designated by the company in their charter upon the closing of the prospective round of funding. Any particular rights or preferences that the investor may want can be dictated in the Convertible Note as part of the definition of Qualified Securities. Upon a conversion, the Convertible Note held by the investor will convert into the Qualified Securities. The amount of shares of the Qualified Securities issued to the Convertible Note investor is dependent on the Discount and or the ValCap per the terms of the convertible note contract.

What are the key economic variables in a convertible note?

There are many possible terms in a Convertible Note. The three most important business or economic terms are: (i) the conversion discount (or “Discount”), (ii) the conversion valuation cap (or “ValCap”), and, to a lesser extent, (iii) the interest rate. Unlike other forms of debt, the interest rate is often the least important economic term.

What is a Discount in a Convertible Note?

A conversion discount (Discount) is a mechanism to reward the Convertible Note holders for their investment risk by granting to them the right to convert the amount of the loan, plus interest, at a reduced price (in percentage terms) to the purchase price paid by the Series A investors (in the

6

6/58


Qualified Financing). Discounts range from 0% to 35% or more, with 20% being very common. The way this works in the contract is that the note holder will convert the principal and interest from the Convertible Note into the Qualified Securities at a price per share equal to 80% (or 65%, or…) of the price per share paid by the Qualified Financing investors (the investors putting in enough money on the right terms to trigger a Qualified Financing). The founders are saying to the investors, in effect, if you take this risk and give us money today, we’ll reward you by giving you “20% off” at our Qualified Financing (e.g. Series A round) down the road (again, 20% being a typical, but not universal, discount). For example, if the investors in a $500,000 convertible note seed financing were granted a discount of 20%, and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price (referred to as the “conversion price”) of $0.80 per share and thus receive 625,000 shares ($500,000 divided by $0.80). That’s 125,000 shares more than a Series A investor would receive for its $500,000 investment and a 1.25x return on paper ($625,000 divided by $500,000) and this example does not include accrued interest on the note, which is typically about 2%-7%, or more, annually.

Here is the basic outline of how convertible debt math works: (1) Lisa Angel invests $500,000 in Startup. (2) Startup issues Lisa Angel a Convertible Note for $500,000. The Convertible Note

has an automatic conversion feature at $2,000,000 (the “Qualified Financing”) with a conversion discount equal to 20%.

(3) Startup closes $2,000,000 Series A Preferred Stock round (the “Qualified Securities”) by a VC at a Series A Preferred Stock price of $1.00 per share.

(4) Since the Automatic Conversion feature in Lisa Angel’s Convertible Note is triggered by the Series A round, Lisa Angel’s convertible debt will be converted to Series A shares at a per share price of $0.80. [She gets a 20% discount, or pays 80% of the list price]

(5) The Startup issues Lisa Angel 625,000 shares ($100,000/$0.80 per share) of its Series A Preferred Stock in full and final satisfaction of the note. The Convertible Note is cancelled.

(6) This example does not include calculation of interest into the conversion.

Increasing Discount. One interesting spin on the Discount, is to have the discount increase over time to reward the noteholder for additional risk and additional time value of the money – e.g., (i) 1.5% per month up to 25%; or (ii) 10% if the Series A round closes within 6 months, 15% if it closes between 6 and 12 months, and 20% if it closes after 12 months.

What is a Valuation Cap in a Convertible Note and how does it work?

The ValCap is another mechanism to reward the noteholders for their investment risk (and for their efforts in increasing the value of the startup as a result of introductions, advice, etc.). A Convertible Note valuation cap sets the maximum valuation at which the investment made via the Convertible Note can convert into equity (the “ValCap”). Specifically, a ValCap is a ceiling on the value of the startup (i.e., a maximum dollar amount) for purposes of determining the conversion price of the note — which (like a discount) thereby permits investors to convert their loan, plus interest, at a lower price than the purchase price paid by the Series A investors. With a ValCap, investors in the Convertible Note will have their principal and interest converted to equity at the lesser of: (i) the valuation of the Qualified Financing or (ii) the ValCap negotiated in the note contract. Using the example above, let’s assume the ValCap was $5 million and the pre-money valuation in the Series A round was $10 million. If the noteholders invested $500,000 and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price of $0.50 per share ($5,000,000 divided by $10,000,000) and thus receive 1,000,000 shares

7

7/58


($500,000 divided by $0.50), which is 500,000 shares more than a Series A investor would receive for its $500,000 investment and a 2x return on paper ($1,000,000 divided by $500,000), not including any accrued interest on the loan. Notice that if there were a 20% discount and no ValCap, the noteholders would only receive 625,000 shares or a 1.25x return, as noted above. If we bump-up the pre-money valuation to $20 million and the ValCap remains at $5 million, you can see how the noteholders are rewarded (and protected): Their $500,000 loan now converts at an effective price of $0.25 per share ($5,000,000 divided by $20,000,000) and they would thus receive 2,000,000** shares ($500,000 divided by $0.25), which is 1,500,000** shares more than a Series A investor would receive for its $500,000 investment and a 4x return on paper ($2,000,000 divided by $500,000), not including any accrued interest on the loan. Again, if there were a 20% discount and no ValCap, the noteholders would only receive 625,000 shares or a 1.25x return. In this scenario, the ValCap is orders of magnitude the more valuable term versus the Discount. As you can see, noteholders with a 20% discount and no ValCap would receive 625,000 shares whether the pre-money valuation in the Series A round were $10 million, $20 million or $50 million. This is why sophisticated investors vehemently argue that a Convertible Note without a ValCap (i) misaligns the interests of the founders and the investors; and (ii) penalizes investors for their efforts in helping the startup increase its value. The math can be tricky, but the bottom line is that noteholders without a ValCap do not share in any increase in the value of the startup prior to the Series A round.

What if the Convertible Note has both a Discount and a ValCap?

For Convertible Notes that include both a Discount and a ValCap, the notes will typically specify that the conversion price will be the lower of (i) the price per share determined by the discount to the next qualified Priced Round price per share OR (ii) the price per share determined by dividing the ValCap by the next qualified priced round pre-money valuation. The lower of means that the investor receives the better of the two possibilities and the best possibility is obviously the one that converts the Convertible Note into more shares in the Series A.

What happens at the Maturity Date with a Convertible Note?

The maturity date of a Convertible Note indicates the date when the note is due to be repaid to the investor along with any accrued interest, if it has not yet been converted to equity by the various methods allowed in the note (e.g. a Qualified Financing). The maturity date is usually set at between 6 to 18 months after issuance. In general, Convertible Note maturities are much shorter on the west coast for a couple of reasons. One, California has some interesting regulations about loans with greater than a one year maturity, and, two the pace and volume of startup finance is simply faster. In Georgia, my experience is that maturities are longer, sometimes up to two years. Participants just realize gaining business traction and or attracting and closing investment capital takes longer and, knowing that, the players do not want to prematurely force the maturity date showdown. In most situations, if there has not been a Qualified Financing prior to maturity. the startup will not have the cash to pay off the investor on the maturity date. The investor will probably not make the decision to call the Convertible Note to be paid in full, because calling a note from a startup is usually self-defeating to the investor; the startup most likely will be bankrupted or at least adversely impacted by a called note, and by providing the startup with more time to reach a next milestone, the investor is getting an option on upside gain. That said, there are rare instances, for example when a startup has managed to reach profitability and has plenty of excess cash, where calling a note may not adversely impact a startup, but in those cases, an investor most likely has more to gain by enabling their note to convert to equity at a subsequent equity round or acquisition than to call their note.

8

8/58

http://k9ventures.com/blog/2011/03/22/thoughts-on-convertible-notes/

http://www.bothsidesofthetable.com/2010/08/30/is-convertible-debt-preferable-to-equity/


There are at least two ways a startup can avoid this tense standoff (a “Sit Down Meeting”): (i) include a provision in the Convertible Note that requires an automatic conversion of the loan, plus interest, into equity on the maturity date; or (ii) negotiate an extension of the loan (i.e., a new maturity date) with the noteholders.

1) Automatic Conversion. Founders can often convince “friends and family” and less-sophisticated investors to agree on an automatic conversion into shares of common stock in the event that there hasn’t been a Series A round (i.e. Qualified Financing) prior to the maturity date. Sophisticated investors, however, will push back hard against such a provision. From their perspective, requiring the loan (plus interest) to convert automatically into shares of common stock (or a new series of preferred stock) upon a default arguably rewards the founders and removes the significant leverage and rights the noteholders would have as creditors of the startup. Indeed, in the event of the startup’s bankruptcy or an assignment for the benefit of creditors, the noteholders would have priority (i.e., be ahead of the stockholders) with respect to any payments or distribution of assets. Moreover, the noteholders would likely have the leverage to negotiate a conversion into equity on terms satisfactory to them regardless of the terms of the Convertible Note.

2) Loan Extension. The second approach — negotiating an extension — is more

common and obviously depends on a number of different factors, including the startup’s financial condition and prospects, the market conditions, the relationship between the founders and the investors, etc. Moreover, for an extension to work from a practical standpoint, it is often necessary that the Convertible Note include a provision permitting its amendment or a waiver of its terms upon the written consent of a majority of the holders (based on the principal amount outstanding) – a form of intercreditor agreement. Founders and company counsel sometimes miss this issue, and it later comes back to haunt them when one minor noteholder ends-up holding the negotiations hostage. ProTip: draft in some binding voting agreement to corral the various noteholders.

How does the interest rate work on a Convertible Note?

The interest rate of a Convertible Note indicates how much interest accrues to the investor prior to the note’s conversion to equity or its repayment as cash when called. Some study’s say that typical interest rates on Convertible Notes in California are down to a nominal 2%1. Elsewhere in the US, typical interest rates on most Convertible Notes range from 4-8%, and I will report that they often go higher in Georgia. Calculation of interest is straightforward, usually using only simple interest. For example, with an interest rate of 8%, $100 invested on day 0 would convert as if $108 had been invested on day 365, if conversion happens on day 365. From an investor standpoint, the interest rate term is not as impactful to startup returns as picking the right startups to fund, and as other convertible note terms such as the conversion ValCap and/or Discount rate. This is one reason why the interest rate has come down to a nominal 2% for most west coast convertible notes, and why the SAFE and KISS (see below) were introduced as simpler investment vehicle alternatives to the convertible note and most do not include an interest rate.

1 Convertible debt must have interest at the applicable federal rate (AFR) published by the IRS or higher, or the IRS will deem that the lender should have received imputed interest at AFR.

9

9/58


What happens to a Convertible Note if a company shuts down and goes out of business?

As holders of a debt instrument, Convertible Note investors come ahead of holders of equity in terms of a claim to repayment through liquidation of any remaining assets. In concept, the holder of a Convertible Note will be paid ahead of all equity holders, common or preferred. However, there may be more senior debt holders who come ahead in line of convertible note holders, such as providers of venture debt, lines of credit, equipment finance, and others.

Does a Convertible Note holder have a choice about converting a note in an equity financing round?

The terms of conversion both mandatory and optional should be listed in the Convertible Note contract. Typically, conversion to equity is automatic at the next equity raise that meets the definition of a Qualified Financing. Some Convertible Notes (poorly drafted ones) do not have a concept of Qualified Financing and might convert as soon as any new stock investment is made. A well drafted Convertible Note (certainly from the perspective of the investor) will not automatically convert unless and until there has been the Qualified Financing. The point is that an investor does not want to move from his senior (on liquidation) position as a debt holder to a junior position as an equity holder, especially if the security he is converting into does not have any preferred rights. The minimum raise is set so that the early investor does not have to convert from debt until he can take some comfort that the company has enough capital to give it a viable shot at success. Optional Conversion. Some Convertible Notes will give the investor the right, but not the obligation, to convert into a new round of funding that does not meet the definition of Qualified Financing. This would play out if there was a round of new funding but it did not raise enough capital (e.g. only $800K, when the Qualified Financing number was $1milion) to trigger the mandatory conversion.

What is a “Most Favored Nation” clause in a Convertible Note?

A most favored nation clause, referred to as a MFN clause, is a rare, but increasingly less so, convertible note term that allows the convertible note holder to elect to inherit any more favorable terms that are offered to any subsequent investors following the original investor’s investment and prior to a next equity round. The MFN clause is sometimes seen on uncapped convertible notes as a way to balance a company’s desire not to cap the note, and an investor’s concern that a capped note may subsequently be issued. In some ways, the MFN is the convertible note version of an anti-dilution ratchet.

Convertible Note Advantage for Founders – No (or very few) Control Rights

Another significant advantage to founders of issuing Convertible Notes is to avoid giving the investors any control rights. When investors receive shares of preferred stock, they are typically granted certain significant control rights, including a board seat and protective provisions (e.g. veto rights with respect to certain corporate actions like the sale of the company, taking on significant debt, or paying huge salaries to founders). Also, all stockholders (common or preferred) have certain rights under applicable State law (in Delaware or Georgia). Convertible noteholders are rarely granted control rights and since they are not stockholders they have no minority stockholder rights under state law.

Do Convertible Note holders get pre-emptive (i.e. pro rata) rights?

Unless a pro-rata right clause is explicitly listed in the Convertible Note terms, holders do not get pro-rata rights. Generally speaking, convertible notes do not include a pro rata right clause. Investors may still be included in subsequent rounds in these cases, but at the discretion of the lead investor for the round and the company. It is worth noting that even if pro-rata right terms are

10

10/58


included in a convertible note, it is not unheard of for a lead investor to request prior investors to waive their pro-rata rights.

Fun with Convertible Note Math. For simplicity, the following examples do not include the analysis of the accrued interest amounts

Hypo: $25k convertible note with $5M ValCap, no discount

1. You invest $25k in a startup’s seed round using a Convertible Note with a $5M ValCap

2. At the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $10M with a per share price of $5.00

3. Your $25k loan would convert into shares of Series A Preferred Stock at a price of $2.50 per share ($5M ValCap divided by $10M pre-money valuation) which gives 10,000 shares of Series A Preferred Stock ($25,000 divided by $2.50/share); a new Series A investor would receive only 5000 shares of Series A Preferred Stock for $25k

4. On paper, your 10,000 shares at $5.00/share are worth $50,000 which is an unrealized return of 100%

5. If the pre-money valuation were higher at $20M, your $25k note would convert at $1.25/share ($5M ValCap divided by $20M) into 20,000 ($25k divided by $1.25) Series A shares worth $100,000 for a paper unrealized return of 300%.

