My blogger friends (and the firm's blogger consultants), indeed, it seems the entire blogosphere seems to agree that blogs are not really an optimal publication platform for dissemination of pure content. I take that to mean that putting law review articles (or any substantive articles on legal (or other) topics) is really not what blogs are "about."
Instead, blogs are supposed to be pithy comments on other people's posts (or perhaps some other thing going on in the real or virtual world). Hence the prevalence of blog posts that begin with some reference like, "Harry has a great post about his date with Sally...." Harry's post, it turns out, is likely to be some observatlon about something Sally wrote on her blog. Sally's blog, in turn, refers to Tom and Dick....
So, the consultants appear to say, blog posts should be pithy comments about pithy comments.
And, the occasional pithy comment is probably a good idea, but when I look at the statistical data concerning this blog and I consider which posts seem to have generated interest and which have not, the numbers (meager as they are) support a completely different notion.
Readers want content more than conversation – at least as much as conversation.
I am, for example, under the impression that Fred Wilson was very successful with MBA Mondays. (Now, his entire blog is a huge success.)
Switching gears, Prithvi has told me on many occasions that the content posts I have done in the past are more geared for consumption by lawyers than by entrepreneurs.
So, I am going to try and take a trick from Fred's book and apply Prithvi's advice and write a series of posts (I will try for weekly) that will be both substantive and usable by entrepreneurs. The posts will be checklists for things that are legal in nature. The idea is to put the entrepreneur in a position to think about whether he or she has covered everything he or she needs to cover in a document or deal.
Of course, the usual caveats about how this is not legal advice and does not create a lawyer client relationship etc. apply.
I thought I would tackle seed preferred term sheets first. Although these can vary from one pagers to 5 pagers (or more), for the purpose of creating a checklist, I am going with the longish form. After all, it is the purpose of a checklist to be over inclusive. Also, I have linked each of the terms (and some other items) to the glossary defining these terms on the EEC microsite and, where it seemed relevant, to my blog.
Please send me thoughts on the checklist. If the checklists seem useful (or popular) I will post them on their own site on an easy to use open source basis.
Here goes:
|
Term |
Included |
Comment |
|
|
Yes |
No |
||
|
Amount of Investment
|
Term sheets typically state the amount to be raised, either as a specific amount or a range.
|
||
|
Single closing
|
If the entire amount of the investment is to be raised at a single closing, then term sheets are often silent on the matter of single vs multiple closings
|
||
|
Multiple closings
|
Often the parties anticipate an initial close on some portion of the raise, with one or more follow-on closings at which additional investors come in. When multiple closings are envisioned, term sheets often state that
|
||
|
Security
|
Term sheets clearly state the name of the security being sold (for example "Series Seed Preferred" or "Series A Preferred Stock").
|
||
|
|
Dividends typically come in one of two flavors: (1) no dividends (which really means that the investor gets dividends if any are declared on the common stock – which typically is never) or (2) the investor gets dividends that accrue (but are not actually paid until a liquidity event) at a stated rate. While experience indicates that accruing dividends are not the "norm" for seed stage deals, they are not unheard of (at least not in New England). Accruing dividends can have a material impact on the economics of a transaction and can set precedent for future investments (which can materially magnify the impact). If accruing dividends are contemplated, they should be discussed and included in the term sheet. If accruing dividends are not contemplated, the term sheet can merely refer to dividends as declared.
|
||
|
|
By far the most common term is for a liquidation preference equal to the amount invested (referred to in the trade as a "1x liq pref"). However, rarely, but sometimes, you see no liq pref or, multiple x liq prefs. In each of these circumstances, there is some externality (such as a very hot deal or some unusual risk) that accounts for the variance
|
||
|
|
Participation means that the Seed Preferred (or any preferred) gets to participate with the common stock in the proceeds of any liquidity event on an as converted basis. While this might seem self-evident, this provision must be considered in connection with the liq pref. There are investments in which any of the following might be the deal: (1) the investor gets the greater of the liq pref or whatever she would get upon conversion, (2) the investor gets the greater of the liq pref plus whatever she would get upon conversion up to a cap (for example 2 times money invested) or whatever she would get upon conversion or (3) the investor gets her liq pref plus (after receipt of the liq pref) gets to participate with the common on whatever is left over. Needless to say, number (1) is the best deal for the founder and number (3) is the best deal for the investor.
|
||
|
|
Term sheets typically state the rate of conversion from seed preferred to common stock (typically the cap table is arranged so this rate starts out at one for one – and is subject to adjustment in accordance with antidilution provisions).
|
||
|
Antidilution -- Weighted Average
|
Broad based weighted average antidilution makes adjustments to the conversion rate to protect investors on a weighted average basis against future issuances of stock at prices below what they paid. It is by far the most commonly seen form of antidilution protection for investors. Unlike full ratchet provisions, its impact on entrepreneurs is not often draconian. This provision may be contrasted with narrow based and fully broad based provisions, as well as with full ratchet provisions. The formula for weighted average antidilution is complex and clumsy and a description is beyond what can be done in a checklist. Nonetheless, if you are not familiar with these terms check out the links provided above.
|
||
|
|
Unlike weighted average provisions, full ratchet antidiluton provisions are likely to have draconian consequences for founders. Full ratchet provisions protect investors by reducing the conversion rate to the lowest price at which a share of common stock (or common equivalents) is sold by the company – without regard for the quantity of shares sold. Full ratchet provisions are only seen in a small minority of cases where there is some factor (such as an otherwise not bridgeable disagreement over valuation) that accounts for the full ratchet. If full ratchet provisions are contemplated, the founders should consider negotiating limitations such as a bottom on the conversion rate, or a time limit, or exclusions for strategic issuances or issuances to lenders (or all of the above or other additional limits).
