PE TERMS SHEETS COVENANTS
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Questions and Answers

What is the primary purpose of a company's bylaws?

  • To mandate how the company will operate (correct)
  • To elect the board of directors
  • To file taxes with the IRS
  • To outline the company's business strategy

    • What is the main advantage of stage financing in venture capital investments?

  • It guarantees a fixed rate of return on investment
  • It provides a one-time lump sum investment
  • It allows investors to withdraw their funds at any time
  • It mitigates the risk of the entrepreneur using the funds for unintended purposes (correct)

    • What happens to the assets of a company during the liquidation process?

  • They are converted into cash and distributed (correct)
  • They are transferred to the new investors
  • They are stored in a warehouse
  • They are donated to charity

    • What is the difference between pre-money and post-money valuation?

    <p>Pre-money is the value before new investment, post-money includes the new investment</p> Signup and view all the answers

    Why is it important to understand the incorporation process of a firm?

    <p>To understand the rights and powers of stakeholders</p> Signup and view all the answers

    What is the purpose of filing a corporate charter?

    <p>To describe the corporation's purpose, place of business, and officers</p> Signup and view all the answers

    What happens to the ownership percentage of existing shareholders when new shares are issued?

    <p>It decreases due to dilution</p> Signup and view all the answers

    How is the post-money valuation of a company computed?

    <p>By adding the amount of the investment to the pre-money valuation</p> Signup and view all the answers

    What is the primary benefit of convertible preferred shares to investors?

    <p>Higher returns if common stock value increases</p> Signup and view all the answers

    What determines the number of common shares received for each preferred share?

    <p>Conversion ratio</p> Signup and view all the answers

    What protects investors from ownership dilution?

    <p>Anti-dilution provisions</p> Signup and view all the answers

    What is the purpose of a term sheet in Series A preferred stock financing?

    <p>To outline the obligations of the company and investors</p> Signup and view all the answers

    What happens during the winding-up process of a firm?

    <p>Taxes are paid, and all business affairs are settled</p> Signup and view all the answers

    When might it be advantageous for an investor to convert preferred shares into common stock?

    <p>When the common stock price rises above the conversion price</p> Signup and view all the answers

    What determines the implied pre-money valuation of a company?

    <p>Post-money valuation minus new investment amount</p> Signup and view all the answers

    What is a 'deemed liquidation event'?

    <p>Consolidation or asset sale treated as a liquidation event</p> Signup and view all the answers

    What is the purpose of the 'no shop' clause in a term sheet?

    <p>To prevent the company from soliciting investment offers from other parties</p> Signup and view all the answers

    What are the typical terms regarding dividends for Series A Preferred Stock in a term sheet?

    <p>Accruing at a specified annual rate, payable when declared by the Board</p> Signup and view all the answers

    What is the primary purpose of the anti-dilution provision in a term sheet?

    <p>To protect investors from ownership dilution</p> Signup and view all the answers

    What is the typical voting structure for Series A Preferred Stockholders?

    <p>They vote with common stock on an as-converted basis</p> Signup and view all the answers

    What is the purpose of the 'no shop' clause in a term sheet?

    <p>To prevent the company from seeking or entertaining investment offers from other parties for a specified period</p> Signup and view all the answers

    What determines the number of common shares received per preferred share?

    <p>The conversion ratio</p> Signup and view all the answers

    What is the significance of a 'deemed liquidation event' in a term sheet?

    <p>It treats certain corporate events like mergers or asset sales as liquidation events, triggering the liquidation preferences for preferred stockholders</p> Signup and view all the answers

    What information rights are typically granted to major investors in a term sheet?

    <p>Access to company facilities, financial statements, operating budgets, and other key information</p> Signup and view all the answers

    What triggers the mandatory conversion of Series A Preferred Stock?

    <p>The company closes a public offering that meets specified price and net proceeds thresholds</p> Signup and view all the answers

    What is the purpose of the right of first refusal for investors in a term sheet?

    <p>To allow investors to participate in subsequent equity issuances before other parties</p> Signup and view all the answers

    What is the role of the board of directors in the context of a term sheet?

    <p>To be responsible for corporate governance, meeting regularly, and making decisions on significant company matters</p> Signup and view all the answers

    What is the typical vesting structure for employee stock options in a term sheet?

    <p>25% vesting after one year, with the remaining vesting monthly over the next 36 months</p> Signup and view all the answers

    Study Notes

    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

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