Hypo: $25k convertible note with $5M ValCap, 20% discount

1. You invest $25k in a startup’s seed round using a convertible note with a $5M ValCap, 20% discount

2. If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $10M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the ValCap, the price per share would be $2.50/share ($5.00 times ($5M ValCap divided by $10M pre-money valuation)) THUS the ValCap would apply and the note would convert at $2.50/share which gives 10,000 shares of Series A Preferred Stock ($25,000 divided by $2.50/share). On paper, your 10,000 shares at $5.00/share are worth $50,000 which is an unrealized return of 100%.

3. If, at the Series A, the startup raises money from a venture capital firm that invests at a pre-money valuation of $6M with a per share price of $5.00 IF we apply the discount, the price per share would be $4.00/share ($5.00 times (1 minus 20%)) IF we apply the ValCap, the price per share would be $4.1667/share ($5.00 times ($5M ValCap divided by $6M pre-money valuation)) THUS the discount would apply and the note would convert at $4.00/share which gives 6,250 shares of Series A Preferred Stock ($25,000 divided by $4.00/share). On paper, your 6,250 shares at $5.00/share are worth $31,250 which is an unrealized return of 25%

Hypo: $25k convertible note with no ValCap, 20% discount

1. You invest $25k in a startup’s seed round using a convertible note with a 20% discount

2. At the Series A, the startup raises money from a venture capital firm that pays $5.00 per share of Series A Preferred Stock

3. Your $25k loan would convert into shares of Series A Preferred Stock at a price of $4.00 per share ($5.00 times (1 minus 20%)) which gives 6250 shares of Series A

11

11/58


Preferred Stock ($25,000 divided by $4.00/share); a new Series A investor would receive only 5000 shares of Series A Preferred Stock for $25k

4. On paper, your 6,250 shares at $5.00/share are worth $31,250 which is an unrealized return of 25%

Now that we have the basics terms of a Convertible Note down, let’s dig deeper… Why Doesn’t a Startup Just Issue Shares of Common Stock to Investors?

Because savvy angel investors don’t want plain old common stock. Early friends and family investors are often issued shares of common stock but sophisticated investors will require that the company designate and sell them a senior class of equity - shares of preferred stock - with special rights (as discussed below). There are other practical issues that are forces pushing founders and investors to use Convertible Note in the startup finance world. These issues and their potential problems are as follows:

1. Dilution / Valuation. With a Priced Round the founders and the investors must agree on a value for the company in order to set a price for stock. That it is exceedingly difficult especially if the company is a true startup and pre-product or pre-revenue. For example, if a startup is merely two guys and an idea, how much equity should an investor receive for a $200,000 investment? 5%? 15%? 20%?

2. Tax treatment. There may be tricky tax issues depending upon the timing of the

investment. For example, if two co-founders are issued shares of common stock for a nominal purchase price upon incorporation, and investors pay substantially more for their shares of common stock at the same time or shortly thereafter, the IRS may impute a much higher value on the shares issued to the founders and deem the excess amount over the purchase price a form of compensation — and therefore taxable to the founders as ordinary income.

3. Option Pricing. The issuance of shares of common stock may cause potential

problems with respect to stock option grants because the underlying value of the shares of common stock (i.e., the “strike” or “exercise” price) will have been established. To be treated as an incentive stock option under the IRS Code2, the option must have a strike price great than or equal to the fair market value of the shares underlying the option. The goal, of course, regarding option grants is to price the options as low as possible so that the option recipients are incentivized and are able to adequately share in the increased value of the company that they help create. A high strike price (a possible byproduct of a priced round) undermines that goal.

How Does the Issuance of Convertible Notes Address These Problems?

Answer - “Kicking the valuation Can Down the Road” One of the key advantages of issuing Convertible Notes is that the valuation issue is kicked down the road until the Series A round of financing – when there are a lot more data points and thus it’s much easier to value the startup (i.e. Priced Round), and, in most scenarios, a new third-party investor is the one doing the valuation for the Qualified Financing, not the founder and investors who negotiated the Convertible Note. Accordingly, the issuance of Convertible Notes largely ameliorates the foregoing three problems above. First, a valuation of the startup is not necessary

2 26 U.S. Code § 422

12

12/58


so the founders do not have to truly feel the pain of dilution (yet). Second, a Convertible Note is a loan (debt, not equity) for tax purposes so there are no issues of comparing the value of the note holders investment to that of the founders. Likewise, for setting the option strike prices. In summary, if there is no valuation, there are no problems of dilution, taxes and option pricing.

Herding The Cats and High Resolution Fundraising.

As a deal lawyer, my favorite reason to use a Convertible Note is that it helps herd the cats. It gets people to move. Take action. In many situations, if the company does not get funded they are not going to be around for much longer. Something has to be done. In many cases, the founders and investors really want to get a deal done. They want to exchange $XX thousand dollars for some stake in the company but they do not know how. They want to get it done but they cannot or do not want to take the time to understand, negotiate and execute upon a complex deal that is a modern day venture capital transaction. Many times they are hung up on valuation and that is the universal signal to introduce the discussion of whether a Convertible Note is right for your client and for the counterparty. Finally, another advantage of issuing Convertible Notes (and probably the least understood and most important) is the extraordinary flexibility they offer in individually incenting prospective investors and raising the round. As discussed in numerous blog posts from those in the venture capital game, Convertible Notes have made variable pricing possible. See for example, Paul Graham (founder of Y Combinator) who concluded in his September 2010 post, “High Resolution Fundraising”3 that Convertible Notes essentially allow founders to give variable pricing. Different valuation caps and different discounts – thus different “prices” for the investment to each investor. By making it easier for startups to give different prices to different investors, they help them break the sort of deadlock that happens when investors all wait to see who else is going to invest. It must be said that a ValCap is akin to a valuation in a Priced Round (i.e., if the startup were issuing shares of common or preferred stock). But the beauty of the ValCap is that it is not a valuation for tax purposes (as discussed above), which is why different investors may get different ValCaps. Similarly, in a Priced Round of equity with different prices there may be issues related to integration of the securities offerings (unless there were subsequent closings sufficiently far enough apart to justify different valuations). As Paul Graham says in his post cited above: The reason convertible notes allow more flexibility in price is that ValCaps aren’t actual valuations, and notes are cheap and easy to do. So you can do high-resolution fundraising: if you wanted you could have a separate note with a different ValCap for each investor. In summary, one of the significant advantages of issuing convertible notes, as opposed to shares of preferred stock, is the extraordinary flexibility they offer in connection with “herding” prospective investors and raising the round. Clearly, a greater discount can be offered to early investors who are assuming more risk, particularly in the common scenario where the startup is closing its financing on a rolling basis over an extended period of time. Bottom line, the reason startups have been using more convertible notes in angel rounds is that they make deals close faster.

Arguments Against Convertible Note. Reasons why many sophisticated investors push for a Priced Round of preferred stock instead of convertible notes.

We’ve already covered one of the principal reasons: preferred stockholders are typically granted control rights, including a board seat and certain veto rights. They are also typically granted certain additional economic rights (like Series A investors), such as pro-rata rights and a liquidation preference.

3 http://www.paulgraham.com/hiresfund.html

13

13/58

http://paulgraham.com/bio.html

http://paulgraham.com/bio.html

http://paulgraham.com/hiresfund.html



http://twitter.com/paulg/status/22319113993

http://www.quora.com/Is-it-typical-for-lead-angel-investors-in-a-seed-round-to-request-the-right-to-pro-rata-participation-at-series-A-time

http://walkercorporatelaw.com/vc-issues/what-is-a-liquidation-preference/

http://walkercorporatelaw.com/vc-issues/what-is-a-liquidation-preference/


Other reasons have been articulated by a number of high-profile investors (including Fred Wilson, Mark Suster, Manu Kumar and Seth Levine), the most significant of which can be summarized as follows:

1) There are now stripped-down, preferred stock financing documents (like “Series Seed” at www.seriesseed.com, and Series AA by Y Combinator at https://www.ycombinator.com/documents/, and other standardized forms that are open sourced all over the web) that make a Priced Round just as fast and cheap as issuing convertible notes. This is only an argument you will read about in a blog post. While it is true, there are now “open source” Series A-like preferred investment documents available on the web the reality is I have never seen or heard of an investor who says, let’s not do a convertible note, lets to a Series A, and you can just go to www.seriesseed.com, fill in the blanks and send them to our CFO to get your check. In the real world, an investor about to spend hundreds of thousands of dollars is going to have his attorney draft an initial set of transaction documents that, while closely aligned with the term sheet or business deal, are aggressively protective of the client in the “boilerplate” and not use a publicly available form verbatim.

2) The interests of the founders and the investors are “misaligned” if the investors are

issued convertible notes that are not capped. This is because it’s in the founders’ interest to maximize the company’s valuation in the Series A round, and it’s in the noteholders’ interest to minimize it. Investors are thus “penalized” for helping a startup get a higher valuation as a result of their introductions, domain expertise, etc. If the parties truly understand it, this is a very compelling argument. I get this one.

3) Obtaining a fair valuation may be tricky for unsophisticated investors, but not for

sophisticated ones. As Fred Wilson (partner at Union Square Ventures and prominent blogger at AVC.com) argues: “I can negotiate a fair price with an entrepreneur in five minutes…”

4) Noteholders must wait for the date of conversion to equity to start the clock running

for long term capital gains treatment; however, if you buy shares of preferred stock at the outset, the clock starts running immediately.

What Happens If a Startup is Acquired Prior to the Note’s Conversion to Shares of Preferred Stock?

As discussed above, in the context of a seed financing, a Convertible Note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. One of the tricky issues that founders must address in the note is what happens if their startup is acquired prior to the note’s conversion (and prior to the note’s maturity date, as discussed). There are generally three different approaches to handle the acquisition of the company prior to the conversion of a Convertible Note:

1) Money Back, Plus Interest (Founder-Friendly). The first approach is the most founder-friendly, and it is a provision that merely requires the startup to pay-off the loan, plus interest. In other words, in the event of the startup’s “acquisition” (which is often broadly defined to include a merger, change of control or sale of substantially all its assets), the maturity date of the Convertible Note would be accelerated, and the amount of the loan, plus interest, would become due at the closing of the acquisition. Obviously, this is not very appealing to sophisticated investors because their return on a high-risk investment would only be the interest on the loan, which (as discussed earlier) is typically between 2%-8% annually.

14

14/58

http://www.avc.com/a_vc/2010/08/some-thoughts-on-convertible-debt.html



http://www.sethlevine.com/wp/2010/08/has-convertible-debt-won-and-if-it-has-is-that-a-good-thing

http://www.seriesseed.com/



http://www.feld.com/wp/archives/2010/03/the-proliferation-of-standardized-seed-financing-documents.html






2) Conversion Right (Investor-Friendly). The second approach is the most investor-friendly, and it is a provision that permits the noteholders to convert the notes into equity (or otherwise grants them a certain percentage of the sale proceeds), based on an agreed-upon valuation of the startup. There are variations and complicated language that is typically negotiated to address the conversion right; however, the bottom line is that the noteholders would be able to share in any upside if the startup were acquired.

For example, let’s assume that the noteholders invested $500,000 and were granted the right to convert into shares of common stock at a $4.5 million valuation in the event the startup were acquired prior to the Series A round (or other Qualified Financing”). If the startup were then acquired for $20 million, the noteholders would receive $2 million or 10% of the proceeds (not including accrued interest), by converting the $500,000 loan into shares of common stock representing 10% of the issued and outstanding shares, post-conversion ($500,000 divided by the sum of $4,500,000 and $500,000).

3) Premium (Intermediate Approach). The third approach is generally deemed an

intermediate approach, and it is a provision granting the investors the right to get their money back with interest, plus a premium, which is typically drafted as a multiple of the principal amount of the loan (generally in the 0.25x to 1.50x range). Using our example above, and assuming a 1.0x premium, the noteholders would receive $1 million, plus interest, computed as follows: $500,000 (principal amount) plus $500,000 (premium) plus interest, which is obviously $1 million less than investors with a conversion right would receive.

Notice, however, that this so-called intermediate approach can actually be the most beneficial to noteholders (and the least beneficial to the founders) if the startup were sold for a relatively low price. Using our example above, but dropping the purchase price to $7 million, we can see that the noteholders would receive (i) $700,000 (10% of $7 million), plus interest, if they converted the note into shares of common stock; and (ii) $1 million, plus interest, if they were granted a 1x premium (an additional $300,000). This is why many sophisticated investors will push for both a conversion right and a premium, with the right to choose the higher amount. Sophisticated investors will also push for a provision prohibiting the pre-payment of the Convertible Note to prevent an end-run around the second and/or third approach. Again, the typical buyer of a Convertible Note in a startup financing is not looking to receive a return of capital plus a few points of interest, she is looking to multiply her money based on significant equity gains.

Does a Startup Have to Comply with Any Securities Laws in Connection with the Issuance of Convertible Notes?

Yes, a convertible note is a “security” under federal and state securities laws4. Accordingly, founders must understand that, even though a convertible note is debt upon issuance, it is no different than issuing shares of common or preferred stock for purposes of securities-law compliance. Needless to say, a comprehensive discussion of applicable securities laws is beyond the scope of this post; however, here are two key takeaways for founders: (i) make sure all the noteholders are “accredited investors”; and (ii) don’t compensate anyone for helping you raise funds unless they’re a registered “broker-dealer.”

1) Accredited Investors. The rule of thumb in connection with private placements (like a convertible note seed financing) is to issue securities only to accredited investors in reliance on Rule 506 of Regulation D of the Securities Act of 1933. There are two significant reasons for

4 see generally SEC v. W.J. Howey Co., 328 U.S. 293 (1946)

15

15/58

http://www.sec.gov/answers/accred.htm

http://www.sec.gov/divisions/marketreg/bdguide.htm#II

http://www.sec.gov/answers/rule506.htm

http://www.sec.gov/answers/regd.htm


this: First, Rule 506 preempts (or overrides) state securities laws5 – which means that a startup doesn’t have to spend a lot of time and money dealing with applicable state securities commissions (other than preparing and filing a Form D). Second, there is no written disclosure requirement, like a private placement memorandum, if the investors are accredited. That said, an issuer is always subject to the anti-fraud regulations so disclosure of some sort is always advised. There are eight categories of investors under the current definition of “accredited investor,” the most significant of which for seed financings is an individual who has (i) a net worth (or joint net worth with his/her spouse) that exceeds $1 million at the time of the purchase, not including the value of their primary place of residence; or (ii) income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000 for those years) and a reasonable expectation of such income level in the current year6.

