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MEMORANDUM OF TERMS
FOR PRIVATE PLACEMENT OF
PREFERRED STOCK OF
(Name of Company I
This memorandum summarizes the principal terms of the -round venture capital financing of
[Name of Company]. This memorandum is for discussion purposes only and[, except as set forth in the "Publicity" and "No Shopping" provisions,] is not intended to be construed as a binding agreement. The completion of the transactions contemplated by this memorandum will be subject to, among other things, satisfactory completion of financial and legal due diligence by the investors, as well as the completion of final documents acceptable to the investors and [Name of Company].
[Name of Company], a [Delaware/California] corporation (the "Company").
Securities to be issued: I
[Number of Shares] of Series _ Preferred Stock. tOfthe
Series Preferred Stock, shares will be issued to
Fund Partners ("Fund") and shares will be issued to
___ 1 [At Fund's discretion. shares will be issued
to [experienced investors/strategic partners] mutually acceptable to Fund and the Company.]
[Warrants to be issued12
Aggregate Proceeds to the Company:
S [. including S_,_ from the conversion of
principal [and interest] on bridge notes].
[Staged investment?1 Milestones?])
S __ per share (based on the capitalization of the Company set forth opposite the heading "Post-Closing Capitalization" below),"
I Companies typically sell Preferred Stock to Investors, These shares or fufcrrcd Stock typically contain liquid'llion .
preferences and superior "olin& rights over stock issued to the Founders. These previsions help justify a higher per share stock pnce ror Preferred Siock and allows companies to grant stock options at the lower Common Stock price withoul adverse tax consequcnces for the employee and ,,;thOUI adverse accounting consequences ror.thc company.
! In certain silualions as part of Ihe '1llualion discussion. thc parties may d .. -cide mal warrant coverage should be granled 10 the investors, The warr.ints can be (or Common Stock or Preferred Stock,
J Typically. financings arc nOI done: with a staged in,oe~tmcnl or with mileston c es, in part because it is difficult 10 agree upon appropriate milestones. InSIC3d. an appropriale valuation is e~labli~hcd to reO c "CI future uncertainties,
E °.h3ckup\cudor.1'~lt3(h\Fon!lTermSheI.'1 doc (I S06I)
Expected Closing Date:
On or about .
Entities manager by Fund Partners], and other mutually agreed investors].
Terms of Series
Annual $ __ per share dividend. payable when and if declared by Board: dividends are [not] cumulative.' No dividends will be declared or paid on the Common Stock unless and until a like dividend has been declared and paid on the Series _ Preferred Stock.
In the event of a liquidation. dissolution or winding-up:
[Alternative I (full participating Preferred Stock) - First pay the original purchase price [plus premium?] plus accrued dividends on each share of Series _ Preferred Stock. Thereafter. Series __ Preferred Stock participates with Common Stock on an asconverted be Jis.]
[Alternative 2 (cap on Preferred Stock participation rights)First pay the original purchase price [plus premium?] plus
accrued dividends on each share of Series Preferred Stock.
[Thereafter, Series __ Preferred Stock participates with Cornmon Stock on an us-converted basis [until the holders of Series _ Preferred Stock receive an aggregate of[3-5JX.J]
[Alternati\'e J (In certain circumstances, the Founders may negotiate a liquidation preference for the Common Stacie. This is less typical and it allows Common Stock to receive a preference after an initial payment to Preferred Stock but before Preferred Stock fully participates} - First pay the original
~ It is important 10 lie: the per share: price 10 the capitalization of the Company. This helps ensure thaI we will receive X% of the Company at the Closing regardless of any outstanding shares or warrants "discovered" between the signing of this Term Sheet and the Ciosin&-
~ Most investors expect that the Company will not pay dividends. If a dividend is 10 be paid or if dividends accrue, a M.to s~. dividend typieally is paid on the Preferred Stock before any dividend arc: paid on the Common Stock, Sometimes, it is possible to ncgotiatc a divide:nd that is cumulative, which means that it accrues from year 10 year until it is paid. Accrual of dividends may be important nOI only because: it afTe:cts Fund's return but also because: it afTects the: investors' eonversion, liquidation and redemption prices.
