California Massachusetts Florida www.rothmanandcompany.com steve@rothmanandcompany.com (310) 993-9664

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

2. 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

3. Terminology “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

4. Terminology 2 “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

5. Terminology 3 “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

6. Simple Initial Capitalization Tables 6

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9. Factors Influencing Pre-Money Valuation (i.e. Founder Share) • Whether there is competition • 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

10. 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

11. 11 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.

12. Investor’s response to convertible but not participating scenario – Convertible and participating. 12

13. Founder’s concern with convertible and participating – the double dip (was founder contribution really worth $8 million?) Partial answer – capped participating convertible preferred 13

14. Similar to uncapped preferred stock participation in corporate context. So founder doesn’t like this. 14

15. 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

16. ‘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

17. Questions? 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