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

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

3. Capitalization Table

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

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

6. 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!)

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

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

9. 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

10. 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

11. 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.

12. Convertible Preferred Payoff Diagram

13. Exit Diagram for Convertible Preferred15

14. 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)

15. 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).

16. Structure I

17. Structure II

18. Structure III

19. Structure IV

20. Structure V

21. Structure V, continued

22. Structure VI, RP component

23. Structure VI, CP component

24. Structure VI, RP + CP

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

26. 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

27. 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)

28. 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.)