61n follow-on linancing rounds, we: should specify whether we: will be senior 10 or ~ passu with a prior series of Preferred Slock.
7 This provision gives investors the right to receive their money baek before the Founders or other shareholders gel any funds.
Four of'the mo)1 common allem:llh'e:s are: listed, The dilli:rence between the altematives is whether Investors will gel any addilional
return be:yond ge:lling their monc.'y back. In addition 10 selecting one of these lhcmalin:s. in follow-on financing rounds. we should )
spc.-cify whether we will be senior 10 or ~ passu with a priM-Scrics of Preferred Stock.
purchase price [plus premium?] plus accrued dividends on each
share of Preferred Stock [then $ on Common Stock].
Thereafter Series _ Preferred Stock and Common Stock share on as-converted basis.]
[Alternative 4 (non-participating Preferred Stock) - First pay the original purchase price [plus premium?] plus accrued dividends
on each share of Series Preferred Stock. The balance to
holders of Common Stock.]'
A merger, reorganization or other transactions in which shareholders of the Company do not own a majority of the outstanding shares of the surviving corporation will be treated as a liquidation event, thereby triggering the liquidation payment.'
[Alternatil·e I (redemption in one lump slim) - Redeemable at the election of holders [of(66-2/3rds] of the outstanding Series
_ Preferred Stock] on or after at a price
equal to the original purchase price [plus accrued dividends)[plus _'Yo per year] or as soon thereafter as legally permissible.]
[Alternative 2 (redemption in three trenches) - Redeemable at the election of holders [of[66-2/3rds] of the outstanding Series _ Preferred Stock] at a price equal to the original purchase price [phis accrued dividends][plus _'Yo per year]. to the extent of 1/3 of the shares of Series _ Preferred Stock on the [__l. l__j and [__] anniversary dates of the Closing of the financing or as soon thereafter as legally permissible], but in no event will more than 1/3 of the outstanding shares of Series _ Preferred Stock (plus 113 of the aggregate accrued dividends) be redeemed in any twelve month period.]
To the extent that the Company's available cash flow does not permit such redemption. the remainder shall be paid in the form of a one-year note to each unredeemed holder of Series _ Preferred Stock bearing % interest per annum, compounded quarterly, and the holders ofa majority of the Series_ Preferred Stock shall be entitleB to elect a majority of the
• If we select this alternative, we will have to convert our Preferred Stock into Common Stock to ranicipate in any gain on our investment, In effec ... afler we receive our money back. all gains will be alloc3tcd to the Foundcrs until ther c3tch-uPIO us. I=or example. we may pay SS per share and the Founders may have paid SO.OI per share. If a liquidation event wen: to occur. we would get the first SS per share. Then the Founders gct the next SS (unless we convert into Common Stock). In this hypothetical. there would be an obvious economic incentive to convert,
• This relatively standard definition clarifies the treatment in a merger, reorganization or similar transaction. !\tlh: that typical Preferred Stock includes a standard protective provision that allows the investors to block a merger.
III We sometimes request this redemption provision, which allows US.l0 force Ihc Company 10 redeem our shares at cost plus a small guaranteed rate of return, In practice, redemption provisions are notllftcn used: however, thcy do provide a form of exit anti some possible leverage over the Company.
E llo3Cl;up',,:udor3'.:I1I3ch\l:onn T o:nnShcct doc (I $061 )
Comrany's Board of Directors until such amounts are paid in
[Alternative J - No other capital stock of the Company is redeemable prior to the Series _ Preferred Stock without the prior written consent of holders ofa [66-213rdslmajority) of the Series _ Preferred Stock.]
[Altenrative -1- The Preferred Stock will not be redeemable}.]
