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Negotiation Table

Category Term Term Sheet Value Negotiating Position Walk away position
- = +
Pre-money valuation ** $5 million
Investment amount $2 + $1 million
Stock Option Plan ** 20%, no accelerated vesting
Dividend Provision ** 12%
Economic Liquidation preference ** 2X
Participating preferred ** Yes
Antidilution ** Full ratchet

Protection Provisions ** 75%, list unspecified

Board of Directors 4 members
Control 2 investor, 2 company
Compensation committee Outside directors

Management changes (other Replace CEO

covenants) Hire VP eng & sales
Other 100%**
Re-vesting of Founders, & repurchase of unvested shares at termination
Non-solicitation/non-disclosure Includes a 2 years non-compete
2. Detailed Explanations


Pre-money valuation1,2

Stock Option Plan3

Dividend Options4

Liquidation Preference4
Antidilution Methods5,6

Protection Provisions4

2. Detailed Explanations

A pre-money valuation is a term used in private equity or venture capital that refers to the valuation of a company or
asset prior to an investment or financing.
External investors, such as venture capitalists and angel investors will use a pre-money valuation to determine how much
equity to demand in return for their cash injection to an entrepreneur and his or her startup company. For example, if an
investor makes a $10 million investment into a company in return for 20% of the company's equity, the implied post-money
valuation is $50 million. To calculate the pre-money valuation, the amount of the investment is subtracted from the post-
money valuation. In this case, the implied pre-money valuation is $40 million.
There are several ways to determine valuation for your
startup. Know that with most of these methods may be difficult to base on objective facts. At the end of the day you may
need to rely on the fairness of your investor to propose a valuation that is consistent with other known "comps" and also
consistent with other relative valuations in his/her existing portfolio.
The % of the fully diluted shares outstanding post-financing that will be reserved for issuance to employees and consultants
pursuant to a stock option plan. The typical vesting schedule is ratable over four years with a one year ‘cliff’. Typically one
fourth of the options are received after the first year at the company. Thereafter, vesting would continue at a monthly or
quarterly rate until the full amount is owned at the end of the fourth year. For example a term may read as follows "All
future option grants shall be subject to four-year vesting at the rate of 25% for the first year and vesting on a 1/48 per
month portion for the remaining three years unless otherwise authorized by the Board. There will be no provisions providing
for acceleration of vesting upon change of control in the option plan."
Two types of dividends are frequently encountered; a third is possible but rarely used:
Protective dividend provision: In this case, there is no intention of dividends actually being paid to investors. For obscure
legal reasons, such a provision may be included, stating that these dividends are payable "when and if declared by the
board." The presumption, however, is that the board will not declare such payments.
Dividends that accrue: These dividends are not paid in cash, but are included in computing distribution to investors at exit
as a way to enhance potential return to investors without affecting the "nominal" valuation. More typically, protective
dividends are used.
Cash dividends: Rarely contemplated in these types of financings because both investors and entrepreneurs want to
conserve cash to fuel additional growth or to show a better bottom line.
Investors may negotiate a liquidation preference. At exit and after secured debt, trade creditors, and other company
obligations are paid, a liquidation preference determines the relative distribution between the preferred shareholders (the
investors) and the common shareholders. There are various kinds of liquidation preferences:
Non-participating simple preference (1x): At exit investors must choose between a return of capital (sometimes partial)
and participation with the common shareholders in proportion to their ownership. If the investors choose complete return of
capital, then any remaining proceeds are divided among common shareholders.
Multiple preference: Works the same as simple preference except that investors get a multiple of their investment before
common shareholders receive anything.
Participating 1x liquidation preference: In this case, the investors first receive their capital (1x preference) and then
their shares convert to common. The concept is to share the gains between preferred and common by first returning capital
to investors and then distributing the gains from the sale of the company in proportion to ownership.
High multiple (5x or 7x or more) preferences: These are also used but much less frequently. Sometimes they reflect
creative deal structures (preventing earlier investors from being washed out while providing a reasonable return to new
investors). At other times they are abusive and might reflect the sharks that surface in a very bad market for raising capital
(as happened after the bubble burst in 2000).
Example: Angels invest $1 million for 25 percent of a company without a liquidation preference, and the company is later
sold for $2 million. In this example, the investors would get only $500,000, losing half of their capital, and the entrepreneurs
would pocket $1.5 million. If the investors negotiate a 1x simple preference, however, they would get $1 million off the top,
and the common shareholders would get the remaining $1 million. Finally, if investors negotiate a 1x participating
preference, they would get $1 million off the top plus another $250,000 (25 percent of the remaining $1 million). The
common shareholders would receive $750,000.
These clauses are intended to protect the VC from dilution during "down" rounds (rounds at a lower valuation). There are
two main types of anti-dilution methods:

Ratchet: lowers VC's per-share price to new share price being offered (tends to be highly dilutive to common shareholders).
In a ratchet, the investor is given additional shares of stock for free if the company later sells shares at a lower price. The
number of free shares the investor receives is enough to make the investor’s average cost per share (counting all of his
purchased and free shares) equal to the lower price per share given to the later investor. What makes the ratchet so
powerful is that the first investor is given these extra shares regardless of the number of shares purchased by the later
investor. Example: For example, if an investor who has a ratchet purchases 100,000 shares of company stock for $200,000,
or $2 a share, and the company later sells another investor 100,000 shares for $1 each, the first investor would receive
another 100,000 shares for free. The result would be the same if the second investor bought only one share for $1.

Weighted Average: re-prices VC's shares by taking into account their number of shares and the number of new, lower-
priced shares. There are two methods:
i. Broad-based anti-dilution method: investor’s shares are repriced to the weighted average of their shares and the new
down-round shares, using the fully-dilutive weighted average shares (better for the common shareholders)
ii. Narrow-based anti-dilution method: calculates the weighted average only using current common shares outstanding
(better for the VC)
Such provisions require the company to obtain approval of the investors as a group before taking certain actions, such as
changing auditors, shareholder rights, the size of the board, or the nature of the business; creating new securities; amending
the bylaws or certificate of incorporation; repurchasing company shares; agreeing to a merger or acquisition; increasing the
employee stock option pool; selling the company's intellectual property; issuing options or shares to executives or directors,
or incurring indebtedness above a threshold.
Rights an employee receives for working at a company a specified length of time. The rights normally include such things as
pension payments, participation in stock plans, and profit sharing. The term is often associated with the period that it takes
for an employee or founder to have the right to own the shares they have been granted. As an example, an investor may
want to keep a founder working at a company for a certain period, say four years. To accomplish this, the investor might
insist that as part of funding, the founder would become entitled to 25 percent of their shares every year, thus it takes four
years to own the stock. Sometimes this can be done retroactively; that is, even if the founder put up the seed money and
owns the stock, there can still be a period of “re-vesting.” This process is often referred to as “Golden Handcuffs.” For
employees, the same process is often applied; their stock options might vest over a number of years. Re-vesting enables the
company to repurchase a certain amount of the founders shares at a nominal price for a period.