Understanding Investors and Preferred Stock
Financings in Silicon Valley
Joseph Perkins
February 23, 2016
Private and Confidential
Orrick, Herrington & Sutcliffe LLP
Term Sheet Review – Venture Capital
Preferred Stock Financing
AGENDA
•  Choosing your Investor
•  Setting the Stage for a Term Sheet
•  Negotiating the Term Sheet
•  Key Terms in a Preferred Stock Financing
•  Process and Getting to Close
•  Next Steps - What to do Now
2
Choosing Your Investor
Steps to Choosing your Investor:
•  Know what you need
•  Understand the Types of Investors and what they provide
•  Investors – the Good, the Bad, and the Ugly
•  Opening the Doors
3
Choosing Your Investor
Know What you Need:
All Companies need Capital to thrive, but there are different types of
Capital:
•  Human Capital (quantity and quality)
•  Social Capital (breadth and depth)
•  Financial Capital (current and access to additional)
4
Choosing Your Investor
Types of Investors:
Incorporation and Seed-Stage Investors
•  Friends & Family
•  Angels and Super Angels
•  Incubators and Accelerators
•  Government and Foundations
Early-Stage and Late-Stage Investors
•  Venture Capitalists
•  Strategic Investors
•  Commercial Banks (as lender)
•  Private Equity and Investment Banks
•  Government and Foundations
5
Choosing Your Investor
The Good, the Bad, and the Ugly:
Investor Type
Friends & Family
Social Capital
Breadth Depth
Financial Capital
Current
Potential
Notes:
Initial money, nothing more
Low
Low
Low
Low
Medium
Low
Medium
Medium
Incubator / Accelerator
High
Low
Low
Low
Gov’t / Foundations
Low
Medium
Medium
Medium
Venture Capitalists
High
Medium
High
High
Diversify your investors
Strategics (C-VCs)
Medium
High
Medium
High
Potential exit partner (good/bad)
Commercial Banks
Medium
Low
High
High
Purely financial interests (Debt)
Private Equity / IB
Medium
Medium
High
Extreme
Angel / Super Angel
Must understand motivations
Social network acceleration
Slow moving, watch for strings
Very late stage
6
Choosing Your Investor
The Good, the Bad, and the Ugly:
Additionally, there are different “Types” of Money – you will need to understand what your
specific investor brings to the table:
Money Matrix
Passive
Active
“Smart”
Good
Ideal
“Dumb”
Good
Avoid at All
Costs
7
Choosing Your Investor
Opening the Doors:
•  Find investors through your current network (other founders, service
providers, prior co-workers, etc.)
•  Reach out 3-6 months before you actually need the investment
(build relationships, set expectations, get advice)
•  After meeting, determine who is likely to be most helpful to you
(analyze their financial and social capital, personality, and strategic
fit)
•  Keep investors updated on key developments and trajectory (but
avoid disclosing too much)
8
Setting the Stage for a Term Sheet
What do you need to do before you get a term sheet?
•  Build your product!
•  Define your metrics and deliver (differs by industry and stage).
•  Get documentation in order (minimize red flags):
»  Organizational documents
»  IP Assignment
»  Capitalization Table clean up as needed
»  Former founder/employee releases
9
Setting the Stage for a Term Sheet
What do Investors Look For?
•  Market (threshold question – must swing for the fences)
•  Product (innovative, simple, scalable within the market)
•  Team
»  Human Capital (depth of experience individually and as a team, diverse
backgrounds, likability)
»  Social Capital (what is the network you already have established)
•  Ultimately, it is about whether they think they can get a big return on
investing in your Company.*
* may not hold true for Strategic Investors / Corporate VCs, who may invest for reasons that are not directly
related to return on investment.
10
Negotiating the Term Sheet
Process
•  Initial Pitch – you and one investor
•  Full Pitch – you and the investor team
•  VC will put together the initial term sheet (don’t negotiate against
yourself)
•  Get quality advice (advisors, attorneys, other founders)
•  2 term sheets are 5x better than 1
11
Negotiating the Term Sheet
Common Mistakes
•  Not understanding valuation (how it is calculated)
•  Overplaying/underplaying your hand (not knowing your position)
•  Getting caught in the weeds (missing the big picture)
•  Getting star-struck by a big name
•  Single Issue fixation
•  Not looking down the road (Series A as a precedent for future
rounds)
•  Not respecting the process (relationship with potential investors)
•  Pay attention to the no-shop (this matters)
12
Key Terms in Preferred Stock Financings
Key Terms
•  Valuation
•  Control
•  Exit Mechanics
•  Everything Else (see Appendix)
Key Documents
•  Certificate of Incorporation
•  Preferred Stock Purchase Agreement
•  Investors’ Rights Agreement
•  Voting Agreement
•  Right of First Refusal and Co-Sale Agreement
13
Key Terms - Valuation
Where does the valuation come from?