Convertible into one share of Common Stock (subject to antidilution adjustment) at any time at the option of the holder.
Automatically converts into Common Stock upon (i) the election of[66-213rd~] of the outstanding shares of Series Preferred Stock or (ii) the consummation of underwritten public offering with a price ofS[3-5 times costt! and aggregate proceeds in excess ofS 10-20,000,000] ("Qualified Public Offering,,)'J.
[Conversion ratio adjusted on [ratchet'4/[broad or narrow]" weighted average) basis in thc event of a dilutive issuance [so long as investor purchases full pro rata share of dilutive issuance ("pay to play")"]. "Dilutive issuance" shall not include the sale
of shares of Common Stock reserved for employees [and
the issuance of warrants to purchase Common Stock in connection with bank lines of credit, equipment lease
II This d.:fault provision could be construed as a h:lrsh pcn:llty and is oflcn resisted by companies,
I:: \\'e should estimate the minimum return we will want be fore the Company goes public (i.c ... we should ensure that we choose a number so iha; Ihe Company will be a success before conversion occurs). For example, if you believe that the Company should not go public below a SJOO million valuation :lnd the valuation :II the Preferred Stock financing is S75 million. you would establish a ~X cost on a pcr share basis.
n This provision pro,' ides somewhat less protection in that most reputable banks will not underwriter an 11'0 with less than
S million in aggregale proceeds.
14 A "full .. lichee antidilution provision is the most favorable 10 investors bUI is difficult 10 negotiate. If we have "full ratchet" protection. if the Company sells stock at a lower price per share in:l subsequent round. our conversion-to-Common Stock price will ;;Idjust so th:lt we receive.the full benefit of the lower price. For example, assume we had invested OIl S2 per share with a conversion price is S2. This means that we will receive I share of Common Stock for each share of Preferred Stock when we convert. If the Company later sells stock at SI per share. our conversion price will adjust to SI. This means that we will receive 2 shares of Common Stock for each share ofPref.:m:d Stock when we convert. 111is may seem h:ush to ille Company because the: conversion price will adjust regardless of how many shares il sells.
U Weighted average is the most typical antidilution protection. It adjusts our conversion ratio based on a formula that takes intn account the lower price per share in the "down round" and the number of shares actually sold in the =down round. - 111e broad-based weighted average formula is less favorable to investors because it takes into account unexercised options and oUlsl.1l1ding cOn\'t.'t1ibl.: notes and warrants. This means Ihat the effecl of the issuance of shares in the -down round" is diluted o.r spread over a "broader base." The less typic:lI narrow-based weighted average formula docs not tak.: into account unexercised options and outstanding convertible notes and warrants. and therefore is more favorable to investors.
16 A -P:lY to rlay- provision is not typical. This provision request us io buy our pro-rata share of any subsequent do\\n-rnunds ).
tn rccefve the benefit of price-protection. '- -
"'h3':~UJl\.cudnr3'·.3113ch\Fllnn".:nnSht'l:1 doc (I ~0611
transactions and real estate transactions.]"
Proponional adjustments for stock splits and stock dividends.
Votes on an as-converted basis, but also has [class/series] vote as provided by law and on (i) the creation of any senior or ~ ~ security. [(ii) payment of dividends on [Common Stock/on any class ofStock)),[(iii) any redemptions or repurchases of Common Stock or Preferred Stock except for purchases at cost upon termination of employment], (iv) any merger, acquisition, recapitalization, reorganization or sale of all or substantially all of the assets of the Company, (v) an increase or decrease in the number of authorized shares of [Series _] Preferred Stock or Common Stock, (iv) any [adverse] change to the rights, preferences, and p,rivileges of the Series _ Preferred. [(vii) any IRC Section 305 9 transaction], [(viii) an increase or decrease in the size of the Board of Directors], [(ix) [material] amendments or repeal of any provision of the Company's Charter or Bylaws].[(x) changes the nature of the company's business] and [(xi)] authorization of any amount of indebtedness in excess of s_.fo
[other special concerns?]