|
||
|
|
Many investments (particularly in Silicon Valley but also almost half in New England) do not provide for redemption at all. By far the most common redemption term is a right of the investor to require the company to repurchase his stock in three equal tranches in years five, six and seven.
|
||
|
Voting
|
Typically, voting is on an as converted basis so that the investor votes with the common stock on matters that are generally submitted to the stockholders. Delaware law requires class by class votes in some circumstances, and the investor will likely negotiate some specific protections that require a separate vote of the investor class
|
||
|
Board of Directors
|
Term sheets tend to be very explicit about the size of the board and who will be on it. Three and five member boards are both common in early stage companies
|
||
|
Founder
|
The term sheet should state if the founder is to be on the board.
|
||
|
Investor
|
The term sheet should state if the investor is to be on the board and, if there is more than one investor, how many investors will be on the board.
|
||
|
Other
|
The term sheet should state who else will be on the board (perhaps the CEO, if he is not the founder, or an independent person).
|
||
|
Information Rights
|
Term sheets sometimes go into some detail about what annual, quarterly, and monthly financial and other information must be made available to investors. Except in a case where something specific and particular to the investment is contemplated, a reference to usual and customary information rights is probably sufficient.
|
||
|
|
Now that IPOs are back (sort of), registration rights may be of greater concern than they have been in the recent past. Typical provisions might be two demand rights, unlimited piggy back registrations, unlimited S-3 registrations and an 180 day lock up in the case of a company offering. Even in a hot market, the likelihood of an IPO is low, so I would not spend a lot of time (or political capital) fighting over this provision.
|
||
|
Right of First Refusal on Company issuances
|
Investors generally like to have a right to maintain their percentage ownership in a company through subsequent rounds of financing. The only downside is that many angels (and even some early stage funds) either can't won't or don't really intend to participate in the future. In those cases and in cases where the seed players want tiny slices of the A round, this right can add some complexity to your negotiation with the next round investor.
|
||
|
Right of First Refusal on Founder sales and co-sale
|
Investors generally like to have a right to acquire any founder shares that might be for sale – if they want them. Also, investors don't want founders selling out and leaving the investors holding the bag. So, they bargain for a right to sell along side the founder. These provisions are absolutely standard in VC transactions. They are less likely to be seen in seed/angel transactions.
|
||
|
Drag along
|
This is the right of someone to force the founders (or other common stockholders) to sell. Drags are typically structured to force everyone who is a party to the contract to sell in any transaction approved by all three of (1) the preferred holders, (2) the common holders, and (3) the board of the company. Such a provision is really a housekeeping arrangement whereby the majority can deliver the entire company in a nice clean package. Sometimes you see drag provsions by which the preferred can force the common to sell. This type of drag needs to be considered carefully – especially in a situation where the common constitutes a majority of the equity of the company. In such a situation, the minority could sell the company against the desire of the majority. And, make no mistake about it, these provisions are likely to be enforced by a court. Here are some thoughts on drag provisions.
|
||
|
Protective Provisions
|
This is a list of the things that will require a separate approval of the seed investor (that is in addition to any other requirement). The list below is pretty standard, and a term sheet could refer to standard provisions and leave it up to later negotiation, but listing them in the term sheet is probably good practice.
|
||
|
Merger
|
|||
|
Sale of Assets
|
|||
|
Dissolution
|
|||
|
Issuance of senior securities
|
|||
|
Issuance of pari passu securities
|
|||
|
Dividends
|
|||
|
Increase in authorized stock
|
|||
|
Change in size of Board
|
|||
|
Incurring debt
|
|||
|
Vesting for Founders
|
It is not unusual for sophisticated angel groups and super angels to insist that the founders subject their stock to vesting. Very small investors typically don't ask for this. Typical provisions might be for some portion (10% to 50%) to be fully vested and the rest to vest over some number of years (one to four – perhaps).
|
||
|
Costs of counsel
|
Angel groups and super angels often ask that their counsel fees be paid out of the transaction proceeds. (Sometimes they don't use counsel – which has the benefit of reducing that cost.) Also, your counsel (who should be doing the drafting of the documents) will have to be paid. Especially in small raises you should strive to keep transaction costs down. The best way to do this is to discuss and agree upon costs up front with the investors and with both sets of counsel. Here is a link to some observations on this topic.
|
||
|
Founder Representations
|
This is a provision whereby founders represent various things about the company and are potentially liable for misstatements. It is never seen in the Valley and is sometimes (often?) seen in New England. I would not be overly paranoid about these, but if you agree to them, you should negotiate some limitations. See the next item on this list.
|
||
|
Limitations on Founder Representations
|
When founder reps are agreed to they are often limited as to matters (such as intellectual property and ownership of the company) as well as to exposure (such as the liability of founders will be limited to their stock).
|
||
|
Most Favored Nation
|
This is a provision not much seen, in New England anyway, that provides for the investor to be given whatever favorable terms the next investor negotiates. This provision may be more relevant where the seed investor has relatively few terms than in a fully negotiated deal (such as one that covers most of the terms listed in this checklist). Here are some thoughts on this topic.
|
||
|
Exclusivity period
|
Investors often ask for some period of exclusivity (30 to 60 days) during which the founders will only deal with the investor.
|
||
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
