november 2015 7645259 v.4 early stage financings for start-ups asaf kharal
TRANSCRIPT
November 20157645259 v.4
Early Stage Financings for Start-ups
Asaf Kharal
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WSGR Advise more than 300 public and 3,000 private enterprises Advise more U.S. technology companies on their initial public offerings than
any other law firm (Capital IQ) Advise more technology companies on their M&A transactions than any other
law firm (Bloomberg) Represent more companies that receive venture financing than any other law
firm (Dow Jones VentureSource/ PitchBook) Most frequently hired securities litigation firm in the country (Securities
Law360) Selected for inclusion in the Intellectual Property Hot List (The National Law
Journal)
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High Level Trends in Early Stage Financings
Pre-Seed is the new Seed; Seed is the new Series A; Series A is the new Series B
Massive late stage rounds New sources of money (China, Russia, Middle East, India) More international startups Investors care more about pro rata rights SAFEs gaining ground
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The New Start-up Financing Ecosystem
Incubation (under $100K)
Pre-Seed (Under $500K)
Seed ($1M-$5M)
Series A ($5M to $15M)
Series B (Over $15M)
Large Venture Funds
Small Venture Funds
Super Angels & Micro-VCs
Angels, Incubators & Accelerators
Pre-Seed is the new SeedSeed is the new Series A
Preparing for Financing
Organization of the company Founder and team equity IP protection
– Intellectual property is an important corporate asset, so taking steps to ensure that it is properly assigned to the company is essential.
– Assignment of IP by founders– Confidentiality and Invention Assignment Agreements with employees and
contractors– Data privacy and protection– Trademarks, copyrights, trade secrets, patents and other registrations
Record keeping
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Types of Early Stage Investment
Key Elements of a Financing
Size – how much money should be raised
Source – where is the money coming from
Type of Security
Valuation required – does the investment require a valuation of the company?
Debt based/interest – does the investment mean a growing debt load?
Impact on control rights
Liquidation preferences
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Founder funding and self funding• Varies in size based on company’s means
and needs• Type – common stock or promissory notes• Important to document capital contributions
and the expectations for equity, repayment or conversion
• Expectations of repayment upon a future financing may not be met
• Valuation must be handled carefully
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Converts into later round preferred stock if sold to investors in connection with later financing
• Intended to solve founder sale of common at preferred price affecting common FMV
• Must be fully vested (or potentially considered compensation income)
• Typically, not more than 25% of founders equity is Series FF
• Cannot be subject to board discretion to allow conversion
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Highly dependent on facts and circumstances• Varies in size though usually less than
$50,000• Type – common stock, promissory notes
(convertible or non-convertible), contributions to capital
• A valuation may be required • Equity or debt• Usually no impact on control rights• Typically no liquidation preference• Potential downsides
• Risks to personal relationships• Investors usually have no experience to bring
to the table• These investments are usually not sources of
a large amount of money• Familiarity with investors can lead
entrepreneurs into the trap of inadequate documentation
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Contracts with lead customers/early adopters for funding in exchange for early access to the developed product or service.
