Startup Equity Allocations, Cap Tables, Pricing Negotiations
UCLA Office of Intellectual Property
December 9, 2013
California Massachusetts Florida www.rothmanandcompany.com
steve@rothmanandcompany.com
(310) 993-9664

Biographical Information
•
27 years business law practice
•
Currently focus on startups from universities and their investors
•
20 university startup formation / financings completed in last two years
•
Largest client is super-angel who does multiple university startup financings each year
•
Formerly a partner at Morrison & Foerster and at Irell & Manella
•
Now 2-person firm
•
Experience as founder and entrepreneur
•
Frequent speaker – NCET2 webinars, Children’s Hospital L.A., USC
Stevens Institute, Caltech Office of Technology Transfer, Florida
Innovation Hub at UF Gainesville
•
J.D., cum laude Harvard Law School, 1985
•
B.A., cum laude, Yale University, 1982
2

“Pre-money valuation”
•
In the context of an upcoming equity transaction, the value that is assigned to the company prior to consummation of the financing.
•
The earlier the stage, the less objective analysis
•
The earlier the stage, the more a product of leverage and negotiation
• Accepted valuation methods for mature companies don’t apply:
•
P/E ratios
•
Acquisition prices
•
Revenue multiples
•
For Internet companies with no revenue, unique visitors
•
Asset valuation
3

“Pre-money valuation” 2
• university based startups usually too early-stage for technical, evidenced based valuation
•
Assigned pre-money valuation is a matter of negotiation and leverage, not a real “valuation.”
4

“
Post-money valuation
”
In the context of an upcoming equity financing transaction, the value that is assigned to the company immediately following consummation of the financing .
Post-money valuation = Pre-money valuation + Money Invested in Round
5

Example 1
Pre-money
Cash in
Post-money
Valuation
$4,000,000
$3,000,000
$7,000,000
Example 2
Ownership (disregards preferences)
Founder %
Investor %
57.14%
42.86%
Pre-money
Cash in
Post-money
Valuation
$2,000,000
$3,000,000
$5,000,000
Ownership (disregards preferences)
Founder %
Investor %
23.00%
60.00%
Employee Pool
University
15%
2%
6

5-Sep-09
Com panyX Consolidated Cap Table
Com m on
Stock
Bridge dates
Com m on
Options Holder
Com m on Stock
Caltech
Early employee
Founder 1
Founder 2
Early employee
Early employee
Early employee
Com m on Options
"2008 Series A options"
Employees 1 -35
XXXXXX Venture XXXXX
Non-founder CEO
Angel
Consultant
Total Pool
Unissued Pool
Com m on Warrants
Attorney
Law firm
Series A Preferred and
Preferred Warrants
_____ _________ Fund LLC
University
Corporate VC Arm
MiYZ Venture Partners
_________________ Bank
Angels w ith converts
Angels w ithout converts
221928
18000
4,000,000
4,000,000
12,308
37,500
170,000
200,000
200,000
165,000
2,544,560
15,000
1,650,000
136,000
40,000
5,502,780
514,720
5/22/2008 5/29/2008
Com m on
Warrants
Series A
Shares
3,750
11,250
521,154
384,615
2,538,462
12/15/2008
Series A
Warrants
41,163
0
0
0 38,465
769230 60756.54873
2593921 204876.6092
1/9/2009
2009 A Price $0.65
Closing date 1/20/2009
Bridge
Warrants
9,632
300,000
2009 A
Shares
307,692
65,397
3,899,378
As
Converted
221,928
18,000
4,200,000
4,200,000
12,308
37,500
170,000
165,000
2,544,560
15,000
1,650,000
136,000
40,000
5,502,780
514,720
3,750
11,250
307,692
562,317
459,645
6,737,840
%
12,811,666 $1,000,000
0.83%
0.07%
15.70%
15.70%
0.14%
0.64%
$200,000
$42,508
0.05% $2,534,596
Series A %
2.40%
4.39%
3.59%
$24,017
$43,891
$35,877
52.59% $525,914
0.30% $3,002
450000 0 0.105635 105635.044
Current
Investm ent
$200,000
$338,750
$292,508
$4,184,596
$0
949999.5
250000 0 0.2484777 248477.684
1936048.65
0.62%
9.51%
98.68% $986,814 $7,901,902 0.06% $3,277,104
6.168%
0.51%
0.150%
20.57%
1.924%
0.01%
0.04%
1.15%
2.10%
1.72%
25.19%
38,465 0.14%
0 692307.6923
1522294.241 0.0536947
0 384615.3846
3183412.994 0.1189986
7
Totals
Total issued from employee pool
(inc exercised options)
Series A total
8,459,736
7,152,643
5,502,780
4,988,060
26.737%
15,000 6,807,382 345,261 309,632 5,349,391 26,751,682
$17,388,593
99.68%