•  How much capital can the Company effectively use over 12-18
months?
•  Target equity ownership.
•  Similar companies (if any) as a comparison point.
•  Fundraise / Target ownership = Pre-Money Valuation (shorthand).
Basic Calculation of Price Per Share
•  Pre-money Valuation / Pre-money capitalization = Price Per Share
14
Key Terms - Valuation
Example 1: $7M premoney valuation and $3M investment
Pre-Money Capitalization
• 
Founders
-
6M
-
85.7%
• 
Employees
-
500k
-
7.15%
• 
Available Pool
-
500k
-
7.15%
7M
Price Per Share: $1.00
Total Cap -
Post Money Capitalization
• 
Investors
-
3M
-
30%
• 
Founders
-
6M
-
60%
• 
Employees
-
500k
-
5%
• 
Available Pool
-
500k
-
5%
Total Cap -
10M
15
Key Terms - Valuation
Example 2: Pool Increased to 20% on Post (dilution in pre)
Pre-Money Capitalization
• 
Founders
-
6M
-
65.9%
• 
Employees
-
500k
-
5.5%
• 
Available Pool
-
2.6M
-
28.6%
9.1M
Price Per Share: $0.7693
Total Cap -
Post Money Capitalization
• 
Investors
-
3.9M
-
30%
• 
Founders
-
6M
-
46.15%
• 
Employees
-
500k
-
3.85%
• 
Available Pool
-
2.6M
-
20%
Total Cap -
13M
16
Key Terms - Valuation
Price Per Share Levers
•  Pre-Money Valuation
•  Pre-Money Capitalization – what goes into the denominator when
calculating price per share in addition to outstanding shares
(warrants, convertible notes, etc.)
•  Option Plan Size
17
Key Terms - Control
Remember what you are selling.
•  Common Stock v. Preferred Stock – What’s the difference?
•  Separate Classes/Series have separate protections
How the Company is Controlled
•  Board of Directors
•  Voting Agreement
•  Protective Provisions
18
Key Terms - Control
Board of Directors
•  Board Composition (how many and who designates)
•  Limitations on rights to designate board members:
»  Minimum share holding
»  Employment with the Company
•  Voting Agreement – obligates all stockholders to vote for the
designees of specific stockholders
•  Board Observer Rights
19
Key Terms - Control
Protective Provisions
•  Company must receive consent of Preferred holders (majority or super majority)
for the following actions (differs from Company to Company):
»  Authorize/Issue new Preferred Stock
»  Amending the terms of the existing Preferred Stock
»  Grant options beyond a certain limit
»  Amend the certificate of incorporation
»  Sell the Company – exit events
»  Additional Debt
»  Change in the Business
»  Key Hires
»  Acquisitions of other Companies
20
Key Terms - Control
Protective Provisions
•  Focus on the voting threshold (whose consent do you need).
•  Watch out for Veto Power held by multiple stockholders.
•  Consider Board Carve-Outs (i.e. if unanimous board approves,
separate stockholder consent not required).
•  Protective Provisions can slow the management of the Company.
21
Key Terms - Exit Mechanics
Liquidation Preference
•  Paid on a Change of Control (merger, asset sale or other
liquidation).
•  “Preference” – they get paid first (down-side protection).
•  “Participation” – Having your cake and eating it too.
•  Cap on Participation – limiting the damage.
•  Think through the potential exit scenarios and try to get incentives to
line up as much as possible (minimize the “Zone of Indifference”)
22
Key Terms - Exit Mechanics
Examples Assuming the following cap table:
Class/Series of Stock
Shares
Outstanding
% of Fully
Liquidation
Diluted
Preference
Capitalization per Share
Common Stock
7,000,000
70%
$0
Series A Preferred Stock
3,000,000
30%
$1.00
Total Shares:
10,000,000
23
Key Terms - Exit Mechanics
Liquidation: 1x, non-participating
24
Key Terms - Exit Mechanics
Liquidation: 4x, non-participating
25
Key Terms - Exit Mechanics
Liquidation: 1x, Fully-Participating
26
Key Terms - Exit Mechanics
Liquidation: 1x, Fully-Participating with 2x Cap
* Additional examples attached.
