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Private Equity Financings

Down-Side Protection . Liquidation PreferenceRight of Redemption Price-based Anti-Dilution Protection. Liquidation Preference. The

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Private Equity Financings

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    1. Private Equity Financings Downside Protection: What’s Important, What’s Not & Why

    2. Down-Side Protection Liquidation Preference Right of Redemption Price-based Anti-Dilution Protection

    3. Liquidation Preference The “New” Standard: participating Issues: Participating vs Non-Participating Disincentivize management team, if LP too large Negotiation Ideas: Repay Preferred, then pay common, THEN share upside Balances investor protection with management incentive

    4. Liquidation Preference Negotiation Ideas cont’d Balance downside protection with upside benefit Different LP for M&A vs Liquidation LP subordinated to retention bonuses Fixed return for investors for greater downside protection

    5. Liquidation Preference The New Standard: Priority Issue: Priority vs Pari Passu Non-Issue: Generally, an investor issue -- potential conflict between classes, but money controls Cal. Corp. Code (§903(b) - Some class protection Some protection through board/observer rights

    6. Redemption The New Standard: More common, but not “standard” Issues: Jeopardize company if insufficient $$ to repay Gives investors inordinate bargaining power Makes company less attractive acquisition candidate

    7. Redemption Old CW: Non-issue Push off for 5 years, which was a long time Within 5 years, company will either exit or fold Corporations code protection, if company cannot not afford redemption

    8. Redemption New CW: Issue? Longer liquidity path - 5 years is “shorter” Corporations code protection, but Obligation still affects company’s attractiveness for merger

    9. Redemption Negotiating Points Disincentive to Management – fully vest and then diminish value of shares Essentially converts equity into debt – so use it to bargain on valuation Push off as far into future as possible, and redeem over time Might deter future investors – whose proceeds are used to pay redemption Permit Company to delay redemption for cause Require “call”, if must have redemption

    10. Anti-Dilution Protection The “New” Standard: Weighted Average Issues: Broad vs Narrow-based Full Rachet Negotiation Points Push hard against full rachet Disincentive to additional investors See example Recommend limited rachet – tied to reduction of risk (e.g., hitting milestones)

    11. Founder Vesting & Acceleration Issues: if Founder can’t get liquid, valuation is secondary Negotiate V&A in context of valuation Removal by Board for “convenience” Acceleration on termination “without cause” Include Constructive Termination Double Trigger

    12. TERM SHEETS 101 Thursday, march 15, 2001 8:30am- 12:00pm Software Development Forum

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