2) Broker-Dealers. There are lots of companies, individuals, websites and other so-called “finders” offering to help startups raise funds. Founders must understand, however, that if a finder is receiving some form of commission or other transaction-based compensation (which is often the case), the finder will generally be deemed a broker-dealer and thus will be required to be registered with the SEC and applicable state commissions. If the finder is not registered as so required and sells securities on behalf of a startup, the private placement will be invalid and the startup will be in violation of applicable securities laws.

New Securities – A Convertible “Thing”. Is it debt or is it equity? Two alternatives: generically called Convertible Equity by some commentators. SAFE (Simple Agreement for Future Equity)

sponsored and published by Y Combinator (https://www.ycombinator.com/documents/) KISS (Keep It Simple Security)

sponsored and published by 500 Startups (http://500.co/kiss/) Why convertible equity is better than convertible debt

1. Convertible debt may need to be repaid. The risk that an investor might demand repayment of a Convertible Note is eliminated with the new-fangled convertible securities.

2. Convertible debt holders must be paid interest. Convertible debt must have interest at the

applicable federal rate (AFR) published by the IRS or higher, or the IRS will deem that the lender should have received imputed interest at AFR. If a Convertible Note with a ValCap is supposed to mimic the economics of equity, then removing interest seems logical. In addition, when a financing occurs and the Convertible Note converts, creating the spreadsheet to track interest on the notes to the penny, especially when notes have been issued on different days, ends up being a painful task — especially as the closing date of a financing may be delayed and the amount of interest increases, resulting in more shares being issued to note holders.

3. Some commentators say the new convertible equity instruments are “equity” and probably

can be characterized as qualified small business stock, which may have a tax benefit for investors. This author is not yet convinced they are equity in their original, unexercised form.

5 see generally National Securities Markets Improvement Act of 1996 6 see Regulation D of the Securities Act of 1933, 17 CFR 230.501

16

16/58

http://walkercorporatelaw.com/entrepreneurship/sec-form-d-and-related-securities-laws-qa-for-entrepreneurs/

https://www.ycombinator.com/documents/

http://www.startupcompanylawyer.com/2008/02/25/what-is-qualified-small-business-stock/


The SAFE (Simple Agreement for Future Equity) was developed by Y Combinator, a leading Silicon Valley accelerator7. Here is their primer on the SAFE.

SAFE PRIMER

Section 1

A SAFE is a Simple Agreement for Future Equity. An investor makes a cash investment in a company, but gets company stock at a later date, in connection with a specific event. A SAFE is not a debt instrument, but is intended to be an alternative to convertible notes that is beneficial for both companies and investors.

Why

1. Debt instruments have requirements – including regulations8, interest accrual, maturity dates, the threat of insolvency and in some cases, security interests and subordination agreements. These requirements can have unintended negative consequences.

2. A SAFE is intended to be simple for both companies and investors, with the usual path to agreement requiring the negotiation of only one item – the “valuation cap.”

3. A simple equity security has the potential to become standardized, and a standardized form has the benefits of certainty and speed, which in turn results in lower (or zero) transaction costs for companies and investors.

When

Most startups need to raise money soon after formation in order to fund operations, and the SAFE is intended as a vehicle for investors to fund companies at that very early stage. Unlike the sale of equity in traditional priced rounds of financing, a company can sell a SAFE quickly and efficiently, without multiple documents and the necessity of a charter amendment. As a flexible, one-document security, without numerous terms to negotiate, the SAFE should save companies and investors money and time.

How

The investor and the company agree on the valuation cap, mutually date and sign a SAFE and the investor sends the company the investment amount. What happens next? Nothing, until the occurrence of one of the specific events described in a SAFE. In the meantime, an outstanding SAFE would be referenced on the company’s cap table like any other convertible security (such as a warrant or an option).

Q & A

• Does a SAFE convert at an equity financing? Yes, when the company decides to sell shares of preferred stock in a priced round, an outstanding SAFE will convert into shares of preferred stock. There is no threshold amount that the company must raise to trigger the conversion.

7 www.ycombinator.com 8 For example, the California Finance Lenders Law.

17

17/58


• What if the pre-money valuation of the company in the financing is higher than the Valuation Cap in a SAFE? The holder of a SAFE gets a number of shares of preferred stock calculated using the Valuation Cap, not the higher pre-money valuation. However, the preferred stock that a SAFE holder is issued will have a liquidation preference that is equal to the original SAFE investment amount, rather than based on the price of the shares issued to the investors of new money in the financing. This feature means that the liquidation preference for SAFE holders does not exceed the original investment amount (a 1x preference). For example, if the company issues Series A preferred stock in the financing, a SAFE holder would be issued Series A-1 preferred stock, the only difference being the name and the share price attributable to that series. See Example 1 in Section 3.

• What is the difference between SAFE Preferred Stock and Standard Preferred Stock? SAFE Preferred Stock will be a separate series of preferred stock issued in the Equity Financing, commonly referred to as “shadow preferred” or “sub-series” preferred stock. SAFE Preferred Stock will have the same rights, privileges, preferences and obligations as Standard Preferred Stock, but the liquidation preference, conversion price, and dividend rate will be calculated based on the price per share of the SAFE Preferred Stock. The price per share of SAFE Preferred Stock is determined by dividing the Valuation Cap in a SAFE by the company’s fully diluted outstanding capitalization (the “Company Capitalization,” described below). See Example 1 in Section 3.

• What if the pre-money valuation of the company in the Equity Financing is lower than the Valuation Cap in a SAFE? The Valuation Cap is inapplicable in this situation. A SAFE holder gets the same preferred stock, at the same price, with the same liquidation preference, as the other investors of new money in the financing. See Example 2 in Section 3.

• Do SAFE holders get pro rata rights? Yes, when they become stockholders of the company. As holders of preferred stock, former SAFE holders will have a pre-emptive right to purchase more shares if and when the company raises another round of financing. This pro rata right must be in either the Equity Financing documents or a side letter.

• Does a SAFE holder have a choice about converting a SAFE in an equity financing? No, conversion in an Equity Financing is automatic and the SAFE then terminates. A SAFE is intended to turn SAFE holders into stockholders.

• What happens to a SAFE if a company is acquired or merges with another company? In a “change of control” transaction, a SAFE holder can convert a SAFE into shares of common stock, calculated based on the Valuation Cap, or have its investment returned. A SAFE holder will decide which of these two options is more advantageous, depending on the terms of the merger or acquisition. See Example 4 and Example 5 in Section 3.

• What is the difference between Company Capitalization and Liquidity Capitalization? “Company Capitalization” is the company’s fully diluted outstanding capital stock as calculated at the time of an Equity Financing. If a company intends to adopt an equity incentive plan in connection with the Equity Financing, Company Capitalization includes the shares allocated to that plan. If a company has already adopted an equity incentive plan, Company Capitalization includes all shares reserved but unissued under that plan, as well as any plan increases contemplated in connection with the Equity Financing. “Liquidity Capitalization” is a company’s fully diluted outstanding capitalization as calculated at the time of a Liquidity Event. This calculation includes outstanding options (vested and unvested) under an equity incentive plan, but excludes all unissued shares in the plan.

• What happens to a SAFE if the company goes public? If a company goes public, a SAFE will convert into shares of common stock calculated based on the Valuation Cap (or a SAFE holder can cash out the SAFE).

18

18/58


• Does a SAFE ever expire? A SAFE has no expiration or maturity date. A SAFE is designed to terminate only when a SAFE holder has received stock or cash, in an equity financing, change of control transaction, IPO or dissolution – whichever occurs first. In theory, a SAFE could remain outstanding for a long time without the need to “extend” any dates or time periods. A SAFE can be amended by the company and the SAFE holder, if necessary. See Example 6 in Section 3.

• What happens to a SAFE if the company shuts down and goes out of business? In a dissolution, any money that the company has to distribute would be distributed to SAFE holders before any money is allocated to holders of common stock.

• Can a SAFE have a discount, or a “Most Favored Nation” provision? Yes. This Primer describes a SAFE with a Valuation Cap only (a “Standard SAFE”). Other versions of the SAFE are described in Section 2.

Section 2

Alternative Versions of a SAFE. (“Standard” version of a SAFE is Valuation Cap only)

1. Cap and Discount (see form in Attachment 3)

• This is a SAFE with a negotiated Valuation Cap and Discount Rate. Either the Valuation Cap or the Discount Rate applies when converting this SAFE into shares of SAFE Preferred Stock.

• The Discount Rate applies to the price per share of the Standard Preferred Stock sold in the Equity Financing. If this calculation results in a greater number of shares of SAFE Preferred Stock for the investor, the price per share based on the Valuation Cap is disregarded (and vice versa). See Example 7 in Section 3.

• The conversion of this SAFE in a Liquidity Event is the same as a Standard SAFE.

2. Discount, No Cap

• This is a SAFE with a negotiated Discount Rate, e.g., a 20% discount off the price per share of the Standard Preferred Stock, applied to the conversion of this SAFE into shares of SAFE Preferred Stock. See Example 8 in Section 3.

• The company and the investor must also negotiate a valuation cap that would apply in a Liquidity Event for purposes of calculating how many shares of common stock this SAFE would convert into, if the investor chose the conversion option. See Example 9 in Section 3.

3. No Cap or Discount, MFN Provision

• This is a SAFE with no Valuation Cap and no Discount Rate. If the company subsequently issues SAFEs with provisions that are advantageous to the investors holding this SAFE (such as a valuation cap and/or a discount rate), this SAFE can be amended to reflect the terms of the later-issued SAFEs. The amendment term is the so-called “MFN Provision.”

• If there is an Equity Financing before this SAFE is amended pursuant to the MFN Provision, the investor would receive the same shares of preferred stock as the investors of new money in the Equity Financing, at the same price. However, this SAFE does not automatically convert into shares of preferred stock unless the amount of new money raised in the Equity Financing is at least $250,000. This threshold amount provides the investor with some protection against an insignificant equity round raised at an artificially high valuation.

19

19/58


• If there is a Liquidity Event before this SAFE is amended by the MFN Provision, the investor could elect to have the Purchase Amount repaid, or to convert the SAFE into shares of common stock, based on the fair market value of the common stock at the time of the Liquidity Event.

Section 3

Example 1

• Investor has purchased a SAFE for $100,000. The Valuation Cap is $5,000,000.

• The company negotiates with investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000.

The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue and sell 220,022 shares of Series A-1 Preferred to the SAFE holder, at $0.4545 per share.

In the SAFE, the Series A Preferred is referred to as “Standard Preferred Stock” and the Series A-1 Preferred is referred to as “SAFE Preferred Stock.” The table below sets forth a comparison between the Standard Preferred and the SAFE Preferred, as each would be described in the company’s certificate of incorporation:

Standard Preferred Stock SAFE Preferred Stock

Liquidation preference on a per share basis:

$0.90 $0.4545

Aggregate payout in a change of control transaction (each series pari passu with the other):

$1,000,000 $100,000

Conversion price and original issuance price at the time of the Series A Preferred financing:

$0.90

(initially converts into 1,100,110 shares of common stock)

$0.4545

(initially converts into 220,022 shares of common stock)

Dividend Rate per share (based on an 8% dividend):

$0.072 $0.036

Example 2


• The company negotiates with investors to sell $600,000 worth of Series AA Preferred Stock at a $3,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 500,000 share option pool to be adopted in connection with the financing, is 12,500,000.

The company will issue and sell 2,500,000 shares of Series AA Preferred at $0.24 per share to the new investors. The Company will issue and sell an additional 416,666 shares of Series AA Preferred to the

20

20/58


SAFE holder at the same price per share. There is no difference between the Series AA Preferred issued to the new investors and the Series AA Preferred issued to the SAFE holder, and the references to “SAFE Preferred Stock” in this case are inapplicable.

Example 3


• The company negotiates with investors to sell $2,000,000 worth of Series A Preferred Stock at an $8,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,500,000 share option pool to be adopted in connection with the financing, is 11,500,000.

The company will issue and sell 2,875,215 shares of Series A Preferred at $0.6956 per share to the new investors. The company will issue and sell an additional 143,760 shares of Series A Preferred to the SAFE holder at the same price per share. As in Example 2, there is no difference between the Series A Preferred issued to the new investors and the Series A Preferred issued to the SAFE holder.

Example 4


• Another entity proposes to acquire the company for cash consideration of $50,000,000. The company’s fully-diluted outstanding capital stock immediately prior to the acquisition, including 1,500,000 outstanding options but excluding any unallocated shares in the option pool, is 11,500,000.

The investor can choose to have the SAFE purchase amount returned, or convert the SAFE into shares of common stock and receive the cash consideration with the other common SH. The SAFE would convert into 115,008 shares of common stock, based on the “Liquidity Price” of $0.8695 per share (the Liquidity Price is calculated by dividing 10,000,000 by 11,500,000). When the $50,000,000 deal consideration is allocated pro rata among all of the common stockholders, including the investor (and assuming outstanding options are all exercised), investor would receive approximately $495,074. Since this amount is considerably more than the $100,000 purchase amount, the investor would elect to convert the SAFE.

Example 5


• Another entity proposes to acquire the company for cash consideration of $200,000. The company’s fully-diluted outstanding capital stock immediately prior to the acquisition, including 795,000 outstanding options but excluding any unallocated shares in the option pool, is 10,795,000.

The investor can choose to have the SAFE purchase amount returned, or convert the SAFE into shares of common stock and participate pro rata in the cash consideration with the other common stockholders. The SAFE would convert into 179,920 shares of common stock, based on the “Liquidity Price” of $0.5558 per share (the Liquidity Price is calculated by dividing 6,000,000 by 10,795,000). When the $200,000 deal consideration is allocated pro rata among all of the common stockholders, including the investor (and assuming: (1) the outstanding options are all exercised; (2) there is no outstanding debt; and (3) for purposes of this example, there is only the one outstanding SAFE), the investor would receive approximately $3,274. This dollar amount is calculated by dividing the $200,000 deal consideration among 10,974,920 shares of outstanding common stock, resulting in $0.0182 per share (179,920 shares multiplied by $0.0182 = $3,274.54). Since this amount is considerably less than the $100,000 purchase amount, the investor would elect to cash out the SAFE in connection with the transaction.

21

21/58


Example 6


• The company grows, generates revenue and becomes cash flow positive, and therefore does not need to raise outside capital. The company has no acquisition offers and no plans to go public.

The SAFE will remain outstanding until the company has a liquidity event, even if that liquidity event doesn’t happen for years after the original date of purchase.

Example 7

• Investor has purchased a SAFE for $100,000. The Valuation Cap is $8,000,000 and the Discount Rate is 85%.

