Equity Financing

Question 1

Optiguard Term Sheet case

What does it mean that preferred shareholders have a “class vote” in the context of the Optiguard term sheet?

Answer 1

Majority of Preferred Shareholders will vote on:

• amend/repeal provisions of Company’s Articles and Bylaws, changing rights or inc/decrease shares of Preferred
• Creating new series or class or shares having preference/priority to dividends
• Create bonds, notes, or obligations convertible into, exchangable, or options rights to purchase shares of stock with any preference or priorty
• Reclassify any class of common into shares with preference/priority
• apply any of its assets to redemption/acqusition shares of common
• agree to merger, sale, or consolidation in which more than 50% of voting power is disposed
• “other protective provisions in the articles”

Question 2

Is the fact that the preferred shares do not pay dividends an entrepreneur-friendly feature?

Answer 2

No dividends (at the board’s discretion) are the most entrepreneur-favorable terms.

Question 3

• When do anti-dilution provisions kick in?
• What is meant by “dilution” in this context?
• What is the difference between fullratchet and weighted average anti-dilution provisions?
• Which of the two is more entrepreneur-friendly?

Answer 3

• AD Provisions:
  
  • Non-Price:
    
    • Structural Protection (Conversion price, selling shares)
    • Right of First Refusal (‘up round’ of financing, if Series B Price > Series A Price)
  • Price-Based:
    
    • Full-Ratchet (severe, lowers CP to the subsequent round’s price)
    • Weighted-Average AD (WAAD) (adjusts conversion price of Series A by considering amount and price of dilutive round… creates New Conv. Price)
• Dilution means the changes that can occur between the rounds of investment.

WAAD is more entrepreneur-friendly, but NONE IS PREFERRED!! Structural AD Protection only.

Question 4

When do liquidation preferences kick in? What is their purpose?

Answer 4

Liquidation Preference kicks in upon a liquidation, dissoultion, or sale of the company, prior to distribution of any proceeds to common shareholders.

Purpose: value-preserving protection against the loss of capital in liquidation.

Participating (purch + div + comm, Capped (capped @ X*purch), Simple (purch + div)

Question 5

• When does the right of first refusal kick in?
• What is its purpose?
• What is a pay-to-play provision?

Answer 5

Kicks in when additional equity raised.

Permits investors to maintain percentage ownership

Makes application of certain protective provisions contingent on the preferred stockholders’ purchasing at least their pro rata share in a new round.

Question 6

• What is the typical IPO fee as a percentage of the total amount of stock offered?
• What is the typical underpricing, also in percent?
• If issuing equity is so expensive, why do firms resort to public equity offerings so often?

Answer 6

• Underwriting spread (~7% for ‘small deals’)
• Underpricing ~20%
• Why do firms do IPOs if they are so expensive?
  
  • Unlock demand from those unable to invest in private equity (e.g. $24 trillion of retirement account money!)
    
    • Greatly reduce cost of equity capital
  • Many IPOs sell small fraction of firm. Goal is not to raise capital but to establish liquid market for shares
    
    • Private equity need to exit
    • Founders may want to sell some of their shares and diversify their portfolio
    • Liquid equity = cheap currency in acquisitions

Question 7

• What is the pre-money valuation for the Series C funding round?
• What is the post-money valuation for the Series C funding round?
• Assuming that you own only the Series A preferred stock (and that each share of all series of preferred stock is convertible into one share of common stock), what percentage of the firm do you own after the last funding round?

It is currently 2019 and you need to raise additional capital to expand your business. You have decided to take your firm public through an IPO. You would like to issue an additional 6.0 million new shares through this IPO. Assuming that your firm successfully completes its IPO, you forecast that 2019 net income will be $6.5 million. Your investment banker advises you that the prices of other recent IPOs have been set such that the P/E ratios based on forecasted earnings average 18.0x.

• Assuming that your IPO is set at a price that implies a similar multiple, what will your IPO price per share be?
• What percent of the firm will you own after the IPO?

Answer 7

Question 8

Answer 8

Question 9

Answer 9

Companies file SEC Form 424B4 in tandem with an (IPO).