1. Venture Capital and the Finance of Innovation [Course number] Professor [Name ] [School Name] Chapter 9 Preferred Stock

2.  Convertible preferred (CP) In our example, conversion point (W A ) occurs when CP (conversion value) = 1/3 * $W = CP (redemption value) = Min ($5M, $W). Conversion Condition:1/3 * W > 5 → W A = 15.

3. CP, in pictures

4. Exit Diagram for CP 15

5. Other types of preferred stock  Redeemable Preferred (RP)  Participating Convertible Preferred (PCP)  PCP with cap (=PCPC)  Key threshold for PCP is a qualified public offering (QPO)

6. Alternatives  Structure I: 5M shares of common;  Structure II: RP ($5M APP);  Structure III: RP + 5M shares of common;  Structure IV: PCP with participation as-if 5M shares of common, QPO at $5 per share;  Structure V: PCPC with participation as-if 5M shares of common, with liquidation return capped at four times OPP, QPO at $5 per share;  Structure VI: RP ($4M APP) + 5M shares of CP ($1M APP).

7. Structure I

8. Structure II

9. Structure III

10. Structure IV

11. Structure V

12. Structure V, continued

13. Structure VI, RP component

14. Structure VI, CP component

15. Structure VI, RP + CP

16. Anti-Dilution Protections  Down round  Full-ratchet vs. weighted average  Broad base vs. narrow base  Adjusted conversion price, adjusted conversion rate

17. Broad-base weighted average anti-dilution CP 2 = adjusted conversion price = CP 1 * (A+B) / (A+C) where CP 2 =New Series A Conversion Price CP 1 =Series A Conversion Price in effect immediately prior to new issue A=Number of shares of Common Stock deemed to be outstanding immediately prior to new issue (includes all shares of outstanding common stock, all shares of outstanding preferred stock on an as-converted basis, and all outstanding options on an as-exercised basis; does not include any convertible securities from this round of financing) B=Aggregate consideration received by the Corporation with respect to the new issue divided by CP 1 C=Number of shares of stock issued in the subject transaction

18. Narrow-base weighted average anti-dilution  Everything the same as in the broad-base formula, except, A (narrow-base) = Number of shares of Common Stock deemed to be outstanding immediately prior to new issue (including all shares of outstanding preferred stock on an as- converted basis, but excluding all shares of outstanding common stock and all outstanding options on an as-exercised basis; does not include any convertible securities from this round of financing)

19. Example Suppose that EBV makes a $6M Series A investment in Newco for 1M shares at $6 per share. One year later, Newco has fallen on hard times and receives a $6M Series B financing from Talltree for 6M shares at $1 per share. The founders and the stock pool have claims on 3M shares of common stock. Consider the following cases:  Case I: Series A has no antidilution protection.  Case II: Series A has full-ratchet antidilution protection.  Case III: Series A has broad-base weighted-average antidilution protection.  Case IV: Series A has narrow-base weighted-average antidilution protection. For each of these cases, what percentage of Newco (fully diluted) would be controlled by EBV following the Series B investment? What would be the post-money and pre-money valuations? (See Example 9.2 in the textbook.)