Corporate Finance & Securities

How the Option Pool Impacts Valuation in Startup Financing

Many startups ask us about reserving an option “pool.” The “option pool” is a reserve of authorized but unissued shares of stock that the founders intend to use to compensate future key employees and investors. There is no size of option pool that is right for every company, although you’ve probably read that a “standard” option pool is generally somewhere between 10-20%. Many founders aren’t terribly concerned with the exact size of the option pool, although we think they should be. The size of the option pool has a considerable impact on the valuation of a startup when it raises capital from investors and ultimately the amount of dilution to founders’ shares.

Pre-money Valuation and Option Pools

As we’ve discussed in our...

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Mergers & Acquisitions

Purchase and Sale of a Business: Preliminary Agreements

In this post in the purchase and sale of a business series, we discuss the preliminary agreements the parties generally consider as part of the business purchase. We’ll refer to the party selling the company as the owner, and the party acquiring the company as the purchaser. If you read about these transactions in other blogs or articles you might also find the selling party referred to as the target company and the acquiring party as the acquirer.

In the preliminary stages of the purchase and sale of a business there are a few primary concerns: (1) the owner wants to make sure that the potential purchaser is serious, (2) the owner wants to make sure the secrets of his or her...

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Corporate Finance & Securities

General Characteristics of Preferred Stock

We’re following up Thursday’s post about Apple’s attempt to prohibit the company from being able to authorize preferred stock by amending its charter documents  with this post, which discusses some of the general characteristics of preferred stock and some of the key terms that affect the value of preferred stock.

General Characteristics of Preferred Stock

Preferred stock is often considered a hybrid security as it offers features of both bonds and common stock. For example, preferred stock is like a bond in that it typically has a fixed-percentage dividend, and it is similar to common stock in that the preferred holder cannot receive a dividend unless it is earned and declared by the corporation. Traditionally, private equity investors are keen on dividends....

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Corporate Finance & Securities

Changes On the Horizon for Filing Private Placement Memoranda

Beginning on Monday, December 3, 2012, members of Financial Industry Regulatory Authority (FINRA) must file a copy of any private placement memorandum, term sheet, or other offering document used within 15 calendar days from the date the sale took place; the filer will have a continuing obligation to file any materially amended versions of the offering documents; if no offering documents are used, it must indicate that it did not do so; and filings must be made electronically with FINRA through the FINRA Firm Gateway.

FINRA has taken active steps to increase transparency and investor protection in private placements. In addition to the Rule 5123 filing requirements, Rule 5122 establishes standards on disclosure, use of proceeds, and a filing requirement for...

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Business Startup

Key Term Sheet Provisions: Wrapping Up the Series

This is the final installment in our key term sheet provisions series. This post reviews rights of first refusal, restrictions on sales, voting rights, proprietary information and inventions agreements, co-sale agreements, founders activities, no shop agreements, and indemnification provisions.

Right of First Refusal The right of first refusal provision grants investors a right to participate in subsequent stock offerings. This right is sometimes called a pro rata right, because it enables investors to participate pro-rata. Pro rata means proportional, and in this context means that an investor can purchase an amount of new stock proportionate to their holdings in the company immediately prior to the issuance of the new offering. In more simple terms, it means that if an investor has 5%...

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Business Startup

Key Term Sheet Provisions: Registration Rights

Today, we’re continuing our series on key term sheet provisions by discussing registration rights.

What Are Registration Rights? Before you understand registration rights, you should familiarize yourself with registration statements. Form S-1 is the registration statement companies file with the SEC to become a publicly traded company. If you want to see what a completed S-1 looks like, you can check out Facebook’s registration statement here.

Registration rights define the rights of investors to cause the company to file a registration statement, or to participate in a registration. The registration rights also apply to initial registrations (when the company “goes public”) and to registrationss made after a company has gone public.

What Are the Different Provisions That Make Up the Registration Rights Section? There are...

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Business Startup

Key Term Sheet Provisions: Information Rights

Today we’re continuing our key term sheet provisions series by taking a look at information rights. I almost skipped over this provision because information rights are ubiquitous and relatively unimportant. But before you agree to any terms you should understand their ramifications, even if your lawyer says they’re relatively unimportant. So in the interest of thoroughness, here are a few words on information rights:

What are information rights? Information rights grant shareholders, including investors, the right to receive specific company records typically including, among other records, audited annual financial statements, unaudited quarterly statements and annual budgets. Information rights also grant shareholders the right to inspect records on the company premises.

Why aren’t they that important? Information rights are not that important of a term for a company to...

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Business Startup

Key Term Sheet Provisions: Conditions Precedent to Financing

This week in our series on key term sheet provisions, we’re taking a look at conditions precedent to financing. In order to understand conditions precedent to financing, you have to remember that the term sheet itself is non-binding. The conditions precedent to financing detail events that have to occur before the term sheet will become binding.

What Are Typical Conditions Precedent to Financing? There is typically a clause that states the funding is conditioned on the investors completing due diligence, and being happy with what they find. This condition gives the investors the right to walk away from the deal even after the term sheet has been signed, if they find something out about the company that makes them no longer want...

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Business Startup

Key Term Sheet Provisions: Redemption Rights

Today we’ll continue our series on key term sheet provisions by discussing redemption rights.

What Are Redemption Rights? Redemption rights provisions give investors a future right to have stock repurchased at the original purchase price plus declared and unpaid dividends. The provision can be drafted to provide for mandatory redemption or redemption at the investor’s option.

Generally the right doesn’t mature for at least 5 years, and the redemption payments are spread out over multiple years.

A recent survey indicates that only about one in five venture financings include terms providing for redemption rights.

What is the Rationale for Redemption Rights? Investors like redemption rights because they provide an alternative exit. If the company is neither collapsing nor rising quickly enough to be an acquisition target...

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Corporate Finance & Securities

Key Term Sheet Provisions: Dividends

Continuing our series on key term sheet provisions, this week we will be taking a look at dividends.

What Are Dividends? Dividends are distributions of company cash (or stock) to shareholders, and are most typically issued by mature companies. It is very rare for start ups and emerging companies to have extra cash to give back to shareholders. Dividends are only issued if authorized by the board of directors, and directors have nearly complete discretion in determining if and when they opt to distribute company cash to shareholders rather than opt to reinvest the money back into the company.

Stock Dividends vs. Cash Dividends Dividends are most commonly issued in the form of cash disbursements. But dividends can be structured in the form of...

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