• Varies in size• No valuation, typically no debt or equity
issued• Later strategic deals may involve ROFR or
ROFN • No liquidation preference• Contracts can raise important issues
including:• Commercial rights and restrictions• Ownership and rights in intellectual property• Confidentiality• Early strategic agreements can make or
break a company
Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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• A promissory note for the full investment amount with an interest rate and a maturity date
• Typical maturities are one year• Automatic conversion on a “qualified
financing”• Optional conversion on other financings• Discount and/or warrants on conversion• Premium on a change of control• Valuation caps for conversion • The larger the convertible debt financing, the
less likely it is to be combined with the new money in a preferred stock financing
Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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• Essentially a convertible note that lacks and interest rate provision or maturity date
• Not debt, the instrument is best conceptualized as a placeholder for which the investor pays full value up front in exchange for a future security at a later date
• Perceived to be founder friendly
Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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• SAFE: Simple Agreement for Future Equity• Another form of convertible equity• Like convertible security it strips the debt like
attributes from the convertible note• Drafted to be layperson friendly as
accessibility is prioritized over comprehensiveness - only 6 pages long
• It has the backing of Y Combinator and its partners
Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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• Size – varies • Source – angel investors; accelerators• Valuation – no • Debt based – no• Control rights given up – typically no• Liquidation preference – yes
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Common stock at founder price • Plus convertible equity for $15-$100K• YC, AngelPad, TechStars• Avoid creating a high common stock FMV• Additional “blind pool” financing
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Size – $50,000 to $1M• Source –a single investor or a group of
affiliated investors • Type – common stock, convertible debt,
promissory notes• Valuation – depends on if debt or equity
based• Control rights – depends on the size of the
round, may include a board seat, protective provisions and participation rights
• Liquidation preferences – yes if preferred stock
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Simplified series A financing documents available at http://www.seriesseed.com/
• Designed to save time and money relative to traditional equity based financing documents, they omit specific provisions in an effort to simplify
• What they’re missing relative to traditional series A documents
• Dividend preference• Registration rights• Anti-dilution protection and other protective
provisions• Voting agreements• Comprehensive representations and
warranties
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Size – roughly $500,000, typically not larger because of investors’ desire for protective provisions
• Source – Angels, Friends and Family• Type - preferred stock• Valuation required – yes• Debt based/interest concerns – no• Control rights given up – often include a
board seat, participation rights and protective provisions
• Liquidation preference – yes 1x non-participating typical
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Lots of groups call their own documents “series seed” and these can differ from the standardized documents. Be wary.
• The provisions are relatively inelastic and cannot be easily customized
• They contain fewer investor protections by default
• New documents often have to be drafted for later rounds and things like the certificate of incorporation must be amended
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• The practice of funding a project or venture by raising money from large numbers of people, typically over the internet
• It can be conceptualized in two different contexts
• Preselling a product – pebble smartwatch, Shenmue III
• Selling equity in a company • This is an evolving area of the law. The
passage of the Jumpstart Our Business Startups Act (JOBS Act) in 2012 created opportunities for funding based on the sale of equity or debt through the internet, but details and a clear regulatory structure have been slow to emerge.
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• SEC Guidance• Companies will be allowed to raise a
maximum aggregate amount of $1 million through crowdfunding offerings in a 12-month period. Companies must disclose:
• The price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount
• The company’s financial condition• Reviewed or audited financial statements • A description of the business and the use of
proceeds from the offering• Information about officers and directors as
well as owners of 20% or more of the company
• Certain related party transactions
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Dangers of Crowdfunding:• Securities laws are complicated and securities
offerings are subject to strict reporting requirements. Failure to comply with securities laws can lead to penalties and problems down the road with future offerings
• Be cautious with Crowdfunding websites. Some websites allow the dissemination of investment information to anyone browsing the internet. This can constitute a securities law violation. It’s best to know the website you are dealing with and know who your information is being disseminated to
• Since it involves disclosing your company and idea, this funding is more appropriate for some types of start-ups than others
• Established sites that limit access are preferred
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Types of Early Stage Financings
• Size – varies. Typically $2-10 million• Source – venture capital investors, often
several• Type – preferred stock• Valuation – Yes• Debt based – Not typically• Control rights given up – Yes, at least a board
seat• Liquidation preference – Yes
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Choosing the right VC Partner• What network does the specific partner you
are working with bring to bear?• What past experience does that partner have
that might be helpful if on your board?• Speak to members of that partners current
and past portfolio• or her?• How involved will the VC Partner want to be in
your company
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Key Parts of a Series A Term Sheet: • Valuation• Pre and Post Money Valuations• Option Pool• Dividends – Non-Cumulative• Liquidation Preference
• Initial Preference• Participating or non-participating• Participation caps• Non-cumulative
• Antidilution – broad-based weighted average• Board Composition• CEO seat• Founder Vesting• Drag Along• Protective Provisions
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Types of Early Stage Financings
Bootstrapping
Founder Preferred
Friends and Family
Customer Funding
Convertible Debt
Convertible Equity
SAFE Instruments
Incubators
Angels
Seed Rounds
Crowdfunding
Series A Venture Round
• Valuation Jargon• “3 on 3” means $3M pre-money with $3M
round• With a $6M post-money ($3+$3) • VCs will own 50% of the company• Let’s assume the required option pool is 15%
• This is what the cap table will look like:• Investors 50%• Founders 35%• Option Pool 15%
ASAF KHARAL
Wilson Sonsini Goodrich & Rosati, P.C.
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