During this webinar you will learn the basics of the venture model and path along with the necessary steps to take so that your company’s legal structure is an attractive investment. The discussion will cover:
1. Why a Delaware C-Corp is the most-common structure
2. How to document the relationship of the founders and early employees
3. The typical funding stages of a successful startup
4. An overview of convertible debt and SAFEs
5. Why it’s critical to run pro forma cap tables before financings
6. What happens in a venture financing
7. Why compliance with securities laws is important
8. Common legal mistakes in raising capital
9. And much, much more
2. IMPORTANT CAVEATS
Today’s Discussion is General Information – Not Legal
Advice
We will be discussing rules and exceptions. Those rules,
exceptions, and exceptions to the exceptions may not be
applicable to your situation.
You need to retain competent legal counsel to review all
facts and circumstances before weighing in with advice.
Off-the-cuff answers to your questions are not, and
should not be taken, as legal advice.
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3. OVERVIEW
My Background
Structural Considerations
Entity Form
Typical Financing Stages
Documentation for Founders and Early Employees
An Overview of SAFEs and Convertible Debt
Overview of Valuation & Dilution—Pro Forma Cap Tables
Overview of Venture Financings
Common Pitfalls
Q&A
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4. Background
Venture Capital and Emerging
Growth Company attorney-
practicing law since 2005.
My office is in San Francisco,
but I work with companies
throughout the US and the
world.
I love working with
entrepreneurs on financings, as
outside counsel, and on exits.
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Jason Putnam Gordon
Partner
+1.415.882.8124
Jason.Gordon@klgates.com
7. FOUNDER AND EARLY EMPLOYEE
DOCUMENTATION
IP Assignments
Vesting
Stock Options
Restricted Stock
Transfer Restrictions
Shareholder Agreements
Restrictions in Bylaws
Stock Purchase Agreements
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8. FINANCING OPTIONS
Convertible Debt/Equity
Also known as bridge notes
Convertible debt is the parent of convertible equity,
which can also be known as a SAFE Instruments
Y Combinator developed the SAFE
Venture Rounds
Series Seed and Series A
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9. CONVERTIBLE SECURITIES
Convert to future equity securities at a
negotiated discount to a future qualified equity
financing
This avoids valuing the company
Far less expensive than a venture round like a Series
Seed or Series A round
Downsides (At least for Convertible Notes)
This is debt and may be required to be paid at some point
Extra liquidation preference above all other equity, unless
otherwise handled
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10. CONVERTIBLE SECURITIES (CONT.)
Maturity*
Interest Rate*
Conversion Terms
Amendment Terms, e.g., majority in interest
Remaining Terms
It’s not that common to negotiate these
(*For Convertible Notes, not SAFEs)
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11. CONVERSION TERMS
Mandatory conversion at a discount of price paid
in Next Qualified Financing
Series Seed/A needs to meet the definition of a
“Qualified Financing”
Equity financing
Minimum size, e.g., “$2,000,000”
Discount has to be reasonable or later investors will
not go for it. 20-25% is typically reasonable.
Conversion Price Cap
Conversion upon a change of control/sale
Optional maturity conversion
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12. FOUNDATIONAL BASICS – VALUATION
AND DILUTION
Pre-money valuation – the value of the company
before the next round of investment.
Post-money valuation – the value of the
company after the round of investment.
Fully-diluted basis – all common stock issued
and outstanding, plus all securities that can be
converted to common, plus (typically) the shares
reserved for equity compensation.
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13. FOUNDATIONAL BASICS – VALUATION
AND DILUTION
Very Simple Example (not factoring in the option pool or
any other equity)
Pre-money $10,000,000
10,000,000 shares split among three equal founders
Founder A = 3,333,333 shares or 33%
Investment $3,000,000 at $1.00/share ($10,000,000 pre-
money/10,000,000 outstanding shares) (Post-money is
$13,000,000)
Founder A = 3,333,333 of ~25% with a paper value of
$3,333,333
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14. FOUNDATIONAL BASICS – EXAMPLE
CONTINUED
Basic Examples with Convertible Securities
If there had been $450,000 convertible security with 25%
discount only, holder would have received 600,000 shadow
shares. $450,000/((1-.25)*$1.00)
This example ignores the circular math: in determining the price the new
money will pay and on which the discount will be applied, the investor will
include the shadow shares in the fully diluted basis.
If there had been a $450,000 convertible security with
$5MM cap only, holder would have received 900,000
shares. $450,000/(5,000,000/10,000,000)
This example also ignores that the investor will include the shadow
shares in the fully diluted basis, which will change the price per
share the investor pays.
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15. OVERVIEW OF VENTURE FINANCINGS
Have a credible business plan with milestones
Run a Systematic Process
Have more than enough capital from your earlier seed
rounds
Connect with the right Investors
Understand your ideal term sheet
Prepare for through diligence
Be prepared for cleanup
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16. OVERVIEW OF VENTURE FINANCINGS
(CONT.)
Understand your ideal term sheet
How much of the company is being sold
Dividends
Liquidation preferences
Voting Rights
Protective provisions
Optional and Mandatory Conversion
Antidilution protection
Vesting for founders
Documentation
Attorneys Fees
No Shop and Confidentiality Provisions
Whether investors will get a board seat
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17. OVERVIEW OF VENTURE FINANCINGS
(CONT.)
Diligence process
Documentation Process
NVCA - https://nvca.org/model-legal-documents/
Series Seed - https://www.seriesseed.com/
Proprietary forms
Closing
Post-Closing Items
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18. COMMON PITFALLS
Non-Compliance with Securities Laws
Other Regulatory Issues
Not managing cap tables
Thinking that there are “standard” terms
Finders
Side Letters
Failure to obtain proper corporate authorization
Not forming an entity or the right entity
Not getting vesting agreements in place
Not filing 83(b) elections
Not paying attention to securities laws
Risk of employment-law issues
Undocumented stakes in the company
IP that resides in other entities
Tax issues – E.g., federal, state, local
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