Class A Common Stock
Founder 1
Founder 2
Founder 3
Pledged by Founders for
Unvest Options for
_____________ Emp
Pledged by Founders for
Key Emp Exit Sales
Bonuses
Before Debt
__________ Inc. Capitalization Table As of December 31, 2013
With Debt Angel 2 $5M
10,152,361
3,534,575
3,534,575
1,767,287
397,605
918,319
29.9%
10.4%
10.4%
5.2%
1.2%
2.7%
10,152,361
3,534,575
3,534,575
1,767,287
397,605
918,319
16.5% 7,657,461
5.7% 2,536,615
5.7% 2,536,615
2.9% 1,268,307
0.6%
1.5%
397,605
918,319
Option Pool
Series A (1)
Anti-Dilution Additional A
Angel 2
Series B Notes, Fully Converted
Series B, Warrants (Vested)
Total
3,933,333
15,000,000
4,847,639
33,933,333
11.6%
44.2%
14.3%
100.0%
3,933,333
15,000,000
27,713,304
4,847,639
61,646,637
6.4%
100.0%
6,428,233
24.3% 15,000,000
25,593,671
4,591,595
45.0% 27,713,304
7.9% 4,847,639
91,831,903
8.3%
2.8%
2.8%
1.4%
0.4%
1.0%
7.0%
16.3%
27.9%
5.0%
30.2%
5.3%
2,494,900
79.66% Angel 1
100.0%
CP1 A =
CP1 B =
$ 0.5459
$ 1.03
(1) 11,000,000 shares divided by 0.73333 conversion price
Full anti-dilution protection Angel 1 On=1.0
Angel 2 Price
Angel 2 Initial Shares
$ 2.5620
1,951,625
Angel 2 converted to Common
Angel 2 Anti-dilution shares
2,661,307
1,930,288
1
4,591,595
Total Angel 2 Fully Diluted Shares 4,591,595
Series A Preferred Shares 11,000,000
Series A Conversion Price
Series B Investment
Series B Notes Accrued Int to
December 31, 2013
$ 0.73333
$ 26,400,000
Series B Conversion Price
ESOP Shares
$ 2,184,333
$ 1.03143
3,933,333
Series B ESOP Target
New $5M Bridge On=1
9/30/2013
10/31/2013
-
7.00%
1
1,690,583
11/30/2013
12/30/2013
1,765,583
1,840,583
1,915,583
Checks for ESOP exericse
$ 4,781.16
$ 2,860.66
$ 1,800.00
$ 1,755.00
$ 11,196.82
62,205 Shares issued
$
$
$
$
1.03143
25,000.00
51,750.00
83,750.00
115,750.00
$ 147,750.00
$ 179,750.00
$ 211,750.00
$ 268,750.00
$ 37,400,000
$ 2,500,000
$ 2,500,000
$ 700,000
$ 700,000
$ 5,000,000
8

Factors Influencing Pre-Money Valuation (i.e. Founder Share)
•
Overall startup investment climate
•
Negotiation sophistication of founder or founder representative
•
Same factors that investors consider in deciding whether to invest at all:
• market size;
• market attractiveness;
• Investment fads
• management team / previous startups
• stage of development;
• market for exits.
9

Types of Equity Interests in Corporations
•
Common Stock – residual category
•
Straight Preferred Stock – almost like debt priority over common but no upside
•
Convertible Preferred Stock – has the benefits of both common and straight preferred.
•
Participating Convertible Preferred Stock – various level of “double dip”
10

Convertible but not Participating
Cash Invested
Pre-money valuation
$8,000,000
$8,000,000
Preferred as converted %
Common as converted %
Sale Price
50%
50%
Common
Convertible Preferred
$5,000,000
Proceeds
$0
$5,000,000
Common
Convertible Preferred
Sale Price
$13,000,000
Proceeds
$5,000,000
$8,000,000
Investor won’t like this scenario.
Founder is “making $5 million” and “I just get my money back.”
Go back to concept of pre-money valuation and the concept of preferences that we skipped over; did the founders really put in
$8 million of value or not.
11

Investor’s response to convertible but not participating scenario –
Convertible and participating.
Cash Invested
Pre-money valuation
Preferred as converted %
Common as converted %
Common
Convertible Preferred
$8,000,000
$8,000,000
50%
Sale Price
$5,000,000
50%
Proceeds
$0
$5,000,000
Common
Convertible Preferred
Sale Price
$13,000,000
Proceeds
$2,500,000
$10,500,000
12

Founder’s concern with convertible and participating – the double dip (was founder contribution really worth $8 million?)
Partial answer – capped participating convertible preferred
$8 million invested, 50/50 as converted, 2X cap
Sale Price
Common
Convertible Preferred
$5,000,000
Proceeds
$0
$5,000,000
Common
Convertible Preferred
Sale Price
$13,000,000
Proceeds
$2,500,000
$10,500,000
Common
Convertible Preferred
Sale Price
>$32,000,000
Proceeds
50/50
13

LLC Capital Accounts
Percentage Interest Capital Contribution
Investor
Founder
50%
50%
IRS Rule Distribution According to Capital Accounts
$4,000,000
$0
Sale price $5,000,000
Proceeds Investor $4,500,000 Founder $500,000
Similar to uncapped preferred stock participation in corporate context. So founder doesn’t like this.
14

Possible Alternatives in LLC
• “Layer Cake” Profit and Loss Allocations
• Allocated P&L per percentage interests
• Distributions on sale per capital accounts
• Investor has infinite double dip
• “Target” Profit and Loss Allocations
• Specify how you would like distributions to come out
• Allocate P&L however you need to in order to make capital accounts consistent with those distributions
• Satisfies IRS rule that distributions are pursuant to capital accounts, though only because the capital accounts have been tinkered with to make them equal desired distributions.
15

‘Median pre-money valuation of venture capital seed-stage enterprises has varied over a narrow range between $1.7 million and $2.5 million since 2002.”
Kauffman eVenturing The entrepreneur’s trusted guide to high growth. “Valuing Pre-revenue companies.” p.8. www.eVenturing.org
16

Stephen P. Rothman, Esq.
Rothman and Company, P.A.
E-MAIL: steve@rothmanandcompany.com
Direct Phone: (310) 993-9664
Sean Brady, Esq.
Rothman and Company, P.A.
E-MAIL: sean@rothmanandcompany.com
Direct Phone: (626) 993-8424 17 www.rothmanandcompany.com