• The company has negotiated with investors to sell $1,000,000 worth of Series A Preferred Stock at a $10,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing, including a 1,000,000 share option pool to be adopted in connection with the financing, is 11,000,000.

The company will issue and sell 1,100,110 shares of Series A Preferred at $0.909 per share to the new investors. The company will issue Series A-1 Preferred to the SAFE holder, based on the Valuation Cap or the Discount Rate, whichever results in a lower price per share. The 15% discount applied to the per share price of the Series A Preferred is $0.77265. The Valuation Cap results in a price per share of $0.72727. Accordingly, the company will issue 137,500 shares of Series A-1 Preferred to the SAFE holder, at $0.72727 per share. The Discount Rate does not apply in this case.

Example 8

• Investor has purchased a SAFE for $20,000. The Discount Rate is 80%.

• The company has negotiated with investors to sell $400,000 worth of Series AA Preferred Stock at a $2,000,000 pre-money valuation. The company’s fully-diluted outstanding capital stock immediately prior to the financing is 10,500,000.

The company will issue and sell 2,105,263 shares of Series AA Preferred at $0.19 per share to the new investors. The 20% discount applied to the per share price of the Series AA Preferred is $0.152. Accordingly, the company will issue 131,578 shares of Series AA-1 Preferred to the SAFE holder, at $0.152 per share.

Example 9

• Investor has purchased a SAFE for $50,000. The Discount Rate is 90%.

• Investor and the company negotiate a $5,000,000 valuation for purposes of a Liquidity Event.

• Another entity proposes to acquire the company for cash consideration of $2,000,000. The company’s fully-diluted outstanding capital stock immediately prior to the acquisition is 12,500,000.

The investor can choose to have the SAFE purchase amount returned, or convert the SAFE into shares of common stock and participate pro rata in the cash consideration with the other common stockholders.

The Liquidity Price $0.40, calculated by dividing 5,000,000 by 12,500,000. The Discount Rate is inapplicable. The SAFE would convert into 125,000 shares of common stock. When the $2,000,000 deal consideration is allocated pro rata among all of the common stockholders, including the investor (and assuming (1) there is no outstanding debt and (2) for purposes of this example, there is only the one

22

22/58


outstanding SAFE), the investor would receive approximately $19,801.25. This dollar amount is calculated by dividing the $2,000,000 deal consideration among 12,625,000 shares of outstanding common stock, resulting in $0.15841 per share (125,000 shares multiplied by $0.15841 = $19,801.25). Since this amount is less than the $50,000 purchase amount, the investor would elect to cash out the SAFE in connection with the transaction.

23

23/58


KISS (Keep It Simple Security), developed by 500 Startups, an accelerator in California.9

See Attachment 4 for form KISS – debt version

See Attachment 5 for form KISS – equity version

9 http://500.co/kiss/

24

24/58


Additional information on Convertible Notes can be found from numerous sources. The ones listed below are just a few of the ones that I have reviewed. In fact, much of this paper was developed directly from content available at these sites.

Partial List of Resources:

http://www.startuplawblog.com/

http://walkercorporatelaw.com

https://www.cooleygo.com/

https://fundersclub.com/

http://www.startupcompanylawyer.com/

Daniel A. Shmalo 360 Venture Law (Shmalo Turner), LLP

270 Carpenter Drive NE, Suite 225 Atlanta, GA 30328

404.575.4360 office [email protected]

www.360vlaw.com

25

25/58

http://www.startuplawblog.com/

http://walkercorporatelaw.com/

https://www.cooleygo.com/

https://fundersclub.com/

http://www.startupcompanylawyer.com/

mailto:[email protected]

KISS’s, SAFE’s and Convertible Notes – The Latest Startup Financing Tools ICLEGA Oct 22, 2015

Attachment 2

Sample Term Sheet for Convertible Promissory Note

26

26/58

Page 1 of 3 Convertible Note – Term Sheet RockStar, Inc.

TERM SHEET FOR CONVERTIBLE PROMISSORY NOTE FINANCING

OF ROCKSTAR, INC.

This term sheet is an expression of intent only, does not express the agreement of the parties, is not meant to be binding on the parties, and is meant to be used as a negotiation aid by the parties. The parties do not intend to be bound until they enter into definitive agreements regarding the subject matter of this term sheet.

Issuer: RockStar, Inc., a Delaware corporation (the “Company”).

Financing Amount:

Up to $900,000 from investors identified by the Company (the “Investors”, each an “Investor”). Amounts may be funded in multiple closings.

Promissory Notes:

The Company will issue promissory notes (the “Notes”) in exchange for amounts invested by the Investors. The Notes will have the following principal provisions: Maturity: Unless earlier repaid or converted, outstanding principal and unpaid accrued interest on the Notes will be due and payable upon request of the Majority Holders made on or after the date which is 18 months from the initial closing (the “Maturity Date”). Interest: Simple interest will accrue on an annual basis at the rate of 7% per annum based on 365 days in a year. Future Notes: If, while this Note is outstanding, the Company issues other indebtedness of the Company convertible into equity securities of the Company with material terms that are more favorable, from the perspective of the Investor (“Other Debt”), than the terms of this Note, then the Company will provide the Investor with written notice thereof, together with a copy of all documentation relating to such Other Debt and, upon request of the Investor, any additional information related to such Other Debt as may be reasonably requested by the Investor. The Company will provide such notice to Investor promptly (and in any event within 30 days) following the issuance of such Other Debt. In the event the Investor determines that the terms of the Other Debt are preferable to the terms of this Note, the Investor will notify the Company in writing within 5 days following Investor’s receipt of such notice from the Company. Promptly after receipt of such written notice from the Investor, but in any event within 30 days, the Company will amend and restate this Note to be substantially identical to promissory note evidencing the Other Debt, excluding the principal and accrued interest. Conversion: In the event the Company consummates, prior to the Maturity Date, an equity financing pursuant to which it sells shares of its preferred stock (the “Preferred Stock”), with an aggregate sales price of not less than $1,500,000, excluding any and all indebtedness under the Notes that is converted into Preferred Stock, and with the principal purpose of raising capital (a “Qualified Financing”), then all principal, together with all accrued but unpaid interest under the Notes, will automatically convert into shares of the Preferred Stock at the lesser of (i) 85% of the price per share paid by the other purchasers of Preferred Stock in the Qualified Financing and (ii) the price obtained by dividing

27

27/58

- 2 -

$5,000,000 by the Company’s fully-diluted capitalization immediately prior to the Qualified Financing (which in all cases excludes any shares issued upon conversion of convertible debt). If the conversion price of the Notes is less than the price per share at which Preferred Stock is issued in the Qualified Financing, the Company may, solely at its option, elect to convert this Note into shares of a newly created series of preferred stock having the identical rights, privileges, preferences and restrictions as the Preferred Stock issued in the Qualified Financing, and otherwise on the same terms and conditions, other than with respect to: (i) the per share liquidation preference and the conversion price for purposes of price-based anti-dilution protection, which will equal the conversion price; and (ii) the per share dividend, which will be the same percentage of the conversion price as applied to determine the per share dividends of new investors in the Qualified Financing relative to the purchase price paid by such investors. In the event that the Note remains outstanding on the Maturity Date, then the outstanding principal balance of this Note and any unpaid accrued interest will automatically convert in whole without any further action by Holder into such shares of the Company’s Common Stock at a conversion price equal to the quotient resulting from dividing $4,000,000 by the number of outstanding, fully-diluted number of shares immediately prior to the Maturity Date (including all outstanding options, warrants and any other shares reserved for future issuance under stock option or other equity incentive plans of the Company, but excluding the shares of equity securities of the Company issuable upon the conversion of Notes or other indebtedness).

Change of Control: If the Company is acquired prior to the Qualified Financing, then at the Investor’s option, either (i) Investor will receive cash repayment equal to the outstanding principal and accrued but unpaid interest, plus an additional payment equal to 200% of the principal amount of the Note, or (ii) such Investor’s Note will be converted into shares of Common Stock at a conversion price implied by a $5,000,000 fully-diluted valuation. Pre-Payment: The principal and accrued interest may not be prepaid unless approved in writing by the Majority Holders (as defined below). Security: The Notes will be unsecured obligations of the Company.

Documentation: The investments will be made pursuant to documentation prepared by the Company’s legal counsel: 360 Venture Law (Shmalo Turner), LLP The Notes may be amended by the Company and the holders of a majority (by unpaid principal amount) of the Notes (the “Majority Holders”).

Expenses: The Company and Investors will each bear their own legal and other expenses with respect to the Notes financing.

[Signatures on next page]

28

28/58

This term sheet is non-binding and is intended solely as a summary of the terms that are currently proposed by the parties. The parties acknowledge that they neither intend to enter, nor have they entered, into any agreement to negotiate a definitive agreement pursuant to this term sheet, and either party may, at any time prior to execution of such definitive agreement, propose different terms from those summarized herein or unilaterally terminate all negotiations pursuant to this term sheet without any liability whatsoever to the other party. Each party will be solely liable for all of its own fees, costs and other expenses in conjunction with negotiation and preparation of a final agreement pursuant to this term sheet.

COMPANY: RockStar By: Name: Johnny Appleseed Title: Chief Executive Officer

INVESTOR (if an entity): By: Name: Title:

Subscription Amount: $

INVESTOR (if an individual):

Signature:

Subscription Amount: $

29

29/58


Attachment 3

SAFE (Simple Agreement for Future Equity)

30

30/58

Page 1 of 6

SAFE “Note” Cap and Discount TechCo. Inc.

THIS INSTRUMENT AND ANY SECURITIES ISSUABLE PURSUANT HERETO HAVE NOT BEEN REGISTERED

UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE “ACT”), OR UNDER THE SECURITIES LAWS OF

CERTAIN STATES. THESE SECURITIES MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED,

PLEDGED OR HYPOTHECATED EXCEPT AS PERMITTED UNDER THE ACT AND APPLICABLE STATE

SECURITIES LAWS PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT OR AN EXEMPTION

THEREFROM.

[COMPANY NAME]

[[NTD: cap and discount, see https://blog.ycombinator.com/announcing-the-safe-a-replacement-for-convertible-

notes

SAFE

(Simple Agreement for Future Equity)

THIS CERTIFIES THAT in exchange for the payment by [investor name] (the “Investor”) of $[amount] (the

“Purchase Amount”) on or about [date], [company name], a Delaware corporation (the “Company”), hereby issues to the

Investor the right to certain shares of the Company’s capital stock, subject to the terms set forth below.

The “Valuation Cap” of this SAFE is $[___________].

The “Discount Rate” of this SAFE is [100 minus the discount]%.

See Section 2 for certain additional defined terms.

1. Events

(a) Equity Financing. If there is an Equity Financing before the expiration or termination of this instrument,

the Company will automatically issue to the Investor a number of shares of SAFE Preferred Stock equal to the Purchase

Amount divided by either: (1) the SAFE Price or (2) the Discount Price, whichever calculation results in a greater number

of shares of SAFE Preferred Stock.

In connection with the issuance of SAFE Preferred Stock by the Company to the Investor pursuant to this

Section 1(a):

(i) The Investor will execute and deliver to the Company all transaction documents related to the Equity

Financing; provided, that such transaction documents are the same documents to be entered into with the purchasers of the

Standard Preferred Stock, with appropriate variations for the SAFE Preferred Stock;

(ii) The Investor and the Company will execute a Pro Rata Rights Agreement, unless the Investor is already

included in such rights in the transaction documents related to the Equity Financing; and

(iii) This instrument will expire and terminate.

(b) Liquidity Event. If there is a Liquidity Event before the expiration or termination of this instrument, the

Investor will, at its option, either (i) receive a cash payment equal to the Purchase Amount (subject to the following

paragraph) or (ii) automatically receive from the Company a number of shares of Common Stock equal to the Purchase

Amount divided by the Liquidity Price, if the Investor fails to select the cash option. Thereafter, this instrument will expire

and terminate.

In connection with Section (b)(i), the Purchase Amount will be due and payable by the Company to the Investor

immediately prior to, or concurrent with, the consummation of the Liquidity Event. If there are not enough funds to pay the

31

31/58

Page 2 of 6


Investor and holders of other SAFEs (collectively, the “Cash-Out Investors”) in full, then all of the Company’s available

funds will be distributed with equal priority and pro rata among the Cash-Out Investors in proportion to their Purchase

Amounts, and the Cash-Out Investors will automatically receive the number of shares of Common Stock equal to the

remaining unpaid Purchase Amount divided by the Liquidity Price. In connection with a Change of Control intended to

qualify as a tax-free reorganization, the Company may reduce, pro rata, the Purchase Amounts payable to the Cash-Out

Investors by the amount determined by its board of directors in good faith to be advisable for such Change of Control to

qualify as a tax-free reorganization for U.S. federal income tax purposes, and in such case, the Cash-Out Investors will

automatically receive the number of shares of Common Stock equal to the remaining unpaid Purchase Amount divided by

the Liquidity Price.

(c) Dissolution Event. If there is a Dissolution Event before this instrument expires or terminates, the

Company will pay the Investor an amount equal to the Purchase Amount, due and payable to the Investor immediately prior

to, or concurrent with, the consummation of the Dissolution Event. The Purchase Amount will be paid prior and in

preference to any Distribution of any of the assets of the Company to holders of the Company’s capital stock by reason of

their ownership of such stock. If immediately prior to the consummation of the Dissolution Event, the assets of the Company

legally available for distribution to the Investor and all holders of all other SAFEs (the “Dissolving Investors”), as

determined in good faith by the Company’s board of directors, are insufficient to permit the payment to the Dissolving

Investors of their respective Purchase Amounts, then the entire assets of the Company legally available for distribution will

be distributed with equal priority and pro rata among the Dissolving Investors in proportion to the Purchase Amounts they

would otherwise be entitled to receive pursuant to this Section 1(c). After the payment, or setting aside payment, to the

Investor, this instrument will expire and terminate.

2. Definitions

“Change of Control” means (i) a transaction or series of related transactions in which any “person” or “group”

(within the meaning of Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended), becomes the

“beneficial owner” (as defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended), directly or indirectly,

of more than 50% of the outstanding voting securities of the Company having the right to vote for the election of members

of the Company’s board of directors, (ii) any reorganization, merger or consolidation of the Company, other than a

transaction or series of related transactions in which the holders of the voting securities of the Company outstanding

immediately prior to such transaction or series of related transactions retain, immediately after such transaction or series of

related transactions, at least a majority of the total voting power represented by the outstanding voting securities of the

Company or such other surviving or resulting entity or (iii) a sale, lease or other disposition of all or substantially all of the

assets of the Company.

