Term Sheets

1. Term Sheets mccomas

2. “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) mccomas

3. Big Picture • What are Term Sheets? • Negotiated before definitive contract • Contains summary of material terms • Binding v. Non-Binding • 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. mccomas

4. 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 mccomas

5. Dividend/Distribution - Options • 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 mccomas

6. 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. • Challenge areas is an outbound exclusive license a liquidation? How about a material sale of a division? Or a change of business? mccomas

7. 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 numberof 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) mccomas

8. Protective Investor Provisions Limit - Limited to some [[fixed number | %| or “any”]] of shares outstanding Examples of decisions: • 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) mccomas

9. Conversion • Optional Conversion– shareholder may elect to convert on a 1 to 1 (Conversion factor) basis with adjustments and sometimes “anti-dilution” adjustments • Mandatory Conversion • IPO – with qualifiers such as on original purchase price multiplier • Consent - __ % of the class • Adjustmentsto conversion factor- • Stock dividends • Stock splits • Combinations • Etc. mccomas

10. Dilution • 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 mccomas

11. 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 mccomas

12. Redemption Rights • 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 mccomas

13. Purchase Agreement • Standard Agreement • Representations and Warranties normally standard but trends include • Open Source Software concerns • 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 • Consents and licenses • Completion of financial, IP and operation due diligence • Opinion of counsel • Blue sky law clearance • Expenses – • 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 mccomas

14. 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. mccomas

15. 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. • % 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. mccomas

16. 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: • % 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. mccomas

17. 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 • RegistrationExpenses – Usually paid by the Company and sometimes includes the expenses of one special counsel to represent the class along with a CAP on exp. • Lock-Up Periodin which no investor will sell or attempt to transfer shares – Underwriters usually seek it • 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. • Right to Participate in future stock issuances(similar to pay to play)– • Usually on a Pro-rata basis and • Excluded issuances typically are the same found in the Anti-Dilution provision. • Termination- • Upon a liquidation event • Investor share are all eligible for sale without restrictions under Rule 144 • The [[[___]]anniversary of the IPO. mccomas

18. 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. mccomas

19. Investor Protective Provisions at Board Level • 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]] mccomas

20. 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. mccomas

21. Voting Agreement • Board of Directors – Number of Directors fixed • 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. mccomas

22. 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. • Expiration Date for the definitive deal to be closed mccomas

23. Questions Bill McComas 443-921-4214 mccomas@bowie-Jensen.com mccomas