introduction to venture capital financing

Introduction to Venture Capital Financing

Ed Pease Gary Schall

November 4, 2013

Attorney Advertising

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Venture Capital Financing

What is a venture capital transaction? Type of private equity capital typically provided for early-

stage, high-potential, growth companies in the interest of generating a return through an eventual realization event such as an IPO or sale of the company

Venture capital investments are generally made as cash in exchange for shares in the invested company

This session is about traditional venture capital financing, not new crowdfunding approaches to financing.

Source: Wikipedia

© 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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Venture Capital Financing

Securities Law Compliance Under federal securities laws, every issuance of a security

must either be registered under the Securities Act or exempt from registration

All issuances of securities that are not being registered with the SEC must also be reviewed for compliance with state securities laws, or so-called "blue sky" laws

Securities law compliance is not addressed in this presentation


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Transaction Documents

Ancillary Documents • Management Rights Letters • Director Indemnification

Agreements • Legal Opinion of Company

Counsel

Term Sheet Certificate of Incorporation

Pre-Closing

Operative Documents • Stock Purchase Agreement • Investor Rights Agreement • Voting Agreement • Right of First Refusal and Co-

Sale Agreement

Signing and Closing


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Summarizes the principal terms of the transaction

Generally not legally binding, except for confidentiality and exclusivity provisions

Term Sheet


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Deal Terms

Term Sheet Offering Terms Closing Date

Investors

Amount Raised

Price Per Share

Pre- and Post-Money Valuation

Current and Pro Forma Capitalization


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Deal Terms

Term Sheet Binding Provisions No-shop / Exclusivity

Confidentiality

Expenses


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Sets forth the basic terms of the purchase and sale of the

preferred stock to the investors and identifies the other financing documents

Typically fully negotiated and approved by the Board and stockholders but not signed until after the Certificate of Incorporation is filed

Stock Purchase Agreement


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Deal Terms

Stock Purchase Agreement Type and Amount of Shares

Purchase Price

Representations and Warranties of Company, Founders and Investors

Conditions to Closing/Closing Deliverables

Counsel and Expenses


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Establishes the rights, preferences, privileges and restrictions

of each class and series of the company’s stock

Filed with the Secretary of State of the state of the company’s incorporation

Certificate of Incorporation

Pre-Closing


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Deal Terms

Certificate of Incorporation Pay-to-Play

– If an investor does not participate in a future financing, its preferred stock automatically converts to common stock or a “shadow” series of preferred stock without anti-dilution and/or other rights

Redemption Rights – At election of preferred holders as a class after 3-5 years

– All or portion

– Price can be original purchase price plus dividends or FMV


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Deal Terms

Certificate of Incorporation Dividends

– When, as and if declared or paid on common

– Accruing / cumulative

Liquidation Preference – Non-Participating

– Participating


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Deal Terms

Certificate of Incorporation Anti-dilution Provisions

– Weighted average – broad v. narrow (i.e., exclude common stock equivalents and shares reserved for issuance under incentive plans)

– Full ratchet


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Deal Terms

Certificate of Incorporation Director Voting Rights

– Right of a class of stock to elect one or more directors

Protective Provisions – Right of a class of stock to approve key matters (e.g., equity

issuances, transactions)


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Deal Terms

Certificate of Incorporation Optional Conversion

Mandatory Conversion – At a qualifying IPO or upon a class vote


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Investor Rights Agreement – Covers ongoing rights and obligations of investors and ongoing

obligations of the company, including registration rights and company covenants

Voting Agreement – Agreement among stockholders, generally investors and founders

to vote shares for various matters, including board designees and drag-along rights

Right of First Refusal and Co-Sale Agreement – Grants rights to the company and investors on sales of stock by

founders and “key holders” Operative

Documents

Closing


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Deal Terms

Investor Rights Agreement – Registration Rights Registrable Securities

Demand Registration

Registration on Form S-3

Piggyback Registration

Expenses


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Deal Terms

Investor Rights Agreement – Investor Rights and Covenants Management and Information Rights

Right to Maintain Proportionate Ownership (“preemptive rights”)

Matters Requiring Investor Director Approval

Lock-up in an IPO


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Deal Terms

Investor Rights Agreement – Company Covenants Non-Competition and Non-Solicitation and Agreements

Non-Disclosure and Developments Agreement

Board Matters

Employee Stock Options

Key Person Insurance

Other Covenants


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Deal Terms

Voting Agreement Board size and composition

Increase common stock to cover conversion of preferred stock

Drag-along – Holders of specific percentage of stock can require all holders to

vote for certain matters


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Deal Terms

Right of First Refusal and Co-Sale Agreement Right of First Refusal

– Company has primary right of first refusal

– Investors have secondary right of first refusal if company does not exercise in full

Right of Co-Sale (“tag along”) – If company and investors do not exercise their right of first

refusal, investors can sell some of their stock


Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000; 1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/code-of-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP

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