“Common Stock” means the common stock of the Company.

“Company Capitalization” means the sum of: (i) all shares of the Company’s capital stock (on an as-converted

basis) issued and outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants and

other convertible securities, but excluding (A) this instrument, (B) all other SAFEs, and (C) convertible promissory notes;

and (ii) (ii) all shares of Common Stock reserved and available for future grant under any equity incentive or similar plan

of the Company, including any equity incentive or similar plan created or increased in connection with the Equity Financing.

“Discount Price” means the product of the price per share of the Standard Preferred Stock sold in the Equity

Financing multiplied by the Discount Rate.

“Distribution” means the transfer to holders of the Company’s capital stock by reason of their ownership of

such stock of cash or other property without consideration whether by way of dividend or otherwise, other than dividends

on the Common Stock payable in Common Stock, or the purchase or redemption of shares of the Company by the Company

or its subsidiaries for cash or property other than: (i) repurchases of the Common Stock issued to or held by employees,

32

32/58

Page 3 of 6


officers, directors or consultants of the Company or its subsidiaries upon termination of their employment or services

pursuant to agreements providing for the right of said repurchase, (ii) repurchases of Common Stock issued to or held by

employees, officers, directors or consultants of the Company or its subsidiaries pursuant to rights of first refusal contained

in agreements providing for such right and (iii) repurchases of capital stock of the Company in connection with the

settlement of disputes with any stockholder.

“Dissolution Event” means (i) a voluntary termination of operations, (ii) a general assignment for the benefit

of the Company’s creditors or (iii) any other liquidation, dissolution or winding up of the Company (excluding a Liquidity

Event), whether voluntary or involuntary.

“Equity Financing” means a bona fide transaction or series of transactions with the principal purpose of raising

capital, pursuant to which the Company issues and sells shares of preferred stock of the Company at a fixed pre-money

valuation.

“Initial Public Offering” means the closing of the Company’s first firm commitment underwritten initial

public offering of the Common Stock pursuant to a registration statement filed under the Securities Act of 1933, as amended

(the “Securities Act”).

“Liquidity Capitalization” means all shares of the Company’s capital stock (on an as-converted basis) issued

and outstanding, assuming exercise or conversion of all outstanding vested and unvested options, warrants and other

convertible securities, but excluding (i) all shares of the Common Stock reserved and available for future grant under any

equity incentive or similar plan of the Company; (ii) this instrument, (iii) all other SAFEs, and (iv) convertible promissory

notes.

“Liquidity Event” means a Change of Control or an Initial Public Offering.

“Liquidity Price” means the price per share equal to the quotient obtained by dividing (i) the Valuation Cap

by (ii) the Liquidity Capitalization as of immediately prior to the Liquidity Event.

“Pro Rata Rights Agreement” means a written agreement between the Company and the Investor (and holders

of other SAFEs, as appropriate) giving the Investor a right to purchase its pro rata share of private placements of securities

by the Company occurring after the Equity Financing, subject to customary exceptions. Pro rata for purposes of the Pro

Rata Rights Agreement will be calculated based on the ratio of (a) the number of shares of capital stock of the Company

owned by the Investor immediately prior to the issuance of the securities to (b) the total number of shares of outstanding

capital stock of the Company on a fully diluted basis, calculated as of immediately prior to the issuance of the securities.

“SAFE” means an instrument containing a future right to the Company’s capital stock, similar in form and

content to this instrument, purchased by investors for the purpose of funding the Company’s business operations.

“SAFE Preferred Stock” means the shares of a series of the Company’s preferred stock issued to the Investor

in an Equity Financing, which will have the identical rights, privileges, preferences and restrictions as the shares of Standard

Preferred Stock, other than with respect to the per share liquidation preference, which will equal the SAFE Price or

the Discount Price (as applicable), as well as price-based antidilution protection and dividend rights, which will be based

on such SAFE Price or the Discount Price (as applicable).

“SAFE Price” means the price per share equal to the quotient obtained by dividing (i) the Valuation Cap by

(ii) either (A) the Company Capitalization as of immediately prior to the Equity Financing or (B) the capitalization of the

Company used to calculate the price per share of the Standard Preferred Stock, whichever calculation results in a lower

price.

33

33/58

Page 4 of 6


“Standard Preferred Stock” means the shares of a series of the Company’s preferred stock issued to the

investors investing new money in the Company in connection with the initial closing of the Equity Financing.

3. Company Representations

(a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the

state of its incorporation, and has the power and authority to own, lease and operate its properties and carry on its business

as now conducted.

(b) The execution, delivery and performance by the Company of this instrument is within the power of the

Company and, other than with respect to the actions to be taken when equity is to be issued to the Investor, has been duly

authorized by all necessary actions on the part of the Company. This instrument constitutes a legal, valid and binding

obligation of the Company, enforceable against the Company in accordance with its terms, except as limited by bankruptcy,

insolvency or other laws of general application relating to or affecting the enforcement of creditors’ rights generally and

general principles of equity. To the knowledge of the Company, it is not in violation of (i) its current certificate of

incorporation or bylaws, (ii) any material statute, rule or regulation applicable to the Company or (iii) any material indenture

or contract to which the Company is a party or by which it is bound, where, in each case, such violation or default,

individually, or together with all such violations or defaults, could reasonably be expected to have a material adverse effect

on the Company.

(c) The performance and consummation of the transactions contemplated by this instrument do not and will

not: (i) violate the any material judgment, statute, rule or regulation applicable to the Company; (ii) result in the acceleration

of any material indenture or contract to which the Company is a party or by which it is bound; or (iii) result in the creation

or imposition of any lien upon any property, asset or revenue of the Company or the suspension, forfeiture, or nonrenewal

of any material permit, license or authorization applicable to the Company, its business or operations.

(d) No consents or approvals are required in connection with the performance of this instrument, other than: (i)

the Company’s corporate approvals; (ii) any qualifications or filings under applicable securities laws; and (iii) necessary

corporate approvals for the authorization of any shares of capital stock of the Company issued pursuant to Section 1.

(e) To its knowledge, the Company owns or possesses (or can obtain on commercially reasonable terms)

sufficient legal rights to all patents, trademarks, service marks, trade names, copyrights, trade secrets, licenses, information,

processes and other intellectual property rights necessary for its business as now conducted and as currently proposed to be

conducted, without any conflict with, or infringement of the rights of, others.

4. Investor Representations

(a) The Investor has full legal capacity, power and authority to execute and deliver this instrument and to

perform its obligations hereunder. This instrument constitutes valid and binding obligation of the Investor, enforceable in

accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or

affecting the enforcement of creditors’ rights generally and general principles of equity.

(b) The Investor is an accredited investor as such term is defined in Rule 501 of Regulation D under the

Securities Act. The Investor has been advised that this instrument and the underlying securities have not been registered

under the Securities Act, or any state securities laws and, therefore, cannot be resold unless they are registered under the

Securities Act and applicable state securities laws or unless an exemption from such registration requirements is available.

The Investor is purchasing this instrument and the securities to be acquired by the Investor hereunder for its own account

for investment, not as a nominee or agent, and not with a view to, or for resale in connection with, the distribution thereof,

and the Investor has no present intention of selling, granting any participation in, or otherwise distributing the same. The

Investor has such knowledge and experience in financial and business matters that the Investor is capable of evaluating the

34

34/58

Page 5 of 6


merits and risks of such investment, is able to incur a complete loss of such investment without impairing the Investor’s

financial condition and is able to bear the economic risk of such investment for an indefinite period of time.

5. Miscellaneous

(a) Any provision of this instrument may be amended, waived or modified only upon the written consent of

the Company and the Investor.

(b) Any notice required or permitted by this instrument will be deemed sufficient when delivered personally or

by overnight courier or sent by email to the relevant address listed on the signature page, or 48 hours after being deposited

in the U.S. mail as certified or registered mail with postage prepaid, addressed to the party to be notified at such party’s

address listed on the signature page, as subsequently modified by written notice.

(c) The Investor is not entitled, as a holder of this instrument, to vote or receive dividends or be deemed the

holder of the Company’s capital stock for any purpose, nor will anything contained herein be construed to confer upon the

Investor, as such, any of the rights of a stockholder of the Company or any right to vote for the election of directors or upon

any matter submitted to stockholders at any meeting thereof, or to give or withhold consent to any corporate action or to

receive notice of meetings, or to receive subscription rights or otherwise until shares have been issued upon the terms as

described herein.

(d) Neither this instrument nor the rights contained herein may be assigned, by operation of law or otherwise,

by either party without the prior written consent of the other; provided, however, that the rights of the Investor may be

assigned without the Company’s consent by the Investor to any other entity who directly or indirectly, controls, is controlled

by or is under common control with the Investor, including, without limitation, any general partner, managing member,

officer or director of the Investor, or any venture capital fund now or hereafter existing which is controlled by one or more

general partners or managing members of, or shares the same management company with, the Investor; and provided,

further, that the Company may assign this instrument in whole, without the consent of the Investor, in connection with a

reincorporation to change the Company’s domicile.

(e) In the event any one or more of the provisions of this instrument is for any reason held to be invalid, illegal

or unenforceable, in whole or in part or in any respect, or in the event that any one or more of the provisions of this instrument

operate or would prospectively operate to invalidate this instrument, then and in any such event, such provision(s) only will

be deemed null and void and will not affect any other provision of this instrument and the remaining provisions of this

instrument will remain operative and in full force and effect and will not be affected, prejudiced, or disturbed thereby.

(f) All rights and obligations hereunder will be governed by the laws of the State of [California], without regard

to the conflicts of law provisions of such jurisdiction.

(Signature page follows)

35

35/58

Page 6 of 6


IN WITNESS WHEREOF, the undersigned have caused this instrument to be duly executed and delivered.

[COMPANY]

By:

[name]

[title]

Address:

Email:

INVESTOR:

By:

Name:

Title:

Address:

Email:

[Signature page to SAFE Note]

36

36/58


Attachment 4

KISS (Keep it Simple Security) – Debt Version

37

37/58

Page 1 of 10

KISS – Debt Version TechCo, Inc.

THIS INSTRUMENT AND THE SECURITIES ISSUABLE UPON THE CONVERSION

HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS

AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED,

HYPOTHECATED, OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN

EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS

AMENDED, OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT

REGISTRATION IS NOT REQUIRED UNDER SUCH ACT OR UNLESS SOLD PURSUANT

TO RULE 144 UNDER SUCH ACT.

[NTD – DEBT VERSION CARRIES INTEREST RATE AND MATURITY FEATURE,

SEE http://500.co/kiss/]

SERIES [1]

KISS

“Purchase Price” “Date of Issuance”

$

_______________ __, 201_

FOR VALUE RECEIVED, _______________, Inc., a Delaware corporation (the

“Company”), hereby promises to pay to the order of _______________ (the “Investor”), the

principal sum of the Purchase Price, together with interest thereon from the Date of Issuance.

Interest shall accrue at the Interest Rate. Unless earlier converted into Conversion Shares pursuant

to Section 2, the principal and accrued interest shall be due and payable by the Company on

demand by the Majority in Interest at any time after the Maturity Date. This KISS is one of a

series of Series [1] KISSes issued by the Company to investors with identical terms and on the

same form as set forth herein (except that the Investor, Purchase Price and Date of Issuance may

differ in each KISS) (collectively, the “Series”).

1. Definitions.

(a) “Conversion Shares” shall mean:

(i) with respect to a conversion pursuant to Section 2.1, shares of the

Company’s Preferred Stock issued in the Next Equity Financing; provided, however, that, at the

Company’s election, “Conversion Shares” with respect to a conversion pursuant to Section 2.1

shall mean shares of a Shadow Series;

(ii) with respect to a conversion pursuant to Section 2.2, shares of the

Company’s Common Stock; and

(iii) with respect to a conversion pursuant to Section 2.3, shares of a

newly created series of the Company’s Series Seed Preferred Stock, upon the terms and provisions

set forth in the most recent version of the Series Seed documents posted at www.seriesseed.com

(or if not so posted, as reasonably agreed by the Company and a Majority in Interest); provided

that, for the avoidance of doubt, the Conversion Price shall be determined pursuant to Section

1(b)(iii).

38

38/58


Page 2 of 10


(b) “Conversion Price” shall equal:

(i) with respect to a conversion pursuant to Section 2.1, the lower of

(A) the product of (1) one (1) minus the Discount and (2) the price paid per share for Preferred

Stock by the investors in the Next Equity Financing or (B) the quotient resulting from dividing (1)

the Valuation Cap by (2) the Fully-Diluted Capitalization immediately prior to the closing of the

Next Equity Financing;

(ii) with respect to a conversion pursuant to Section 2.2, the quotient

resulting from dividing (A) the Valuation Cap by (B) the Fully-Diluted Capitalization immediately

prior to the closing of the Corporate Transaction; and

(iii) with respect to a conversion pursuant to Section 2.3, the quotient


prior to the conversion.

(c) “Corporate Transaction” shall mean (i) the closing of the sale, transfer or

other disposition of all or substantially all of the Company’s assets, (ii) the consummation of the

merger or consolidation of the Company with or into another entity (except a merger or

consolidation in which the holders of capital stock of the Company immediately prior to such

merger or consolidation continue to hold at least 50% of the voting power of the capital stock of

the Company or the surviving or acquiring entity), (iii) the closing of the transfer (whether by

merger, consolidation or otherwise), in one transaction or a series of related transactions, to a

person or group of affiliated persons (other than an underwriter of the Company’s securities), of

the Company’s securities if, after such closing, such person or group of affiliated persons would

hold 50% or more of the outstanding voting stock of the Company (or the surviving or acquiring

entity), or (iv) the liquidation, dissolution or winding up of the Company; provided, however, that

a transaction shall not constitute a Corporate Transaction if its sole purpose is to change the state

of the Company’s incorporation or to create a holding company that will be owned in substantially

the same proportions by the persons who held the Company’s securities immediately prior to such

transaction. Notwithstanding the prior sentence, the sale of shares of Preferred Stock in a bona

fide financing transaction shall not be deemed a “Corporate Transaction.”

(d) “Corporate Transaction Payment” shall mean an amount equal to all

accrued and unpaid interest due on this KISS plus two times (2X) the Purchase Price.

(e) “Discount” shall mean _________ percent (__%).