27
Key Terms - Exit Mechanics
Liquidation Control
•  Board Control (Board must approve all exits)
•  Protective Provisions
•  Drag-Along Right. Forcing other stockholders to consent to a sale of
the Company
»  Who is dragging? (Triggers for activating the drag along)
»  Who is being dragged?
»  Conditions for enforcing the drag along (restrictions)
•  Unwritten control of the Founders – IF the founder is still at the
Company
28
The Process – Getting to Close
Timing of a Deal
•  Getting to know the investors: 3-6 months
•  Investor diligence and investigation period: 2-4 weeks
•  Term Sheet negotiation: 1-2 weeks
•  Definitive Document Negotiation and Drafting: 2-4 weeks
•  Closing and Funding: 2-5 days
29
The Process – Getting to Close
How to Close a Deal Fast
•  Prepare Now
»  Organize your documents
»  Flag issues that will need to be discussed / disclosed
•  Focus on the Right Things
»  Key business terms
»  Relationships (Social Capital)
•  Respond to questions/inquiries promptly
•  Prepare your Board / Stockholders / Noteholders for what is coming
•  Coordinate schedules ahead of time
•  Use a checklist.
30
Next Steps – What to do Now
Action Items to Take Today
•  Take Inventory – figure out where your weak spots are
•  Increase Human and Social Capital
»  Get the right co-founders (diversity of skill sets and backgrounds)
»  Networking (investors, partners, service providers)
•  Develop your product
•  Put together your timeline (business plan – this is meant to by dynamic)
•  Create an Executive Summary (1 page summary of the Company)
•  Get corporate documents in order
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Joseph Z. Perkins
650.289.7188
[email protected]
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Joseph Z. Perkins
Joseph Z. Perkins, a partner in Orrick's Silicon Valley office, is a member of
the Technology Companies Group, which advises emerging companies and
venture capital firms. Mr. Perkins focuses his practice on providing private
venture financing and merger and acquisition services to Internet, high tech,
and clean technology companies in the United States and Japan.
Some of Mr. Perkins's current and former clients include the following.
• 
• 
Education
•  J.D., Harvard Law School
•  B.S., summa cum laude,
Philosophy, University of
Utah
•  B.A., summa cum laude,
Japanese, University of
Utah
• 
• 
• 
• 
• 
• 
Admitted In
•  California
Honors
•  Phi Beta Kappa
• 
• 
• 
• 
• 
• 
• 
Technology Companies
Group
Silicon Valley
Contact
+1 (650) 289-7188
[email protected]
Bleacher Report (Sports media; acquired by Turner Broadcasting)
Doki Doki (Stealth)
FOVE (Virtual Reality Hardware)
Getaround (Car sharing community)
Instagram (Photo social media; acquired by Facebook)
iSpace (Robotics)
Life360 (Family connectivity and safety)
Orchestra - aka Mailbox (e-mail management; acquired by Dropbox)
Ooma (VoiP hardware)
Pinterest (Social Media)
PowerSet (Search; acquired by Microsoft)
Social Finance (Social Lending)
UniversityNow (Online education)
WHILL (Personal Mobility)
Xobni Corporation (e-mail and contact management; acquired by Yahoo)
33
Appendix
34
Key Terms - Exit Mechanics
Additional Examples of Liquidation Preference
•  The Following Slides assume the Company has raised funds
through a Series D Financing, with the B, C, and D each raising
funds at 2x the prior valuation for 25% of the company. The Cap
would be as follows:
•  Common Stock
-
6,500,000 shares (assume no options)
•  Series A Preferred
-
3,000,000 shares ($1.00 per share)
•  Series B Preferred
-
3,166,667 shares ($2.00 per share)
•  Series C Preferred
-
4,222,222 shares ($4.00 per share)
•  Series D Preferred
-
5,629,630 shares ($8.00 per share)
(implied Valuation at Series D - $180,148,148)
35
Key Terms - Exit Mechanics
Liquidation: Multiple Series (Pari Passu), 1x, Fully-Participating
36
Key Terms - Exit Mechanics
Liquidation: Multiple Series (Pari Passu), 1x, Non-Participating
37
Key Terms - Exit Mechanics
Liquidation: Multiple Series – Senior with higher
Preference, 1x, Fully-Participating
38
Key Terms - Everything Else
Dividend
•  Cumulative vs. non-cumulative dividends
•  Generally, non-cumulative dividends are never paid as they are
payable only “when and if declared by the Board of Directors”
•  Generally set around 6.0%-8.0% per annum – can be used in
redemption provisions
•  Cumulative may be treated as debt for accounting
39
Key Terms - Everything Else
Redemption Rights (not common)
•  Force the Company to repurchase the Preferred Stock
•  Return is often similar to liquidation preference or original purchase
price but with a hurdle
»  Timing for redemption – the further out the better (5-7 years)
»  Triggers for calling a redemption – the more difficult the better
»  Installments – the more the merrier
»  May Trigger Debt Treatment for Accounting
40
Key Terms - Everything Else
Conversion
•  Optional Conversion
»  Preferred stock is convertible into common stock at any time at the
option of the holder.