Terms of Preferred Srock Purchase Agreement
Representations and Warranties:
Standard representations and warranties by the Company. [Representations and warranties by Founders regarding [technology ownership, etc).f
Conditions to Closing:
Standard conditions to Closing. which shall include, among other things, satisfactory completion of financial and legal due diligence, qualification of the shares under applicable Blue Sky laws. the filing of a Certificate of Incorporation establishing the rights and preferences of the Series _ Preferred Stock and an opinion of counsel to the Company.
Assignment of Inventions and Confidentiality Agreement:
All employees and consultants shall enter into Company's standard form inventions and proprietary information agreement.
17 These are typical can·e-out.~. Irwe arc worried abeet being diluted, we can limit the issuance 10 I~~ of the Company or require the directors elected by the Series _ Preferred Stack 10 vnte in favor orlhe transaction.
II We should pay particular attention to the voting thresholds to ensure that we can control the series of Preferred Slack. Ifnot. we should consider a VOling Agreement.
I~ A Section )05 transaction refers 10 certain distributions or stock h~ a company 10 its shareholders,
:~ The 13."1 two provisions can he: particularly onerous.
:1 In L'arly stage financings and especially in C3."CS where the Founde'r:l have transferred technology to the Company. we should gel the Founders to stand behind the representations and warranties,
[if olltside of California and in a state where these agreements are enforceable - Non-Competition Agreements:
___ and __ will each enter into a non-competition agreement in a form acceptable to the investors.]
Counsel to the Company [Company/investors] will draft documents. The Company shall pay reasonable fees [, not to exceed $ __ ,1 and expenses of investors' counsel.
Terms of Investor Rights Agreement
(a) Demand Rights. B~inning earlier of[3-5 years from Closing], or [three/six], months after the Company's initial public offering ("IPO"), [t-2] demand registrations [for underwritten public offerings 1 upon initiation by holders of at least % of outstanding Series _ Preferred Stock (or Common Stock issuable upon conversion of the Series Preferred Stock or any combination thereof) for aggregate""
proceeds in excess ofS . Expenses paid by Company.
including expenses of one counsel for the selling shareholders,
(b) Piggyback Rights, Investors in Series _ Preferred Stock will have [unlimited] piggyback registration rights subject to pro rata cutback at the underwriter's discretion, Full cutback upon the IPO; [30% minimum inclusion thereafter], Investors will not be subject to cutback unless all other selling shareholders are excluded from registration, Expenses paid by Company. including expenses of one counsel for the selling shareholdcrs.i'
(c) S-3 Rights, [Unlimited] S-3 Registrations of at least $500.000 each [upon initiation by holders of [20%] of the outstanding Series _ Preferred Stock (or Common Stock issuable upon conversion of the Series _ Preferred Stock or any combination rhereofj]. [No more than two S-3 Registrations in any 12-month period.] Expenses paid by Company. including expenses of one counsel for the selling shareholders,
Registration rights terminate [(i) [3-7] yearsu after the Qualified Public Offering:] or (ii) when [the Company is publicly traded and] all shares can be sold [in any 90-day period] under Rule
l: In follow-on Jinancing rounds, we should discuss \\ heiher we should have registration rights Sc!rarate and independent from those granted to other shareholders, If we arc lumped in with other shareholders. we need to make sure that thc' other shareholdcrs can't usc up all of the demand registraticn rights and that we have sufficient shares (0 make a demand on our own (or with a like-
minded investor). .
:) This istypicall~' six months because the underwriters ofthe Company's IPO will W:IJlt us to agree to lock-up our shares for 180 days after thc IPO.
:. The Company may wish 10 grant piggyback rights to thc Founders, This will be acceptable if, in thc c\ ent of an oversubscription to sctl in the ,)ITering. the Founders arc complcld~ cui- hack before we are cut-back,
:~ We should avoid ha\'ing our registration rights'k:m1in:ate :11 :I fixed date.