(f) “Equity Securities” shall mean the Company’s Common Stock or Preferred

Stock or any securities conferring the right to purchase the Company’s Common Stock or Preferred

Stock or securities convertible into, or exchangeable for (with or without additional consideration),

the Company’s Common Stock or Preferred Stock, except any security granted, issued and/or sold

by the Company to any director, officer, employee or consultant of the Company in such capacity

for the primary purpose of soliciting or retaining their services.

(g) “Financial Statements” shall mean an income statement, balance sheet,

statement of stockholders’ equity, and/or a statement of cash flows, in each case as of the end of

(i) each of the first three (3) fiscal quarters and (ii) each fiscal year of the Company.

39

39/58

Page 3 of 10


(h) “Fully-Diluted Capitalization” shall mean the number of shares of

outstanding Common Stock of the Company on a fully-diluted basis, including (i) conversion or

exercise of all securities convertible into or exercisable for Common Stock, (ii) exercise of all

outstanding options and warrants to purchase Common Stock and, in the case of Section 1(b)(i)

and 1(b)(iii) only, (iii) the shares reserved or authorized for issuance under the Company’s existing

stock option plan or any stock option plan created or increased in connection with such transaction;

but excluding, for this purpose, the conversion contemplated by the applicable provision of Section

2.

(i) “Holder” shall mean a member of the KISS Group that holds a KISS

(including, without limitation, the Investor, for so long as the Investor holds this KISS).

(j) “Interest Rate” shall mean a rate of four percent (4%) per annum,

compounded annually.

(k) “KISS” or “KISSes” shall mean the KISS instruments issued by the

Company to Holders in the form hereof.

(l) “KISS Group” shall mean the holders of all KISSes in the Series,

collectively.

(m) “Majority in Interest” shall mean members of the KISS Group holding a

majority in interest of the aggregate Purchase Prices of all KISSes in the Series.

(n) “Maturity Date” shall mean the date that is eighteen (18) months following

the Date of Issuance.

(o) “Next Equity Financing” shall mean the next sale (or series of related sales)

by the Company of its Preferred Stock following the Date of Issuance from which the Company

receives gross proceeds of not less than $1,000,000 (excluding the aggregate amount of securities

converted into Preferred Stock in connection with such sale (or series of related sales)).

(p) “Participation Amount” shall mean an amount in US dollars equal to one

times (1X) the Purchase Price.

(q) “Shadow Series” shall mean shares of a series of the Company’s Preferred

Stock that is identical in all respects to the shares of Preferred Stock issued in the Next Equity

Financing (e.g., if the Company sells Series A Preferred Stock in the Next Equity Financing, the

Shadow Series would be Series A-1 Preferred Stock), except that the liquidation preference per

share of the Shadow Series shall equal the Conversion Price (as determined pursuant to Section

1(b)(i)), with corresponding adjustments to any price-based antidilution and dividend rights

provisions.

(r) “Valuation Cap” shall mean US$__,000,000.

40

40/58

Page 4 of 10


2. Conversion of the KISS.

2.1 Next Equity Financing. Upon the closing of the Next Equity Financing, this

KISS will be automatically converted into that number of Conversion Shares equal to the quotient

obtained by dividing the Purchase Price and unpaid accrued interest on this KISS by the

Conversion Price. Notwithstanding the foregoing, accrued interest on this KISS may be paid in

cash at the option of the Company. At least five (5) days prior to the closing of the Next Equity

Financing, the Company shall notify the Investor in writing of the terms under which the Preferred

Stock of the Company will be sold in such financing. The issuance of Conversion Shares pursuant

to the conversion of this KISS shall be upon and subject to the same terms and conditions

applicable to the Preferred Stock sold in the Next Equity Financing (or the Shadow Series, as

applicable).

2.2 Corporate Transaction. In the event of a Corporate Transaction prior to the

conversion of this KISS pursuant to Section 2.1 or 2.3, at Investor’s election, (i) this KISS shall be

converted into that number of Conversion Shares equal to the quotient obtained by dividing the

Purchase Price and unpaid accrued interest on this KISS by the Conversion Price; or (ii) the

Investor shall be paid the Corporate Transaction Payment. At least ten (10) days prior to the

closing of the Corporate Transaction, the Company shall notify the Investor in writing of the terms

of the Corporate Transaction.

2.3 Maturity Conversion. Unless earlier converted to Conversion Shares or

paid pursuant to Section 2.1 or 2.2, at the election of the Majority in Interest at any time on or after

the Maturity Date, this KISS shall be converted into that number of Conversion Shares equal to

the quotient obtained by dividing the Purchase Price and unpaid accrued interest on this KISS by

the Conversion Price.

2.4 No Fractional Shares. Upon the conversion of this KISS into Conversion

Shares, in lieu of any fractional shares to which the holder of this KISS would otherwise be

entitled, the Company shall pay the holder cash equal to such fraction multiplied by the Conversion

Price.

2.5 Mechanics of Conversion. As promptly as practicable after the conversion

of this KISS, the Company at its expense will issue and deliver to the Investor, upon surrender of

this KISS, a certificate or certificates for the number of Conversion Shares. Conversion of this

KISS may be made contingent upon the closing of the Next Equity Financing or Corporate

Transaction.

3. Representations and Warranties of the Company. In connection with the

transactions provided for herein, the Company hereby represents and warrants to the Investor that:

3.1 Organization, Good Standing and Qualification. The Company is a

corporation duly organized, validly existing, and in good standing under the laws of the State of

Delaware and has all requisite corporate power and authority to carry on its business as now

conducted. The Company is duly qualified to transact business and is in good standing in each

jurisdiction in which the failure to so qualify would have a material adverse effect on its business

or properties.

41

41/58

Page 5 of 10


3.2 Authorization. Except for the authorization and issuance of the Conversion

Shares issuable in connection with the Next Equity Financing, a Corporate Transaction or an

optional conversion on or after the Maturity Date, all corporate action has been taken on the part

of the Company, its officers, directors and stockholders necessary for the authorization, execution

and delivery of this KISS. The Company has taken all corporate action required to make all of the

obligations of the Company reflected in the provisions of this KISS the valid and enforceable

obligations they purport to be, and this KISS, when executed and delivered by the Company, shall

constitute the valid and legally binding obligation of the Company, enforceable against the

Company in accordance with its terms.

3.3 Offering. Subject in part to the truth and accuracy of the Investor’s

representations set forth herein, the offer, sale and issuance of this KISS are exempt from the

registration requirements of any applicable state and federal securities laws, and neither the

Company nor any authorized agent acting on its behalf will take any action hereafter that would

cause the loss of such exemption.

3.4 Compliance with Other Instruments. The execution, delivery and

performance of this KISS, and the consummation of the transactions contemplated hereby, will

not constitute or result in a default, violation, conflict or breach in any material respect of any

provision of the Company’s current Certificate of Incorporation or bylaws, or in any material

respect of any instrument, judgment, order, writ, decree, privacy policy or contract to which it is a

party or by which it is bound, or, to its knowledge, of any provision of any federal or state statute,

rule or regulation applicable to the Company.

3.5 Valid Issuance of Stock. The Conversion Shares, when issued, sold and

delivered upon conversion of this KISS, will be duly authorized and validly issued, fully paid and

nonassessable, will be free of restrictions on transfer other than restrictions on transfer set forth

herein and pursuant to applicable state and federal securities laws and, based in part upon the

representations and warranties of the Investor herein, will be issued in compliance with all

applicable federal and state securities laws.

3.6 Intellectual Property. To its knowledge, the Company owns or possesses or

believes it can acquire on commercially reasonable terms sufficient legal rights to all patents,

patent applications, trademarks, trademark applications, service marks, tradenames, copyrights,

trade secrets, licenses, domain names, mask works, information and proprietary rights and

processes as are necessary to the conduct of its business as now conducted and as presently

proposed to be conducted without any known conflict with, or infringement of, the rights of others.

The Company has not received any communications alleging that the Company has violated or,

by conducting its business, would violate any of the patents, trademarks, service marks,

tradenames, copyrights, trade secrets, mask works or other proprietary rights or processes of any

other person.

3.7 Litigation. To the Company’s knowledge, there is no private or

governmental action, suit, proceeding, claim, arbitration or investigation pending before any

agency, court or tribunal, foreign or domestic, or threatened against the Company or any of its

properties or any of its officers or managers (in their capacities as such). There is no judgment,

decree or order against the Company, or, to the knowledge of the Company, any of its directors or

42

42/58

Page 6 of 10


managers (in their capacities as such), that could prevent, enjoin, or materially alter or delay any

of the transactions contemplated by this KISS, or that could reasonably be expected to have a

material adverse effect on the Company.

4. Representations and Warranties of the Investor. In connection with the transactions

provided for herein, the Investor hereby represents and warrants to the Company that:

4.1 Authorization. This KISS constitutes Investor’s valid and legally binding

obligation, enforceable in accordance with its terms, except as may be limited by (i) applicable

bankruptcy, insolvency, reorganization, or similar laws relating to or affecting the enforcement of

creditors’ rights and (ii) laws relating to the availability of specific performance, injunctive relief

or other equitable remedies.

4.2 Purchase Entirely for Own Account. Investor acknowledges that this KISS

is issued to Investor in reliance upon Investor’s representation to the Company that the KISS will

be acquired for investment for Investor’s own account, not as a nominee or agent, and not with a

view to the resale or distribution of any part thereof, and that such Investor has no present intention

of selling, granting any participation in, or otherwise distributing the same.

4.3 Investment Experience. Investor is an investor in securities of companies

in the development stage and acknowledges that it is able to fend for itself, can bear the economic

risk of its investment, and has such knowledge and experience in financial or business matters that

it is capable of evaluating the merits and risks of the investment in this KISS. Investor also

represents it has not been organized solely for the purpose of acquiring this KISS.

4.4 Accredited Investor. Investor is an “accredited investor” within the

meaning of Rule 501 of Regulation D, as presently in effect, as promulgated by the Securities and

Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended (the “Act”).

4.5 Restricted Security. Investor understands that this KISS is characterized as

a “restricted security” under the federal securities laws inasmuch as it is being acquired from the

Company in a transaction not involving a public offering and that under such laws and applicable

regulations such securities may be resold without registration under the Act, only in certain limited

circumstances.

5. Miscellaneous.

5.1 Most Favored Nation. In the event the Company sells or issues any

convertible instruments (other than the issuance of stock options to service providers of the

Company) at any time prior to the earlier of (a) conversion of this KISS, (b) a Corporate

Transaction or (c) payment in full of all outstanding principal and accrued interest in accordance

with this KISS, the Company shall provide the Investor with written notice of such sale or issuance

no later than five (5) days after the closing date thereof, including the price and terms of such

convertible instruments (the “Subsequent Instruments”). In the event the Investor determines, in

its sole and absolute discretion, that any Subsequent Instrument contains terms more favorable to

the holder(s) thereof than the terms set forth in this KISS, the Investor may elect to exchange this

KISS for a Subsequent Instrument.

43

43/58

Page 7 of 10


5.2 Major Investor Rights. In the event the Investor, together with its affiliates,

purchases one or more KISSes with an aggregate Purchase Price equal to or exceeding $50,000 (a

“Major Investor”), the Company shall provide such Major Investor with the following rights:

(a) Information Rights. To the extent that the Company prepares

Financial Statements, the Company shall deliver to the Major Investor such Financial Statements

upon request, as soon as practicable, but in any event within thirty (30) days after the end of each

of the first three (3) quarters of each fiscal year of the Company and within ninety (90) days after

the end of each fiscal year of the Company. Such Financial Statements shall be in reasonable

detail and prepared on a consistent basis. Additionally, regardless of whether the Company

prepares Financial Statements, the Company shall deliver to the Major Investor such information

relating to the financial condition, business or corporate affairs of the Company as such Major

Investor may from time to time reasonably request. Notwithstanding anything to the contrary in

this Section 5.2(a), the Company shall not be obligated under this Section 5.2(a) to provide

information that (x) it deems in good faith to be a trade secret or highly confidential information

or (y) the disclosure of which would adversely affect the attorney-client privilege between the

Company and its counsel; and the Investor agrees to maintain the confidentiality of all of the

information provided to the Investor under this Section 5.2(a) and agrees not to use such

information other than for a purpose reasonably related to the Investor’s investment in the

Company.

(b) Participation Rights. Each time the Company proposes to offer any

Equity Securities at any time through and including the closing of the Next Equity Financing, the

Company shall provide the Major Investor with at least ten (10) business days prior written notice

of such offering, including the price and terms thereof. The Major Investor shall have a right of

first offer to participate in such offering(s), on the same terms and for the same price as all other

investors in such offering(s), by purchasing an aggregate number of Equity Securities (whether in

one offering or across multiple offerings) valued at up to the Participation Amount. The Major

Investor’s right of first offer set forth in this Section 5.2(b) shall be subject to compliance with


(c) “Major Investor” Rights. The Company shall ensure that the Major

Investor shall be deemed to be a “Major Investor” (or such similar term) for all purposes, including,

without limitation, rights of first offer and information rights, in relevant financing documents

related to all subsequent sales of Equity Securities, to the extent such concept exists.

5.3 Payment. All payments, if any, shall be made in lawful money of the United

States of America. Payment shall be credited first to Costs (as defined below), if any, then to

accrued interest due and payable and any remainder applied to principal or the Corporate

Transaction Payment, as applicable. Prepayment of principal, together with accrued interest, may

not be made without the prior written consent of the Investor. The Company hereby waives

demand, notice, presentment, protest and notice of dishonor.

5.4 Costs, Expenses and Attorneys’ Fees; Indemnity. The Company hereby

agrees, subject only to any limitation imposed by applicable law, to pay all expenses, including

reasonable attorneys’ fees and legal expenses, incurred by the holder of this KISS in endeavoring

to collect any amounts payable hereunder which are not paid when due, whether by declaration or

44

44/58

Page 8 of 10


otherwise (“Costs”). The Company agrees that any delay on the part of the holder in exercising

any rights hereunder will not operate as a waiver of such rights. The holder of this KISS shall not

by any act, delay, omission or otherwise be deemed to have waived any of its rights or remedies,

and no waiver of any kind shall be valid unless in writing and signed by the party or parties waiving

such rights or remedies. If any action at law or in equity is necessary to enforce or interpret the

terms of this KISS, the prevailing party shall be entitled to reasonable attorneys’ fees, costs and

necessary disbursements in addition to any other relief to which such party may be entitled. The

Company shall indemnify and hold the Investor harmless from any loss, cost, liability and legal or

other expense, including attorneys’ fees of the Investor’s counsel, which the Investor may directly

or indirectly suffer or incur by reason of the failure of the Company to perform any of its

obligations under this KISS or any agreement executed in connection herewith; provided,

however, that the indemnity agreement contained in this Section 5.4 shall not apply to liabilities

which the Investor may directly or indirectly suffer or incur by reason of the Investor’s own gross

negligence or willful misconduct.

