Term Sheets
William A. McComas
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
“One of the tests of leadership is the ability to recognize a
problem before it becomes an emergency.”
Arnold Glasgow
“I don’t know about technology and I don’t know about finance
and accounting.”
Bernard J. Ebbers, Former CEO of WorldCom, at his trial
“Shake off any dust that may accumulate from stagnation of
purpose.”
Christopher James Coffland October 2009 (an American War Hero)
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Big Picture
• What are Term Sheets?
– Negotiated before definitive contract
– Contains summary of material terms
– Binding v. Non-Binding
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Know the criteria of Angels investors and Venture Capitalists
Angel investors & Venture Capitalists are not the enemy
How does it work?
They seek return on investment within a finite amount of time
through exits.
• % ownership does not translate directly to entitlement to cash
streams or control over decision making.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas@bowiejensen
(410) 583-2400
What Vehicle Are You Using?
• Equity
– Stock – Corporation
– Membership Interests/Units in an LLC
• Debt
• Hybrid – for example convertible note – starts as debt and
then converts to equity
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Dividend/Distribution - Options
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No Dividend – investors stands with common shareholders on an As-Converted
basis and payable if paid to common shareholders
Cumulative Dividend –
– a % annual dividend
– payable annually, or some material event such as liquidation or redemption
•
Non-Cumulative Dividend - a % dividend when and if declared by board
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Liquidation Preferences
• Timing – Liquidation, dissolution or winding up of the Company.
• Preference –
– A Factor (1,2,3…) times original purchase price
– [[Plus any – accrued/accumulative dividends & any declared & unpaid
dividends]]]
• Types – Non-Participating is preference amount only OR if greater, the investor class
on an as-converted basis with the common without the preference
– The balance distributed on pro-rata to the Common Stock holders.
– Full Participation is the preference and thereafter the investor participates with
common on an as-converted basis (double dip).
– Cap Participation is the Full Participation with a factor (1, 2, 3) used to cap
participation rights.
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Challenge areas is an outbound exclusive license a liquidation? How
about a material sale of a division? Or a change of business?
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Voting Rights
How does the investor or investor class vote on matters as shareholders?
Most decisions are on an as-converted basis
Some decisions are reserved for the investor or investor class
At what point does the investor or class vote as a separate class
Fixed number of class shares outstanding
% or
“any”
Board Composition determines control of the organization
Usually a min and max number of directors as well (See voting agreement)
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Protective Investor Provisions
Limit - Limited to some [[fixed number | %| or “any”]] of shares
outstanding
Examples of decisions:
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Liquidate, dissolve, merge or wind-up the Company
Amend or alter any provisions of the Charter
Create any equity security with the same or greater rights or debt security
Increase the number of shares in the Company or the investor class
Purchase or redeem any capital stock
Pay any dividend on any other than the investor class.
Create or hold capital stock in any subsidiary that is not wholly owned
Increase or decrease the size of the Board (See voting agreement)
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Conversion
• Optional Conversion– shareholder may elect to convert on a 1 to 1
(Conversion factor) basis with adjustments and sometimes “antidilution” adjustments
• Mandatory Conversion
– IPO – with qualifiers such as on original purchase price
multiplier
– Consent - __ % of the class
• Adjustments to conversion factor
– Stock dividends
– Stock splits
– Combinations
– Etc.
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William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Dilution
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No adjustment - conversion factor will not be adjusted for dilution
Full ratchet protection – the conversion factor is reduced to the new price
regardless of the number of shares that have been issued
Weighted Average adjustment to conversion factor
– CP1=CP2 * (A+B) / (A+C)
– CP2 = Price in Effect Before New Issue
– A = # of shares of common outstanding prior to the new issue (includes all shares of
outstanding common, all shares of preferred on an as-converted basis, all
outstanding options on an as exercised basis);
– B = Aggregate consideration received by Company with respect to the new issue
divided by Corporation
– C = Number of shares of stock issued in the “new” issue.
•
Exceptions
– Securities issued upon conversion of any preferred, warrants, options
– Common stock issues upon split, dividend or subdivision
– Employees, consultants and vendors pursuant to stock option plan approved by board,
sometimes class board member and often capped
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Pay to Play
• Investor(s) must purchase pro-rata securities set aside by the Board in a
subsequent round (or down round).
• If investor(s) doesn’t, then may
– lose Anti-Dilution protection
– lose rights to participate in future rounds
– be forced Convert to common
• Often is open to investor(s) vote to force or overrule provided certain % is
outstanding.
• Not a common provision
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Redemption Rights
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Subject to State Laws
“Usually some duration, sometimes five (5) years.
Percent of the Class usually votes
Original purchase price [[[plus all accrued but unpaid dividends.]]]
Sometimes if more than one investor, some are given option to opt-out
Not a common provision
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Purchase Agreement
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Standard Agreement
Representations and Warranties normally standard but trends include
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Open Source Software concerns
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Defect in title concerns extending to Founders
Outbound source code licenses
Inbound/Outbound exclusives and non-compete
Conditions to Closing are standard and often include
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Consents and licenses
Completion of financial, IP and operation due diligence
Opinion of counsel
Blue sky law clearance
Expenses –
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Who pays expenses (legal etc) investor or company
Is there a cap on expenses
Timing of the payment
What happens if the transaction doesn’t close usually expenses are not paid to the party ho cancels
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Right of First Refusal/Right of
Co-Sale Agreement
• ROFR - The right to purchase shares of certain parties before
transfer.
• Sequence – Company then investors or investors then company.
• Scope – Founders, investors, employees holding more than a
% of share, on an as converted basis.