•  Mandatory Conversion
»  Triggers for mandatory conversion – IPO or vote by the preferred stock
»  Percent preferred vote necessary to trigger conversion
»  Watch out for series block
41
Key Terms - Everything Else
Anti-dilution Provisions If you sell stock at a lower price in the
future
•  Full ratchet vs. weighted average anti-dilution adjustment
•  Broad based vs. narrow based weighted average anti-dilution
adjustment
•  Exceptions for Non-Financing Offerings
»  Stock Options (watch for caps)
»  JV and Commercial Agreement
»  Stock issued in connection with Bank Debt
»  Waivable by % of Preferred
42
Key Terms - Everything Else
Voting
•  Preferred Votes with Common Stock on all matters on an asconverted to Common Stock basis. (Note the 242.b.2 waiver on
authorized Common Stock changes)
Pay to Play
•  Triggers for activating the pay to play
•  Consequences for failure to pay
43
Key Terms - Everything Else
Registration Rights
•  Common Rights – Don’t spend too much time on this
•  Demand registration = forcing function for your company to go
public
•  S-3 registration = short form registration for eligible issuers
•  Piggyback registration = investors tagging along company
registration
•  Lock-up = absolutely necessary for company to retain underwriters
44
Key Terms - Everything Else
Information Rights
•  Common Rights – Don’t spend too much time on this
•  Reserved for “Major Investors”
•  Financial statements –
»  annual, quarterly, monthly; audited vs. unaudited
»  budget
»  cap table
•  Visitation rights – conditions for exclusion
45
Key Terms - Everything Else
Pre-emptive Rights (Participation Rights)
•  Right of investors to maintain ownership %
•  Standard Right for “Major Investors”
•  Calculation of pro rata share (what to include in denominator)
•  Excluded issuances (Carve-outs)
•  Accredited Investor Requirement
•  Lose if they don’t exercise?
46
Key Terms - Everything Else
Negative Covenants
•  Ordinary course of business items vs. extraordinary events
•  Dollar threshold
Affirmative Covenants
•  Non-compete, non-solicit, non-disclosure and inventions assignment
•  Board matters (frequency of meetings, reimbursement, etc.)
•  Option vesting
•  Key person and D&O insurance
47
Key Terms - Everything Else
Founder Restrictions (ROFR and Co-Sale)
•  Right of First Refusal and Co-Sale on Sale of Stock of Founders
and Existing Stockholders
»  Restricted parties
»  Participants
»  Excluded transfers (carve-outs)
•  “Reverse vesting”
•  Customary Terms for Founders - best to have in place prior to deal
»  4 year vesting with credit for time served with double trigger acceleration
on change of control and termination without cause
48
Key Terms - Everything Else
Other Terms
•  No Shop
»  Restriction period and relationship to anticipated closing date
»  Restricted activities
•  Closing Conditions
»  All Consultants/Employees Sign CIIAA
»  Employment/Vesting Agreements with Founders (structures exit of Founder)
»  Legal Opinion
»  Key Common Holders all signing Voting and ROFR Agreement
»  Amendment of Charter
»  Representations True and Correct
49