5.5 Security. This KISS is a general unsecured obligation of the Company.

5.6 Successors and Assigns. The terms and conditions of this KISS shall inure

to the benefit of and be binding upon the respective successors and assigns of the parties hereto;

provided, however, that the Company may not assign its obligations under this KISS without the

prior written consent of the Investor.

5.7 Governing Law. This KISS shall be governed by and construed under the

laws of the State of California as applied to other instruments made by California residents to be

performed entirely within the State of California, regardless of the laws that might otherwise

govern under applicable principles of conflicts of law.

5.8 Notices. All notices and other communications given or made pursuant to

this KISS shall be in writing and shall be deemed effectively given upon the earlier of actual receipt

or: (a) personal delivery to the party to be notified, (b) when sent, if sent by electronic mail or

facsimile during normal business hours of the recipient, and if not sent during normal business

hours, then on the recipient’s next business day, (c) five (5) days after having been sent by

registered or certified mail, return receipt requested, postage prepaid, or (d) one (1) business day

after deposit with a nationally recognized overnight courier, freight prepaid, specifying next

business day delivery, with written verification of receipt. A copy, which shall not constitute

notice, of all communications to the Company shall be delivered to:

360 Venture Law (Shmalo Turner), LLP

270 Carpenter Drive NE, Suite 225

Atlanta, GA 30328

Attn: Daniel A. Shmalo, Esq.

5.9 Financing Agreements. The Investor understands and agrees that the

conversion of the KISS into Conversion Shares may require the Investor’s execution of certain

agreements relating to the purchase and sale of such securities as well as registration, co-sale,

rights of first refusal, rights of first offer and voting rights, if any, relating to such securities. The

Investor agrees to execute all such agreements in connection with the conversion so long as the

45

45/58

Page 9 of 10


issuance of Conversion Shares issued pursuant to the conversion of this KISS are subject to the

same terms and conditions applicable to the Preferred Stock sold in the Next Equity Financing (or

the Shadow Series or Series Seed Preferred Stock, as applicable).

5.10 Severability. If one or more provisions of this KISS are held to be

unenforceable under applicable law, such provision shall be excluded from this KISS and the

balance of the KISS shall be interpreted as if such provision were so excluded and shall be

enforceable in accordance with its terms.

5.11 Acknowledgement. For the avoidance of doubt, it is acknowledged that the

Investor shall be entitled to the benefit of all adjustments in the number of shares of Common

Stock of the Company issuable upon conversion of the Preferred Stock of the Company or as a

result of any splits, recapitalizations, combinations or other similar transaction affecting the

Common Stock or Preferred Stock underlying the Conversion Shares that occur prior to the

conversion of the KISS.

5.12 Further Assurance. From time to time, the Company shall execute and

deliver to the Investor such additional documents and shall provide such additional information to

the Investor as the Investor may reasonably require to carry out the terms of this KISS and to be

informed of the financial and business conditions and prospects of the Company.

5.13 Transfer of a KISS. Subject to compliance with applicable federal and state

securities laws, this KISS and all rights hereunder are transferable in whole or in part by the

Investor to any person or entity upon written notice to the Company.

5.14 Entire Agreement; Amendments and Waivers. This KISS and the other

KISSes in the Series constitute the full and entire understanding and agreement between the parties

with regard to the subjects hereof. The Company’s agreements with each Holder are separate

agreements, and the sales of the KISSes to each Holder are separate sales. Nonetheless, any term

of the KISSes in the Series may be amended and the observance of any term of the KISSes in the

Series may be waived (either generally or in a particular instance and either retroactively or

prospectively), with the written consent of the Company and the Majority in Interest; provided,

however, that Sections 2.2, 5.2 (if and only if Investor is a Major Investor), 5.3, 5.6, 5.13 and 5.14

may not be amended or waived without the written consent of the Investor. Any waiver or

amendment effected in accordance with this Section 5.14 shall be binding upon the Company and

each current and future member of the KISS Group.

5.15 Exculpation Among Holders. Each Holder acknowledges that it is not

relying upon any person, firm, corporation or stockholder, other than the Company and its officers

and directors in their capacities as such, in making its investment or decision to invest in the

Company. Each Holder agrees that no other Holder nor the respective controlling persons,

officers, directors, partners, agents, stockholders or employees of any other Holder shall be liable

for any action heretofore or hereafter taken or omitted to be taken by any of them in connection

with the purchase and sale of the KISSes.

[Signature Page Follows]

46

46/58

Page 10 of 10


6. Approval. The Company hereby represents that its Board of Directors, in the

exercise of its fiduciary duty, has approved the Company’s execution of this KISS based upon a

reasonable belief that the Purchase Price provided hereunder is appropriate for the Company after

reasonable inquiry concerning the Company’s financing objectives and financial situation. In

addition, the Company hereby represents that it intends to use the Purchase Price primarily for the

operations of its business, and not for any personal, family or household purpose.

_______________, INC.

By:

Name:

Title:

Address:

ACKNOWLEDGED AND AGREED:

______________________________

By:

Name:

Title:

Address:

Signature Page to Series [1] KISS

47

47/58


Attachment 5

KISS (Keep it Simple Security) – Equity Version

48

48/58

Page 1 of 10

KISS – Equity Version TechCo, Inc.

THIS INSTRUMENT AND THE SECURITIES ISSUABLE UPON THE CONVERSION

HEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS

AMENDED. THEY MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED,

HYPOTHECATED, OR OTHERWISE TRANSFERRED EXCEPT PURSUANT TO AN

EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, AS

AMENDED, OR AN OPINION OF COUNSEL SATISFACTORY TO THE COMPANY THAT

REGISTRATION IS NOT REQUIRED UNDER SUCH ACT OR UNLESS SOLD PURSUANT

TO RULE 144 UNDER SUCH ACT.

[NTD – EQUITY VERSION, NO INTEREST OR MATURITY, SEE http://500.co/kiss/]

SERIES [1]

KISS

“Purchase Price” “Date of Issuance”

$

_______________ __, 201_

For the Purchase Price, the receipt and sufficiency of which is hereby acknowledged, this

KISS is issued on the Date of Issuance by _______________, Inc., a Delaware corporation (the

“Company”), to _______________ (the “Investor”). This KISS is one of a series of Series [1]

KISSes issued by the Company to investors with identical terms and on the same form as set forth

herein (except that the Investor, Purchase Price and Date of Issuance may differ in each KISS)

(collectively, the “Series”).

1. Definitions.

(a) “Conversion Shares” shall mean:

(i) with respect to a conversion pursuant to Section 2.1, shares of the

Company’s Preferred Stock issued in the Next Equity Financing; provided, however, that, at the

Company’s election, “Conversion Shares” with respect to a conversion pursuant to Section 2.1

shall mean shares of a Shadow Series;

(ii) with respect to a conversion pursuant to Section 2.2, shares of the

Company’s Common Stock; and

(iii) with respect to a conversion pursuant to Section 2.3, shares of a

newly created series of the Company’s Series Seed Preferred Stock, upon the terms and provisions

set forth in the most recent version of the Series Seed documents posted at www.seriesseed.com

(or if not so posted, as reasonably agreed by the Company and a Majority in Interest); provided

that, for the avoidance of doubt, the Conversion Price shall be determined pursuant to Section

1(b)(iii).

(b) “Conversion Price” shall equal:

(i) with respect to a conversion pursuant to Section 2.1, the lower of

(A) the product of (1) one (1) minus the Discount and (2) the price paid per share for Preferred

49

49/58


Page 2 of 10


Stock by the investors in the Next Equity Financing or (B) the quotient resulting from dividing (1)

the Valuation Cap by (2) the Fully-Diluted Capitalization immediately prior to the closing of the

Next Equity Financing;

(ii) with respect to a conversion pursuant to Section 2.2, the quotient


prior to the closing of the Corporate Transaction; and

(iii) with respect to a conversion pursuant to Section 2.3, the quotient


prior to the conversion.

(c) “Corporate Transaction” shall mean (i) the closing of the sale, transfer or

other disposition of all or substantially all of the Company’s assets, (ii) the consummation of the

merger or consolidation of the Company with or into another entity (except a merger or

consolidation in which the holders of capital stock of the Company immediately prior to such

merger or consolidation continue to hold at least 50% of the voting power of the capital stock of

the Company or the surviving or acquiring entity), (iii) the closing of the transfer (whether by

merger, consolidation or otherwise), in one transaction or a series of related transactions, to a

person or group of affiliated persons (other than an underwriter of the Company’s securities), of

the Company’s securities if, after such closing, such person or group of affiliated persons would

hold 50% or more of the outstanding voting stock of the Company (or the surviving or acquiring

entity), or (iv) the liquidation, dissolution or winding up of the Company; provided, however, that

a transaction shall not constitute a Corporate Transaction if its sole purpose is to change the state

of the Company’s incorporation or to create a holding company that will be owned in substantially

the same proportions by the persons who held the Company’s securities immediately prior to such

transaction. Notwithstanding the prior sentence, the sale of shares of Preferred Stock in a bona

fide financing transaction shall not be deemed a “Corporate Transaction.”

(d) “Corporate Transaction Payment” shall mean an amount equal to two


(e) “Discount” shall mean _________ percent (__%).

(f) “Equity Securities” shall mean the Company’s Common Stock or Preferred

Stock or any securities conferring the right to purchase the Company’s Common Stock or Preferred

Stock or securities convertible into, or exchangeable for (with or without additional consideration),

the Company’s Common Stock or Preferred Stock, except any security granted, issued and/or sold

by the Company to any director, officer, employee or consultant of the Company in such capacity

for the primary purpose of soliciting or retaining their services.

(g) “Financial Statements” shall mean an income statement, balance sheet,

statement of stockholders’ equity, and/or a statement of cash flows, in each case as of the end of

(i) each of the first three (3) fiscal quarters and (ii) each fiscal year of the Company.

(h) “Fully-Diluted Capitalization” shall mean the number of shares of

outstanding Common Stock of the Company on a fully-diluted basis, including (i) conversion or

exercise of all securities convertible into or exercisable for Common Stock, (ii) exercise of all

50

50/58

Page 3 of 10


outstanding options and warrants to purchase Common Stock and, in the case of Section 1(b)(i)

and 1(b)(iii) only, (iii) the shares reserved or authorized for issuance under the Company’s existing

stock option plan or any stock option plan created or increased in connection with such transaction;

but excluding, for this purpose, the conversion contemplated by the applicable provision of Section

2.

(i) “Holder” shall mean a member of the KISS Group that holds a KISS

(including, without limitation, the Investor, for so long as the Investor holds this KISS).

(j) “KISS” or “KISSes” shall mean the KISS instruments issued by the

Company to Holders in the form hereof.

(k) “KISS Group” shall mean the holders of all KISSes in the Series,

collectively.

(l) “Majority in Interest” shall mean members of the KISS Group holding a

majority in interest of the aggregate Purchase Prices of all KISSes in the Series.

(m) “Maturity Date” shall mean the date that is eighteen (18) months following

the Date of Issuance.

(n) “Next Equity Financing” shall mean the next sale (or series of related sales)

by the Company of its Preferred Stock following the Date of Issuance from which the Company

receives gross proceeds of not less than $1,000,000 (excluding the aggregate amount of securities

converted into Preferred Stock in connection with such sale (or series of related sales)).

(o) “Participation Amount” shall mean an amount in US dollars equal to one


(p) “Shadow Series” shall mean shares of a series of the Company’s Preferred

Stock that is identical in all respects to the shares of Preferred Stock issued in the Next Equity

Financing (e.g., if the Company sells Series A Preferred Stock in the Next Equity Financing, the

Shadow Series would be Series A-1 Preferred Stock), except that the liquidation preference per

share of the Shadow Series shall equal the Conversion Price (as determined pursuant to Section

1(b)(i)), with corresponding adjustments to any price-based antidilution and dividend rights

provisions.

(q) “Valuation Cap” shall mean US$__,000,000.

2. Conversion of the KISS.

2.1 Next Equity Financing. Upon the closing of the Next Equity Financing, this

KISS will be automatically converted into that number of Conversion Shares equal to the quotient

obtained by dividing the Purchase Price by the Conversion Price. At least five (5) days prior to

the closing of the Next Equity Financing, the Company shall notify the Investor in writing of the

terms under which the Preferred Stock of the Company will be sold in such financing. The

issuance of Conversion Shares pursuant to the conversion of this KISS shall be upon and subject

51

51/58

Page 4 of 10


to the same terms and conditions applicable to the Preferred Stock sold in the Next Equity

Financing (or the Shadow Series, as applicable).

2.2 Corporate Transaction. In the event of a Corporate Transaction prior to the

conversion of this KISS pursuant to Section 2.1 or 2.3, at Investor’s election, (i) this KISS shall be

converted into that number of Conversion Shares equal to the quotient obtained by dividing the

Purchase Price by the Conversion Price; or (ii) the Investor shall be paid the Corporate Transaction

Payment, prior and in preference to any distribution of any of the cash or other assets of the

Company to holders of the Company’s capital stock by reason of their ownership of such stock.

At least ten (10) days prior to the closing of the Corporate Transaction, the Company shall notify

the Investor in writing of the terms of the Corporate Transaction.

2.3 Maturity Conversion. Unless earlier converted to Conversion Shares or

paid pursuant to Section 2.1 or 2.2, at the election of the Majority in Interest at any time on or after

the Maturity Date, this KISS shall be converted into that number of Conversion Shares equal to

the quotient obtained by dividing the Purchase Price by the Conversion Price.

2.4 No Fractional Shares. Upon the conversion of this KISS into Conversion

Shares, in lieu of any fractional shares to which the holder of this KISS would otherwise be

entitled, the Company shall pay the holder cash equal to such fraction multiplied by the Conversion

Price.

2.5 Mechanics of Conversion. As promptly as practicable after the conversion

of this KISS, the Company at its expense will issue and deliver to the Investor, upon surrender of

this KISS, a certificate or certificates for the number of Conversion Shares. Conversion of this

KISS may be made contingent upon the closing of the Next Equity Financing or Corporate

Transaction.

3. Representations and Warranties of the Company. In connection with the

transactions provided for herein, the Company hereby represents and warrants to the Investor that:

3.1 Organization, Good Standing and Qualification. The Company is a

corporation duly organized, validly existing, and in good standing under the laws of the State of

Delaware and has all requisite corporate power and authority to carry on its business as now

conducted. The Company is duly qualified to transact business and is in good standing in each

jurisdiction in which the failure to so qualify would have a material adverse effect on its business

or properties.

