Private Equity Financings

1
Private Equity Financings

• Downside Protection
• Whats Important,
• Whats Not
• Why

2
Down-Side Protection

• Liquidation Preference
• Right of Redemption
• Price-based Anti-Dilution Protection

3
Liquidation Preference

• The New Standard participating
• Issues
• Participating vs Non-Participating
• Disincentivize management team, if LP too large
• Negotiation Ideas
• Repay Preferred, then pay common, THEN share
  upside
• Balances investor protection with management
  incentive

4
Liquidation Preference

• Negotiation Ideas contd
• Balance downside protection with upside benefit
• Different LP for MA vs Liquidation
• LP subordinated to retention bonuses
• Fixed return for investors for greater downside
  protection

5
Liquidation Preference

• The New Standard Priority
• Issue Priority vs Pari Passu
• Non-Issue
• Generally, an investor issue -- potential
  conflict between classes, but money controls
• Cal. Corp. Code (903(b) - Some class protection
• Some protection through board/observer rights

6
Redemption

• The New Standard More common, but not standard
• Issues
• Jeopardize company if insufficient to repay
• Gives investors inordinate bargaining power
• Makes company less attractive acquisition
  candidate

7
Redemption

• Old CW Non-issue
• Push off for 5 years, which was a long time
• Within 5 years, company will either exit or fold
• Corporations code protection, if company cannot
  not afford redemption

8
Redemption

• New CW Issue?
• Longer liquidity path - 5 years is shorter
• Corporations code protection, but
• Obligation still affects companys
  attractiveness for merger

9
Redemption

• Negotiating Points
• Disincentive to Management fully vest and then
  diminish value of shares
• Essentially converts equity into debt so use it
  to bargain on valuation
• Push off as far into future as possible, and
  redeem over time
• Might deter future investors whose proceeds are
  used to pay redemption
• Permit Company to delay redemption for cause
• Require call, if must have redemption

10
Anti-Dilution Protection

• The New Standard Weighted Average
• Issues
• Broad vs Narrow-based
• Full Rachet
• Negotiation Points
• Push hard against full rachet
• Disincentive to additional investors
• See example
• Recommend limited rachet tied to reduction of
  risk (e.g., hitting milestones)

11
Founder Vesting Acceleration

• Issues
• if Founder cant get liquid, valuation is
  secondary
• Negotiate VA in context of valuation
• Removal by Board for convenience
• Acceleration on termination without cause
• Include Constructive Termination
• Double Trigger

12
TERM SHEETS 101

• Thursday, march 15, 2001
• 830am- 1200pm
• Software Development Forum