Based on Andrew Metrick’s Slides Class 7 (Ch. 8 & 9) Based on Andrew Metrick’s Slides

Term Sheets – The Basics Expropriation Charter Investor Rights Agreement Rounds Series A, Series B, etc.

Capitalization Table

Investors and Prices $investment Fully diluted share count Proposed ownership percentage Original purchase price (OPP) Aggregate purchase price (APP) Tranche

Post-Money Valuation Post-money valuation = price-per-share × fully-diluted share count or Post-money valuation = $investment / proposed ownership percentage

Pre-Money Valuation Pre-money valuation = post-money valuation - $investment or Pre-money valuation = price-per-share × pre-transaction (fully diluted) share count (But be careful in down rounds!)

Liquidation Deemed liquidation event Liquidation preference (2X, 3X, etc.) Qualified public offering (QPO)

Dividends Dividend Preference Cumulative vs. non-cumulative dividends Accrued cash dividends Simple interest, compound interest Stock dividends = Payment-in-kind (PIK) dividends

Restricted Stock & Registration Rights Demand S-3 Piggyback Redemption rights In-kind distributions Rule 144, rule 144(k), rule 144A Qualified Institutional Buyers (QIBs) Lockup restrictions

Other issues Step vesting, cliff vesting Right of first refusal, Right of first offer Drag-along rights Take-me-along = tag-along rights Anti-dilution rights, down rounds Pay-to-Play No Shop

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

Convertible Preferred Payoff Diagram

Exit Diagram for Convertible Preferred 15

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)

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).

Structure I

Structure II

Structure III

Structure IV

Structure V

Structure V, continued

Structure VI, RP component

Structure VI, CP component

Structure VI, RP + CP

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

Broad-base weighted average anti-dilution CP2 = adjusted conversion price = CP1 * (A+B) / (A+C) where CP2 = New Series A Conversion Price CP1 = 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 CP1 C = Number of shares of stock issued in the subject transaction

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)

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.)