Term Sheet Madness – The Champion is Crowned!

NCAA Men's Final Four - Championship

This is it, what you all have been waiting for.  Term Sheet Madness finals are here!  Find all you need on prior rounds here.

*Editor’s Note: Yes loyal reader, we also noticed that there is a 3 way battle for the champion of the Madness.  Whoever was in charge of the selection committee must’ve had a few too many “Rounds of the Week” when they selected the field….

1. Liquidation Preference vs. 1. Board of Directors vs. 1. Price (Valuation) 

Explanations: 

Liquidation Preference*: The determining term on how the proceeds of an exit will be shared.  The preference is given to preferred shareholders before common stockholders and can have vast implications for investors/entrepreneurs. Three types with very basic examples below:

  • Fully Participating: Receive shares on an “As-converted” basis i.e. if you have 2x Liquidation preference on 20% stake in a $100M post-money valuation (i.e.a $20M investment).  If the firm sells for $240M you will receive $40M (2x preference) and then 20% of remaining $200M or $40M for a total of $80M or 33% Ownership.  Founders receive remaining $160M.  C:V. Thought: Yikes.
  • Capped Participation: Will only participate up until a limit (i.e. 2x cap).  In this case, the firm makes more than double their money so they will not participate and simply receive 20% of $240M or $48M.  Founders receive remaining $192M. C:V. Thought: Less Yikes.
  • Non-Participating: Firm sells for $240M, investors receive 20% or $48M.  Founders receive remaining $192M. C:V. Thought: Normal.

*Editor’s Note: we combine participation and preference in this term

Board of Directors: One of the biggest control mechanisms and defining aspects of the company.  The Board of Directors is the management team that sets direction and helps the company achieve their vision.

Price (Valuation): The amount of funding received in the round.  Can be referred to in aggregate ($40M) or price per share ($6/Share). This can be used to determine pre/post money valuation.

C:V.’s Chief Term-ologist’s Take: The three juggernauts of the tourney, each with their own strengths and weaknesses, will make for quite an interesting final match up.  While Liquidation Preference has some serious exit ownership implications and Price probably owns the most mindshare, we feel that the Board may have an advantage.  Its ability to advise and assist in the company can reap fantastic rewards. Hopefully so much so that founders do not have to worry about Liquidation Preference caps or Price…

Outcome: The Board fends off both challengers and takes home the hardware!  In the end, their ability to have both an immediate and a longer term impact allowed them to emerge victorious. Congrats to all the participants this year!

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Term Sheet Madness – Boston Finals

We round out the regionals!  Term Sheet Central here!  Boston Round 1 here!

1. Liquidation Preference vs.  2. Antidilution

Explanations: 

Liquidation Preference*: The determining term on how the proceeds of an exit will be shared.  The preference is given to preferred shareholders before common stockholders and can have vast implications for investors/entrepreneurs. Three types with very basic examples below:

  • Fully Participating: Receive shares on an “As-converted” basis i.e. if you have 2x Liquidation preference on 20% stake in a $100M post-money valuation (i.e.a $20M investment).  If the firm sells for $240M you will receive $40M (2x preference) and then 20% of remaining $200M or $40M for a total of $80M or 33% Ownership.  Founders receive remaining $160M.  C:V. Thought: Yikes.
  • Capped Participation:  Will only participate up until a limit (i.e. 2x cap).  In this case, the firm makes more than double their money so they will not participate and simply receive 20% of $240M or $48M.  Founders receive remaining $192M. C:V. Thought: Less Yikes.
  • Non-Participating:  Firm sells for $240M, investors receive 20% or $48M.  Founders receive remaining $192M. C:V. Thought: Normal.

*Editor’s Note: we combine participation and preference in this term

Antidilution: A protective measure in the unfortunate case of a down round, it offers investment protection for investors by redefining the ownership of their initial investment.  Two types below:

  • Full Ratchet:  The harshest of the provisions, this translates the equity ownership from the prior round to the new price at the lower round.  i.e. If the original round was 20% on $100M Post (i.e. $20M investment) and the new round only valued the company at $50M the investors would then be awarded shares to keep their ownership the same at $20M or 40% of the new company. (See, we weren’t kidding that this was basically draconian…)
  • Weighted Average: A more forgiving provision that puts the incentive on both sides of the table.   The weighted average model only considers the new shares being issued and not the entire pool.

C:V.’s Chief Term-ologist’s Take: While Antidilution eased into the finals, we feel that they will not have an easy time with Liquidation Preference.  The powerhouse in the bracket, the Liquidation Preference can drastically reshape an investment landscape and even Antidilution’s most drastic provisions for down rounds should not be enough to overtake the Preference.

Outcome: Liquidation Preference rolls into the finals with a win over Antidilution.