144~ whichever occurs firslJ[, provided that this clause (ii) shall not apply to any 5% holder deemed to be an affiliate of the Company.)
No future registration rights may be granted without consent of a [majority) of investors unless subordinate to investor's rights.
Prior to the Closing. all shareholders of the Company shall agree that in connection with the IPO not to sell any shares of Preferred Stock or Common Stock issuable upon conversion thereof for a period of up to 180 days following the IPO. Such shareholders also shall agree to sign the underwriter's standard lock-up agreement.26
Right of First Refusal:
The Investors shall have a pro rata right, based on their percentage equity ownership of [Preferred Stock) [Common Stock, on a fully diluted basis), to participate in subsequent
financings of the Company (excluding the sale of shares
of Common Stock reserved for employees [and the issuance of warrants to purchase Common Stock in connection with bank lines of credit, equipment lease transactions and real estate transactions.j)." Such right will terminate immediately prior to a Qualified Public Offering.
[Right to Purchase Shares at IPO:
After the one year anniversary of the Closing. Fund shall have the right to purchase up to 10% of the offered shares at the Company's IPO. If the IPO occurs on or prior to the one year anniversary of the Closing. Fund shall have the right to buy ug to 10% of the offered shares in a concurrent private placement.]'
The Investors shall receive standard information rights including [audited) financial reports within (90) days after the end of the fiscal year [and subject to minimum holdings requirements) quarterly [unaudited) financial reports within (45) days after the end of the fiscal year. monthly [unaudited) financial reports within _ days after the end of the month and annual budget and business plan within [30) days of the beginning ofa fiscal year, as well as standard inspection rights. [The annual financial reports and the quarterly financial reports shall be audited in the case of the annual financial statements and unaudited in the case of the quarterly financial reports by an accounting firm of national reputation.)
:6 Underwriters will a.~k that all or most orth.: shares of stock owned by shareholders orlhe Company at the: time of the 11'0 be subject to lock-up agreements. As investors, we should ensure that other investors can't delay or prevent an 11'0 by rerusing 10 sign the underwriters' lock-up agreements. We should consider whether any large shareholders should agree in advance: that they will not be subject to the: lock-up agreement with respect to follew-on offerings,
:7 The exclusions here should match the exclusions from "Dihnivc Issuances" in the antidilution provision,
:a Currently, based on informal SEC advice, it appears that the grantins or an 11'0 allocation tha- vill he exercisable one-year from the date or r.r.mt will not constitute a ,'iolation or the securities laws. Prior to the one-year anniversary, we should onl~ receive our shares in a COnCUrrL'TIt private placement.
I' ;lIxkur\I . .'udllrai3l1:k:h\FnrmT mnShL'd dill: II ~0611
[Board visitation rights?)
Board of Directors:
[The Company's Certificate of Incorporation shall provide that the) Board shall consist of __ . members, with the holders ofa
majoriry of Series Preferred Stock entitled to eleet
member(s) [and the holders ofa majoriry of the Comm~ck entitled to elect _ member(s»). [The Company and the investors intend to select __ outside director with relevant industry experience as soon as possible after Closing.) Board
composition at Closing shall be , [with
Expense Reimbursement for Outside Dlrectors:
The Company shall reimburse outside directors for all reasonable expenses incurred in their services as a director of the Company.
[Series _ Preferred Stock Outstanding:)
Common Stock Outstanding:
Common Stock Reserved for Employees (of" which __ have not yet been issued or committed to as options):
_. __ ~1.
Stock Option Plans:
The number of shares of Common Stock reserved for issuance under the Company's stock option plans and any similar plan
shall not exceed shares without prior written approval of
the Board of Directors[, including each director nominated by holders of Series _ Preferred Stock).