3.2 Authorization. Except for the authorization and issuance of the Conversion

Shares issuable in connection with the Next Equity Financing, a Corporate Transaction or an

optional conversion on or after the Maturity Date, all corporate action has been taken on the part

of the Company, its officers, directors and stockholders necessary for the authorization, execution

and delivery of this KISS. The Company has taken all corporate action required to make all of the

obligations of the Company reflected in the provisions of this KISS the valid and enforceable

obligations they purport to be, and this KISS, when executed and delivered by the Company, shall

constitute the valid and legally binding obligation of the Company, enforceable against the

Company in accordance with its terms.

52

52/58

Page 5 of 10


3.3 Offering. Subject in part to the truth and accuracy of the Investor’s

representations set forth herein, the offer, sale and issuance of this KISS are exempt from the

registration requirements of any applicable state and federal securities laws, and neither the

Company nor any authorized agent acting on its behalf will take any action hereafter that would

cause the loss of such exemption.

3.4 Compliance with Other Instruments. The execution, delivery and

performance of this KISS, and the consummation of the transactions contemplated hereby, will

not constitute or result in a default, violation, conflict or breach in any material respect of any

provision of the Company’s current Certificate of Incorporation or bylaws, or in any material

respect of any instrument, judgment, order, writ, decree, privacy policy or contract to which it is a

party or by which it is bound, or, to its knowledge, of any provision of any federal or state statute,

rule or regulation applicable to the Company.

3.5 Valid Issuance of Stock. The Conversion Shares, when issued, sold and

delivered upon conversion of this KISS, will be duly authorized and validly issued, fully paid and

nonassessable, will be free of restrictions on transfer other than restrictions on transfer set forth

herein and pursuant to applicable state and federal securities laws and, based in part upon the

representations and warranties of the Investor herein, will be issued in compliance with all


3.6 Intellectual Property. To its knowledge, the Company owns or possesses or

believes it can acquire on commercially reasonable terms sufficient legal rights to all patents,

patent applications, trademarks, trademark applications, service marks, tradenames, copyrights,

trade secrets, licenses, domain names, mask works, information and proprietary rights and

processes as are necessary to the conduct of its business as now conducted and as presently

proposed to be conducted without any known conflict with, or infringement of, the rights of others.

The Company has not received any communications alleging that the Company has violated or,

by conducting its business, would violate any of the patents, trademarks, service marks,

tradenames, copyrights, trade secrets, mask works or other proprietary rights or processes of any

other person.

3.7 Litigation. To the Company’s knowledge, there is no private or

governmental action, suit, proceeding, claim, arbitration or investigation pending before any

agency, court or tribunal, foreign or domestic, or threatened against the Company or any of its

properties or any of its officers or managers (in their capacities as such). There is no judgment,

decree or order against the Company, or, to the knowledge of the Company, any of its directors or

managers (in their capacities as such), that could prevent, enjoin, or materially alter or delay any

of the transactions contemplated by this KISS, or that could reasonably be expected to have a

material adverse effect on the Company.

4. Representations and Warranties of the Investor. In connection with the transactions

provided for herein, the Investor hereby represents and warrants to the Company that:

4.1 Authorization. This KISS constitutes Investor’s valid and legally binding

obligation, enforceable in accordance with its terms, except as may be limited by (i) applicable

bankruptcy, insolvency, reorganization, or similar laws relating to or affecting the enforcement of

53

53/58

Page 6 of 10


creditors’ rights and (ii) laws relating to the availability of specific performance, injunctive relief

or other equitable remedies.

4.2 Purchase Entirely for Own Account. Investor acknowledges that this KISS

is issued to Investor in reliance upon Investor’s representation to the Company that the KISS will

be acquired for investment for Investor’s own account, not as a nominee or agent, and not with a

view to the resale or distribution of any part thereof, and that such Investor has no present intention

of selling, granting any participation in, or otherwise distributing the same.

4.3 Investment Experience. Investor is an investor in securities of companies

in the development stage and acknowledges that it is able to fend for itself, can bear the economic

risk of its investment, and has such knowledge and experience in financial or business matters that

it is capable of evaluating the merits and risks of the investment in this KISS. Investor also

represents it has not been organized solely for the purpose of acquiring this KISS.

4.4 Accredited Investor. Investor is an “accredited investor” within the

meaning of Rule 501 of Regulation D, as presently in effect, as promulgated by the Securities and

Exchange Commission (the “SEC”) under the Securities Act of 1933, as amended (the “Act”).

4.5 Restricted Security. Investor understands that this KISS is characterized as

a “restricted security” under the federal securities laws inasmuch as it is being acquired from the

Company in a transaction not involving a public offering and that under such laws and applicable

regulations such securities may be resold without registration under the Act, only in certain limited

circumstances.

5. Miscellaneous.

5.1 Most Favored Nation. In the event the Company sells or issues any

convertible instruments (other than the issuance of stock options to service providers of the

Company) at any time prior to the earlier of (a) conversion of this KISS or (b) a Corporate

Transaction, the Company shall provide the Investor with written notice of such sale or issuance

no later than five (5) days after the closing date thereof, including the price and terms of such

convertible instruments (the “Subsequent Instruments”). In the event the Investor determines, in

its sole and absolute discretion, that any Subsequent Instrument contains terms more favorable to

the holder(s) thereof than the terms set forth in this KISS, the Investor may elect to exchange this

KISS for a Subsequent Instrument.

5.2 Major Investor Rights. In the event the Investor, together with its affiliates,

purchases one or more KISSes with an aggregate Purchase Price equal to or exceeding $50,000 (a

“Major Investor”), the Company shall provide such Major Investor with the following rights:

(a) Information Rights. To the extent that the Company prepares

Financial Statements, the Company shall deliver to the Major Investor such Financial Statements

upon request, as soon as practicable, but in any event within thirty (30) days after the end of each

of the first three (3) quarters of each fiscal year of the Company and within ninety (90) days after

the end of each fiscal year of the Company. Such Financial Statements shall be in reasonable

detail and prepared on a consistent basis. Additionally, regardless of whether the Company

prepares Financial Statements, the Company shall deliver to the Major Investor such information

54

54/58

Page 7 of 10


relating to the financial condition, business or corporate affairs of the Company as such Major

Investor may from time to time reasonably request. Notwithstanding anything to the contrary in

this Section 5.2(a), the Company shall not be obligated under this Section 5.2(a) to provide

information that (x) it deems in good faith to be a trade secret or highly confidential information

or (y) the disclosure of which would adversely affect the attorney-client privilege between the

Company and its counsel; and the Investor agrees to maintain the confidentiality of all of the

information provided to the Investor under this Section 5.2(a) and agrees not to use such

information other than for a purpose reasonably related to the Investor’s investment in the

Company.

(b) Participation Rights. Each time the Company proposes to offer any

Equity Securities at any time through and including the closing of the Next Equity Financing, the

Company shall provide the Major Investor with at least ten (10) business days prior written notice

of such offering, including the price and terms thereof. The Major Investor shall have a right of

first offer to participate in such offering(s), on the same terms and for the same price as all other

investors in such offering(s), by purchasing an aggregate number of Equity Securities (whether in

one offering or across multiple offerings) valued at up to the Participation Amount. The Major

Investor’s right of first offer set forth in this Section 5.2(b) shall be subject to compliance with


(c) “Major Investor” Rights. The Company shall ensure that the Major

Investor shall be deemed to be a “Major Investor” (or such similar term) for all purposes, including,

without limitation, rights of first offer and information rights, in relevant financing documents

related to all subsequent sales of Equity Securities, to the extent such concept exists.

5.3 Payment. All payments, if any, shall be made in lawful money of the United

States of America. Payment shall be credited first to Costs (as defined below), if any, then to the

Corporate Transaction Payment. The Company hereby waives demand, notice, presentment,

protest and notice of dishonor.

5.4 Costs, Expenses and Attorneys’ Fees; Indemnity. The Company hereby

agrees, subject only to any limitation imposed by applicable law, to pay all expenses, including

reasonable attorneys’ fees and legal expenses, incurred by the holder of this KISS in endeavoring

to collect any amounts payable hereunder which are not paid when due, whether by declaration or

otherwise (“Costs”). The Company agrees that any delay on the part of the holder in exercising

any rights hereunder will not operate as a waiver of such rights. The holder of this KISS shall not

by any act, delay, omission or otherwise be deemed to have waived any of its rights or remedies,

and no waiver of any kind shall be valid unless in writing and signed by the party or parties waiving

such rights or remedies. If any action at law or in equity is necessary to enforce or interpret the

terms of this KISS, the prevailing party shall be entitled to reasonable attorneys’ fees, costs and

necessary disbursements in addition to any other relief to which such party may be entitled. The

Company shall indemnify and hold the Investor harmless from any loss, cost, liability and legal or

other expense, including attorneys’ fees of the Investor’s counsel, which the Investor may directly

or indirectly suffer or incur by reason of the failure of the Company to perform any of its

obligations under this KISS or any agreement executed in connection herewith; provided,

however, that the indemnity agreement contained in this Section 5.4 shall not apply to liabilities

55

55/58

Page 8 of 10


which the Investor may directly or indirectly suffer or incur by reason of the Investor’s own gross

negligence or willful misconduct.

5.5 Successors and Assigns. The terms and conditions of this KISS shall inure

to the benefit of and be binding upon the respective successors and assigns of the parties hereto;

provided, however, that the Company may not assign its obligations under this KISS without the

prior written consent of the Investor.

5.6 Governing Law. This KISS shall be governed by and construed under the

laws of the State of California as applied to other instruments made by California residents to be

performed entirely within the State of California, regardless of the laws that might otherwise

govern under applicable principles of conflicts of law.

5.7 Notices. All notices and other communications given or made pursuant to

this KISS shall be in writing and shall be deemed effectively given upon the earlier of actual receipt

or: (a) personal delivery to the party to be notified, (b) when sent, if sent by electronic mail or

facsimile during normal business hours of the recipient, and if not sent during normal business

hours, then on the recipient’s next business day, (c) five (5) days after having been sent by

registered or certified mail, return receipt requested, postage prepaid, or (d) one (1) business day

after deposit with a nationally recognized overnight courier, freight prepaid, specifying next

business day delivery, with written verification of receipt. A copy, which shall not constitute

notice, of all communications to the Company shall be delivered to:

360 Venture Law (Shmalo Turner), LLP

270 Carpenter Drive NE, Suite 225

Atlanta, GA 30328

Attn: Daniel A. Shmalo, Esq.

5.8 Financing Agreements. The Investor understands and agrees that the

conversion of the KISS into Conversion Shares may require the Investor’s execution of certain

agreements relating to the purchase and sale of such securities as well as registration, co-sale,

rights of first refusal, rights of first offer and voting rights, if any, relating to such securities. The

Investor agrees to execute all such agreements in connection with the conversion so long as the

issuance of Conversion Shares issued pursuant to the conversion of this KISS are subject to the

same terms and conditions applicable to the Preferred Stock sold in the Next Equity Financing (or

the Shadow Series or Series Seed Preferred Stock, as applicable).

5.9 Severability. If one or more provisions of this KISS are held to be

unenforceable under applicable law, such provision shall be excluded from this KISS and the

balance of the KISS shall be interpreted as if such provision were so excluded and shall be

enforceable in accordance with its terms.

5.10 Acknowledgement. For the avoidance of doubt, it is acknowledged that the

Investor shall be entitled to the benefit of all adjustments in the number of shares of Common

Stock of the Company issuable upon conversion of the Preferred Stock of the Company or as a

result of any splits, recapitalizations, combinations or other similar transaction affecting the

56

56/58

Page 9 of 10


Common Stock or Preferred Stock underlying the Conversion Shares that occur prior to the

conversion of the KISS.

5.11 Further Assurance. From time to time, the Company shall execute and

deliver to the Investor such additional documents and shall provide such additional information to

the Investor as the Investor may reasonably require to carry out the terms of this KISS and to be

informed of the financial and business conditions and prospects of the Company.

5.12 Transfer of a KISS. Subject to compliance with applicable federal and state

securities laws, this KISS and all rights hereunder are transferable in whole or in part by the

Investor to any person or entity upon written notice to the Company.

5.13 Entire Agreement; Amendments and Waivers. This KISS and the other

KISSes in the Series constitute the full and entire understanding and agreement between the parties

with regard to the subjects hereof. The Company’s agreements with each Holder are separate

agreements, and the sales of the KISSes to each Holder are separate sales. Nonetheless, any term

of the KISSes in the Series may be amended and the observance of any term of the KISSes in the

Series may be waived (either generally or in a particular instance and either retroactively or

prospectively), with the written consent of the Company and the Majority in Interest; provided,

however, that Sections 2.2, 5.2 (if and only if Investor is a Major Investor), 5.3, 5.5, 5.12 and 5.13

may not be amended or waived without the written consent of the Investor. Any waiver or

amendment effected in accordance with this Section 5.13 shall be binding upon the Company and

each current and future member of the KISS Group.

5.14 Priority. This KISS shall rank pari passu in all respects (including right of

payment) to all other KISSes and all convertible indebtedness of the Company, now or hereafter

existing.

5.15 Exculpation Among Holders. Each Holder acknowledges that it is not

relying upon any person, firm, corporation or stockholder, other than the Company and its officers

and directors in their capacities as such, in making its investment or decision to invest in the

Company. Each Holder agrees that no other Holder nor the respective controlling persons,

officers, directors, partners, agents, stockholders or employees of any other Holder shall be liable

for any action heretofore or hereafter taken or omitted to be taken by any of them in connection

with the purchase and sale of the KISSes.

[Signature Page Follows]

57

57/58

Page 10 of 10


6. Approval. The Company hereby represents that its Board of Directors, in the

exercise of its fiduciary duty, has approved the Company’s execution of this KISS based upon a

reasonable belief that the Purchase Price provided hereunder is appropriate for the Company after

reasonable inquiry concerning the Company’s financing objectives and financial situation. In

addition, the Company hereby represents that it intends to use the Purchase Price primarily for the

operations of its business, and not for any personal, family or household purpose.

_______________, INC.

By:

Name:

Title:

Address:

ACKNOWLEDGED AND AGREED:

______________________________

By:

Name:

Title:

Address:

[Signature Page to Series [1] KISS]

58

58/58

Documents

Shmalo - 2015-Convertible Note Paper and Exhibits - FINAL