Term Sheet Madness – Denver Finals

The Finals continue!  All info here at Term Sheet Central!  Denver round 1 here!

1. Board of Directors vs. 2. Vesting

Explanations:

Board of Directors: One of the biggest control mechanisms and defining aspects of the company.  The Board of Directors is the management team that sets direction and helps the company achieve their vision.

Vesting: The time period and speed at which you earn your equity in the company.  Simple in theory, huge implications in practice.

  • Example: If you have a 4 year vesting schedule at 25% a year on 100 shares, you will get 25 shares a year for 4 years.  If you leave after 2 years, you get 50 shares and 50 shares is “left on the table” unvested.

C:V.’s Chief Term-ologist’s Take:  Easily the strongest region and two of the fiercest competitors in the entire tournament.  The Board is a consistent powerhouse with their far-reaching ability to provide advice, structure, and idea validation to the founders but Vesting is no push-over.  Its timing effects and potential implications on employee retention and performance are underrated. This matchup will be a close one.

Outcome: Matchups like these are what the madness is all about. Had the selection committee done better when seeding, this could have been the finals.  Alas, it is not and the Board has simply too strong of a balanced-attack style to be upset.  Board Advances.

 

Term Sheet Madness – Palo Alto Finals

The Regional Finals are upon us!  See here for Term Sheet Central and here for Palo Alto Round 1!

1. Price (Valuation) vs. 2. Pay to Play

Explanations:

Price (Valuation): The amount of funding received in the round.  Can be referred to in aggregate ($40M) or price per share ($6/Share). This can be used to determine pre/post money valuation.

Pay to Play: Investors will have the option to purchase their “pro rata” share in a future financing (i.e. Right of First Refusal), but if they choose not to participate (Pay), the remainder of their allotment of ownership will be converted from preferred to common stock (preventing them to Play).

C:V.’s Chief Term-ologist’s Take: Price looks to continue its hot streak in this competition but will be met with resistance by Pay to Play.  In the end, we feel that Price should be able to advance on its ability to heavily impact all future rounds of a firm even though Pay to Play’s ability to allow only the truly committed investors to remain preferred shareholders should not be forgotten.

Outcome: Price advances to the Term Sheet Madness Finals!  Get the scissors out! (Well, in this tournament, it’s probably more fitting to break out the pen/DocuSign link…)

Term Sheet Madness – Boston Round 1

We wrap up 1st round play in Boston!  Term Sheet central here!

1. Liquidation Preference vs. 4. Employee Option Pool

Explanations: 

Liquidation Preference*: The determining term on how the proceeds of an exit will be shared.  The preference is given to preferred shareholders before common stock holders and can have vast implications for investors/entrepreneurs. Three types with very basic examples below:

  • Fully Participating: Receive shares on an “As-converted” basis i.e. if you have 2x Liquidation preference on 20% stake in a $100M post-money valuation (i.e.a $20M investment).  If the firm sells for $240M you will receive $40M (2x preference) and then 20% of remaining $200M or $40M for a total of $80M or 33% Ownership.  Founders receive remaining $160M.  C:V. Thought: Yikes.
  • Capped Participation:  Will only participate up until a limit (i.e. 2x cap).  In this case, the firm makes more than double their money so they will not participate and simply receive 20% of $240M or $48M.  Founders receive remaining $192M. C:V. Thought: Less Yikes.
  • Non-Participating:  Firm sells for $240M, investors receive 20% or $48M.  Founders receive remaining $192M. C:V. Thought: Normal.

*Editor’s Note: we combine participation and preference in this term

Employee Option Pool: The amount of equity to be held for future issuance to employees. This can be a sneaky way to lower a company’s pre-money valuation if one is not too careful (larger option pool than prior cap table).  This is also a key term as it will help determine the resources a founder will have when allocating and attempting to attract new talent to the company.

C:V.’s Chief Term-ologist’s Take: While Options are key retention measures for future employees, poorly structured liquidation preferences can have devastating ramifications for “less than spectacular” exits on founder/employee ownership.  You can work to redeploy your options at later rounds, but attempting to get rid of a fully participating 3x liquidation preference is an evil nobody EVER wants to deal with.

Outcome:  Liquidation preference fends off an inspired comeback in the 2nd half from Option Pool to advance.

 

 2. Antidilution vs. 3. Conversion Rights

Explanations:

Antidilution: A protective measure in the unfortunate case of a down round, it offers investment protection for investors by redefining the ownership of their initial investment.  Two types below:

  • Full Ratchet:  The harshest of the provisions, this translates the equity ownership from the prior round to the new price at the lower round.  i.e. If the original round was 20% on $100M Post (i.e. $20M investment) and the new round only valued the company at $50M the investors would then be awarded shares to keep their ownership the same at $20M or 40% of the new company. (See, we weren’t kidding that this was basically draconian…)
  • Weighted Average: A more forgiving provision that puts the incentive on both sides of the table.   The weighted average model only considers the new shares being issued and not the entire pool.

