Is the Venture Economy Back or Do We Just Think So?
Everyone thinks things in the venture world are looking up. Numbers of deals are up, valuations are up, terms are friendly. VCs and entrepreneurs are lining Winter Street and Sand Hill Road holding hands and signing kumbaya. Well, not quite. Foley Hoag LLP, Fenwick &West LLP, and Cooley LLP have now all published their reviews of venture financing transactions for Q1 of 2010, and, while there are some interesting differences, the tone is generally upbeat. Having said that, perspective is everything and sweeping statements about the health of the venture economy are l likely to be wrong if you don’t take all the available facts...
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Term Sheets: Six to One - Half a Dozen to the Other (Part 2)
So, here is part 2 (see last Wednesday's post for part 1). Here is my list of half a dozen things not to negotiate (much) over: (1) Voting Rights. Here is a mistake the VCs made a few times way back in the dawn of time, and now they don’t make the mistake any more. Under Delaware law, unless your certificate of incorporation provides otherwise, you need the vote of the holders of common stock, voting separately as a class, to increase the authorized stock of the company. Without this provision, the common have veto rights over all sorts of things, including additional...
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Antidilution Nuances to Ignore
There are a lot of little nuances that can come up in connection with term sheet negotiations. One of my clients recently brought one of the more irrational ones to my attention with a question about what is and what is not fully diluted. It began with the cap table where the option pool first appears. When determining their investment and the pre and post money valuation, the investors assume the issuance in full of the entire option pool. Just to be clear, if the investors want 50% of the company, they mean after all options in the pool have been granted. (So, if you imagine...
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Two Topics: Activity and Antidilution
I have been out of the country and not watching the blog scene as carefully as I should, but as I sit here in Beijing waiting for my delayed flight, a friend has brought two postings to my attention, and they are both good posts. Data on the startup/venture industry: Techcrunch has posted its exec summary (or a portion thereof) for its first year in review. In an industry where good data (let alone information) is hard to come by, this promises to be a welcome new source. Congratulations. With respect to antidilution: Fred Wilson has a post on "Founder...
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Multiple X Preferences
In the rogue’s gallery of investor protective provisions that come out of their cave in bad times, the multiple X preference is among the first. A preference is a provision that gives an investor a return in the event of a sale of the business before any money goes to the common stockholders. So, in a typical (and very commonly seen in good times as well as bad) 1X participating preferred, the investors get a payment in an amount equal to their investment plus accrued and unpaid dividends before the common get anything. After receiving this payment, the investors participate with the common...
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Full Ratchet Antidilution
Bad times may well cause this beast to come out of its cave. Full ratchet antidilution is a provision that protects investors to the max from low priced issuances. The gist of this provision is that the conversion price of a security (usually preferred stock, but not necessarily) will be reduced to the lowest price at which a company sells any shares of its common stock. So, if you have 1,000,000 shares of preferred outstanding with a conversion rate of $1.00, these shares will convert into 1,000,000 shares of common stock. However, if these shares have a full ratchet antidiluton provision and you issue...
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Weighted Average Antidilution
With new rounds getting harder and harder to do and with valuations going down, certain preferred stock terms are taking on more significance than they normally do. Weighted average antidilution is one of those terms. It is so standard that very little thought is ever given to it. The effect of the antidilution provision is to disproportionately shift some of financial dilution to the common stockholders. It is pointless to argue about the intellectual underpinnings of this practice, because the practice is universal among venture investors. Having said that, you need to understand how the weighted average antidulition formula works....
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Dilution -- Financial and Ownership
Antidilution has been the topic of a prior post and is kind of a tough topic. I find I have to go over the concepts carefully with entrepreneurs. Some entrepreneurs tend to think of dilution as purely a matter of percentage ownership. Although ownership dilution is important particularly as it relates to voting control, investors are typically more concerned with financial dilution. Financial and ownership dilution are related but different concepts. Ownership dilution is easy to explain, if Easy Company has 1,000,000 shares issued and outstanding in the hands of stockholders, and you own 500,000 of these, you own 50% of Easy Company. If Easy Company...
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Terms in Down Times
In a recent board meeting for a client, one VC director described the current investment climate as follows: "flat is the new up 50%." Assuming he is right, and I think he probably is, several things follow. Some of them are obvious. Valuations are down; it is harder to get money than it was just a few months ago etc. However, here is another prediction (perhaps it is obvious as well). Certain deal terms that we have not seen since 2001 will start cropping up like mushrooms after rain. Look out for full-ratchet antidilution provisions and multiple X preferences. Also,...
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