PE TERMS SHEETS COVENANTS

Structuring the Deal

• Primary learning objectives of the "Structuring the Deal" course:
  • Understanding incorporation and termination process of a firm
  • Understanding the rationale of stage financing
  • Computing pre-money and post-money valuation
  • Deciding when to convert preferred equity into common stock

Incorporating a Firm

• Steps involved in incorporating a firm:
  • Applying for a corporate charter, which describes the corporation's purpose, place of business, and officers
  • Filing the application for the charter with the Secretary of State
  • Drafting and signing the bylaws after the charter is authorized
• Purpose of a company's bylaws:
  • To outline how the company will operate, including rights and powers of stockholders, directors, officers, or employees

Liquidation Process

• What happens during the liquidation process of a firm:
  • Remaining fixed assets and inventory are converted into cash
  • Assets are distributed
  • Board of directors ceases to exist

Stage Financing

• Importance of stage financing in venture capital investments:
  • Mitigates the risk of the entrepreneur using funds for unintended purposes or leaving the firm prematurely
  • Milestones ensure that funds are disbursed only when specific goals are met

Valuation

• How to compute pre-money valuation of a company:
  • Subtract the amount of the investment from the post-money valuation
• Difference between pre-money and post-money valuation:
  • Pre-money valuation is the value of the company before new investment
  • Post-money valuation includes the new investment

Dilution and Convertible Preferred Shares

• Dilution:
  • Occurs when new shares are issued, reducing the ownership percentage of existing shareholders
• Convertible preferred shares:
  • Give holders the option to convert their shares into a fixed number of common shares
  • Offer fixed dividends and higher returns if the common stock value increases
• Conversion ratio:
  • Determines the number of common shares received for each preferred share
  • Shows the price at which common stock needs to trade for the conversion to be profitable

Protective Provisions and Voter Rights

• Protections for preferred stockholders in the event of a company's liquidation:
  • Receive their original purchase price plus accrued dividends before any distributions to common stockholders
• Anti-dilution provisions:
  • Protect investors from the dilution of their ownership by adjusting the conversion price of preferred shares when new shares are issued at a lower price
• Voting rights of Series A Preferred Stock:
  • Votes together with common stock on an as-converted basis
  • May have the right to elect specific members of the board independently

Term Sheet Provisions

• Purpose of a term sheet in Series A preferred stock financing:
  • Summarizes the principal terms of the investment, outlining the obligations of the company and investors
• Typical terms regarding dividends for Series A Preferred Stock:
  • Accrues dividends at a specified annual rate, payable only when declared by the Board
  • Participates with common stock on an as-converted basis for other dividends or distributions
• Liquidation preference for Series A Preferred Stock:
  • In the event of liquidation, Series A Preferred Stockholders are paid their original purchase price plus accrued dividends before any distribution to common stockholders

Liquidation Events and Winding-Up Process

• Winding-up process of a firm:
  • Taxes are paid
  • All business affairs are settled
  • Official dissolution of the company
• Deemed liquidation event:
  • A merger, consolidation, or asset sale treated as a liquidation event
  • Triggers payment of liquidation preferences to preferred shareholders unless they elect otherwise