Conversion Rights: The ability to convert preferred equity into common stock. Automatic conversion gets infuriating interesting when investors “must” convert at different prices upon an IPO.  If one investor has a $20M auto-conversion and a later round investor has a $60M conversion and the company wants to price an IPO at $50M then the later round investor can stall until the company can float an offering that will reach their $60M auto-conversion price.

C:V.’s Chief Term-ologist’s Take: While Conversion can get interesting upon an IPO, antidilution provisions can effectively cram-down any remaining founder ownership.  You tell us an original founder that is truly motivated to succeed after having half of his/her share taken at the B round and we will tell you about our cousin from Nigeria….

Outcome: In a less than eventful 2 v 3 matchup, Antidilution blows out Conversion to advance.

Term Sheet Madness – Denver Round 1

The Madness continues! Look here for Original Posthere for Full Field, and here for Palo Alto Regional!

1. Board of Directors vs. 4. No-Shop Agreement

Explanations:

Board of Directors: One of the biggest control mechanisms and defining aspects of the company.  The Board of Directors is the management team that sets direction and helps the company achieve their vision.

No-Shop Agreement: The term sheet equivalent of monogamy, the No-Shop Agreement essentially makes it very difficult to field other offers when you are in the final stages of a financing.

C:V.’s Chief Term-ologist’s Take:  Term sheet monogamy is important and all and while we hope No Shops would only be broken for a can’t miss deal, Board of Directors is a powerhouse in the control field.  They advise, direct, mentor, and shape the direction of the company.

Outcome: The Board advances (unanimously)

 

2. Vesting vs. 3. Protective Provisions

Explanations:

Vesting: The time period and speed at which you earn your equity in the company.  Simple in theory, huge implications in practice.

  • Example: If you have a 4 year vesting schedule at 25% a year on 100 shares, you will get 25 shares a year for 4 years.  If you leave after 2 years, you get 50 shares and 50 shares is “left on the table” unvested.

Protective Provisions: Essentially veto power, Protective Provisions are a list of company events (issuing shares, raising debt, selling the company, etc.) that the investors can vote to stop from happening. Depending on severity, this list of events can cause some serious control issues in a company.

C:V.’s Chief Term-ologist’s Take:  A battle of two of the stronger Economics and Control provisions in the field, we see this going down to the wire.  Vesting can have such profound impacts on employee performance (re: Worst Case = feeling of indentured servitude for life of vesting schedule)  yet Protective Provisions, if severe enough, can effectively stop the company from doing anything.  Now obviously we here at C:V. always hope for the best and would hope that vesting would be reasonable given the company stage and protective provisions would include materiality thresholds to allow for certain business measures to be enacted, but even still there is no clear-cut winner in this round.

Outcome: In a double-OT thriller, Vesting survives to advance to the finals to play the Board.

Term Sheet Madness – Palo Alto Round 1

Regional play began today! (See original post here for details)  Full Field here!

1. Price (Valuation) vs. 4. Right of Refusal

Explanations:

Price (Valuation): The amount of funding received in the round.  Can be referred to in aggregate ($40M) or price per share ($6/Share). This can be used to determine pre/post money valuation.

Right of (First) Refusal: Also known as the “Pro Rata Right”, it provides context for current investors to have the ability to purchase shares in a future financing (a good thing! usually…)

C:V.’s Chief Term-ologist’s Take:  While the ability to participate in a future financing is important for all parties at varying levels, Price (Valuation) has much larger ramifications that determine the economics and ownership of the company.

Outcome:  While we love an underdog, this is not RoFR’s day. Top seed Price (Valuation) rolls in a landslide.

 

2. Pay to Play vs. 3. Dividends

Explanations:

Pay to Play: Investors will have the option to purchase their “pro rata” share in a future financing (i.e. Right of First Refusal), but if they choose not to participate (Pay), the remainder of their allotment of ownership will be converted from preferred to common stock (preventing them to Play).

Dividends: Periodic Payments made via Cash or Equity to the investors at a percentage of the initial investment.

C:V.’s Chief Term-ologist’s Take: Pay to Play seems to be more of an issue with down rounds but we agree with their general premise of earning (and continuing to earn via continued participation) what you keep, so we are fans of Pay to Play.  Dividends on the other hand, not so much….While much can be made for a case for dividends in specific business lines, in general, we view cash as king and having to part with any additional cash when trying to scale a business is a recipe for trouble (and possible future down rounds…)

Outcome: If this were a more PE-focused site we could possibly see Dividends with the upset victory, but in the end Pay to Play advances to play tourney favorite Price (Valuation) in the Regional final!