• Oversubscribed – Sometimes includes right to purchase the amount
in the class reserved but not issued.
• Tag Along – Before any [[[investor, founder, key holder]] may sell
shares to a third party, that shareholder must offer the terms to other
investors so that the other investors can participate in selling as well
• Exceptions – Estate planning, affiliate family members.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Investor Rights Agreement
• Registration Rights – the right to require the company to register shares
with the SEC before they can be sold to the public. Company wants to
limit these rights because of the cost and possibility to force pending
material transactions to be disclosed.
• Scope of Rights – certain investors, all investors in a class and
sometimes the common held by those shareholders.
• Demand – Typical Criteria
• [[3-5 years]]] following the closing of the investment or [[6]] months following an
IPO.
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% of shareholder may request.
• Requests normally limited to 1,2,3…
• Acceptable offering price at least is great as 5,15,25,50…
• Request will count if all securities are registered.
• Counts if closed or withdrawn at the request of the investors other than a material
adverse change.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Registration on Form S-3
• Form S-3 - Simplified security registration form from the
SEC, open to companies that have met prior reporting
requirements and only available to companies based in the US.
• Typical Terms:
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% of Shareholders (10%,20%,30%...) require Company to
register Form S-3.
– Usually the threshold on aggregate offering price (1,5,10…million)
– Usually no limit on number of requests but a limit on the actual filings.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Other Terms in IR Agreements
•
Piggyback Registration – holders of “registrable securities” are entitled to “piggyback” registration rights on all
registration statements of the Company
– Usually limited to provide flexibility to underwriters to reduce the number on a [[[pro-rata]] basis and to eliminate if
IPO
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Registration Expenses – Usually paid by the Company and sometimes includes the expenses of one special counsel to
represent the class along with a CAP on exp.
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Lock-Up Period in which no investor will sell or attempt to transfer shares – Underwriters usually seek it
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Right to Participate in future stock issuances (similar to pay to play)–
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Typically 180 Days plus some
Sometimes tied to all Directors and Officers and key Shareholders
Any discretionary waiver is applied to all Shareholders on a pro-rata basis.
Usually on a Pro-rata basis and
Excluded issuances typically are the same found in the Anti-Dilution provision.
Termination–
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Upon a liquidation event
Investor share are all eligible for sale without restrictions under Rule 144
The [[[___]] anniversary of the IPO.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Mgmt & Info Rights in IR Agreements
• Corporate Code provides limited rights so investors expand on
those rights.
• Investors may visit Company facilities and personnel during
normal business hours.
• Annual, Quarterly, Monthly Financials at Least 30 Days Prior
to the End of the Year Budget.
• Major investors sometimes defined as a percent Shareholder
rather than a Shareholder in a Class.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Investor Protective Provisions at Board Level
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Scope – so long as there is an investor board member, the Company without board approval which must
include the investor board member, cannot approve some material actions.
Typical Examples include:
– Loan or advance, or own any stock in any entity unless wholly owned by Company
– Make loan or advance to any person (individual, employee, director, etc.)
– Guaranty any debt other than trade accounts or subsidiary on the ordinary course.
– Make any investment inconsistent with the investment policy approved by the Board.
– Incur debt in excess of
not already included the Board approved budget other than trade
credit in the ordinary course.
– Enter into any agreement with any Director, Officer, or Employee of the Company.
– Hire, fire or change the compensation of executives.
– Change the principle business of the Company.
– Sell, assign, license, pledge, or enter into any material transaction involving IP.
– Enter into a corporate strategic relationship with payment or assignment in excess of ____
– [Budget Approval]
– [Contract in excess of
]
– [Exclusive licenses, source code licenses & non-competes]
– [[Launch, research and/or develop a new product not in the approved budget or plan]]
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Other IR Matters in IR Agreements
• Non-Competes - Founders and key employees often enter a non-compete
and non-solicitation agreement for some period of time (1,3,5…)
• Assignment Inventions - Founders and key employees often enter into a
non-disclosure and proprietary rights agreement.
• Key insurance – The Company is often required to purchase life insurance
on founders and key personnel.
• Employee Option Pool – Usually capped at a certain amount; sometimes
terms such as vesting period are established as well.
• Board Matters – Each committee may be required to have a class director
appointed to it.
• Board Meetings - Board will meet in a scheduled period.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Voting Agreement
• Board of Directors – Number of Directors fixed
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Composition of Directors – how many elected for each class
Odd Number
Lead Investor Appoints sometimes
Founder(s) appoint
CEO of the Company is sometimes automatic
Person who are not employed by Company and acceptable by the other
Directors by requiring Shareholder to vote on a Director.
• Drag Along – Investors may require founders and sometimes other
key shareholders to vote in favor of a liquidation event.
• Sale Rights – Sometimes certain investors may acquire the right to
initiate a process to sell the Company.
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Miscellaneous items found in term
sheets
• Founders Stock - All Founders that own stock may be subject to
Company right to buy back at cost. Usually for
% for [first year]
and lapses in equal monthly amounts only the next period of time [3,5,…].
• Existing Classes - Usually same reconciliation needs to occur if there are
earlier rights with respect to the rights and privileges.
• No-Shop/Exclusive/Confidentiality
– Company will not shop around for some period.
– If Company violates, Company pays investor(s) liquidated damages
equivalent to time and materials.
– Maintain Confidentiality.
– Notify investors of another entity expresses interest.
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Expiration Date for the definitive deal to be closed
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400
Questions
Bill McComas
443-921-4214
mccomas@bowie-Jensen.com
William A. McComas
EMPOWERING BUSINESSES TO SUCCEED
bowie-jensen.com
mccomas @bowiejensen
(410) 583-2400