Common Stock Vesting:
Common Stock shall vest as follows: After 12 months of employment. 25% will vest; the remainder will vest monthly over the following 36 months. Repurchase option on unvested shares at cost.
Restrictions on Common Stock Transfers:
(a) No transfers allowed prior to vesting.
:-0 Consider lite ne, 1 for a V"ting Agreemcnt/Irust, especially if Fund \\iII n"t own enough shares ofa series ofPreferred Stock to elect a member of the: uow on its own of if lite Company can increase and !Io:1I additional shares of Preferred Slock 10 dilute: Fund. thereby prc\·cnling Fund from electing a member oflhe: BO:Jrd:·
(b) No transfers or sales permitted during lock-up period of up to [120 -ISO) required by underwriters in connection with stock offerings by the Company.
Right of First Refusal; Co-Sale Right:30
Any [vested) Common Stock acquired by employees shall be subjcct to a right of first refusal of the Company to repurchase any stock, at the bona fide offered price, The Investors also shall have the right to participate on a pro rata basis in transfers of any shares of [Preferred Stock or) Common Stock, [and a right of first refusal on such transfers, [subordinate to) [prior to) the Company's right of first refusal. [Any shares nQt subscribed for by an Investor may be reallocated among the other eligible Investors.]
[Right of Repurchase of Founders Stock:
[The Company/the Investors) will have the right to repurchase Common Stock at cost owned by the Founders on the following schedule: if a Founder voluntarily terminates his or her employment with the Company or is terminated for cause, then the [Company/the Investors) will have the right to repurchase 100% of the Founders' shares less 1/4S111 of those shares for each complete month of service the employee served with the Company.]"
So long as the Investor) own shares of Series _ Preferred Stock representing at least 25% of the Company's Common Stock on a fully-diluted basis (i.e .• assuming conversion of Preferred Stock into Common Stock [and the conversion or exercise of all warrants. options or convertible notes». the Investors shall have drag-along rights with respect to securities of any of the Founders or principal Common Stock holders in the event of a proposed sale of the Company to a third party (whether structured as a merger. reorganization. asset sale or otherwise). Such right will terminate at and upon a Qualified
Public Orrering).f~ .
[Key Person Insurance:
Company to obtain key person life insurance policy on
-:-- __ -:-" in the amount ofS ,with the [Company)
[Investors) as beneficiary.)
Transfer of Rights:
Any rights accorded to the investors may be transferred to (i) any partner or retired partner of any holder which is a partnership, (ii) any member or former member of any holder which is a limited liability company and (iii) any transferee who acquires at least _ shares: provided that the Company is given written notice thereof.
~I" This provision gives us some protection against Founders selling. their interest to .. third party.
~I This provision discourages founders from quilling their jobs and keeping a 101 of stock because il allows the COnlp:any 10 t>uy t>:aek the stock at the same (presumably low) price that the Founder paid.
~: A drag-along provision is nOI always present in \ enturc deals. It cnuld allow investors to force orh .. -r shareholders In ihe Company In :agr e 'C 10 sell their shares in or "OIC for a merger.
Closing subject to the negotiation of definitive legal documents and completion of legal and financial due diligence by Investors.
The Company will not discuss the terms of this Term Sheet with any person other than key officers. members of the Board of Directors of the Company or the Company's accountants or attorneys without the written consent of Fund. except as required by law. In addition, the Company shall not use the Fund name in any manner, context or format (including, reference on or links to websites, press releases. etc.) without the prior review and approval of Fund.
From the signing date her~funtil 5:00 P.M. California Time on _____ , the Company and the F.ounders agree that they shall not solicit. encourage others to solicit, encourage or accept any offers for the purchase or acquisition of any capital stock of the Company, of all or any substantial part of the assets of the Company, or proposals for any merger or consolidation involving the Company, and they shall not negotiate with or
enter into any agreement or understanding with any other person , with respect to any such transaction.]
AGREED AND ACCEPTED:
[Name of Company I
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