1. Laurel Durham - Partner, Holme Roberts & Owen LLP Mark Weakley – Partner, Holme Roberts & Owen LLP 1 Entrepreneurial Finance: Cap Table Management and Other Issues Surrounding Equity Financing

2. Entrepreneurial Finance – founders, friends & family (the "3Fs", sometimes spelled out as "founders, friends & fools"), or bootstrapping phase – business angels – venture capital (VC) (typically multiple preferred stock rounds), and – initial public offering (IPO) or mergers & acquisitions (M&A ) Typical Funding Cycle:

3. Entrepreneurial Finance Cap Table Management Issues Number of Founders How to split Equity among Founders Plan for changing contribution levels Keep it Simple – Few Angels, Advisors – Pay them off the cap table 3

4. Entrepreneurial Finance Cap Table Management Issues Compensation – Options, Warrants, RSU’s – Title Inflation – “Punished by Rewards” Alfie Kohn Can you attract a fundable team? – Ideally ‘been there, done that’ with investor ties Role of Advisors – Attorney, Accountant – IB (at the end, not the beginning) 4

5. Entrepreneurial Finance Mistakes That Can Hurt Financing Harmful Equity Agreements – Written or oral promises of on-going equity stake – Inflexible stockholder agreements (e.g., amendment approvals or termination upon IPO or liquidity event) – Using up incentive pool too early Clarity around IP ownership – Problems of joint ownership – NDAs, invention assignments, development logs – Public disclosure before patents are filed 5

6. Entrepreneurial Finance Mistakes That Can Hurt Financing Unsettled equity ownership issues – Founders’ Stock Documentation of who owns what percent of the company Stock issuances and consideration documented (cash, technology, etc.) Stock restrictions in place: vesting, repurchase rights, first refusal rights, acceleration and IPO lock-ups Vesting and 83(b) elections – Equity Incentive Compensation Plan early Establish thought-out pool Interplay of timing and valuation 6

7. Entrepreneurial Finance Company valuation Dividends Liquidation preferences and participation Anti-dilution protection Key Financing Terms Impacting Returns:

8. Entrepreneurial Finance Determines the price per share Lower valuations results in greater investor ownership and lower founder ownership Evaluate valuation in the context of the overall economic package – Trade-offs between valuation and other economic terms - dividends, liquidity preferences and anti-dilution rights Pre-Investment Valuations:

9. Entrepreneurial Finance Dividends Dividends are payments to stockholders that represent a current return on the stockholder’s investment. Alternatives: – Cumulative vs. Non-Cumulative – Mandatory vs. Board Discretion – Participating vs. Non-Participating – Cash vs. Stock Key Issues: – Impact at liquidation – adds to economic return of investors (and accordingly, increases dilution to founders/existing investors) – Dividends can be a drag on current earnings 9

10. Entrepreneurial Finance Liquidation Preferences A “liquidation preference” determines how the assets of a corporation (after all debts have been satisfied) will be shared among the stockholders upon a “liquidation event.” A “liquidation event” usually is defined to include not just a voluntary or involuntary liquidation, dissolution or winding up of a corporation but also a sale or lease of all or substantially all of the assets of the company and certain other “change of control” transactions. 10

11. Entrepreneurial Finance Liquidation Preferences Two Components – Preference Multiple return - (1x - 4x) – Participation rights (if any) Rights of preferred stockholders to participate with the common stockholder in the residual (i.e. the amount after paying the actual preference) – full participation, capped participation or no participation 11

12. Entrepreneurial Finance Anti-Dilution Protection Protect investors if new securities are sold below the “conversion price” then in effect – The conversion price determines the number of shares that the holder of preferred stock is entitled to receive upon conversion of its preferred stock into common stock – The conversion price is initially equal to the original purchase price for the preferred stock - a 1:1 ratio Two basic mechanisms for conversion price adjustments – Weighted average – Full ratchet 12

13. Entrepreneurial Finance Weighted Average Anti-Dilution Some amount of “Share the Pain” Basic formula: Initial Purchase Price x Number of preferred shares Conversion Price to be converted Narrow vs. broad-based – Broad-based (favors founders and other common stockholders) In addition to outstanding shares of common stock (assuming conversion of preferred stock), treats all shares underlying options (outstanding options only or outstanding options plus the unissued option pool reserve), warrants, convertible notes and other rights as if they are outstanding. – Narrow-based (favors preferred stockholders) Excludes underlying options, warrants, etc. 13

14. Entrepreneurial Finance Full Ratchet Anti-Dilution Much easier to calculate, but much more difficult on the founders and any other common stockholders. If one share of stock is issued or convertible at a lower price than the price paid for the applicable share of preferred stock, then the conversion price of any existing preferred shares is automatically “ratcheted down” to the lower price. Limitations to consider when representing the company: – Time – Subsequent up-round financing – Waiver by majority of protected class or series 14

15. Entrepreneurial Finance Q&A 15