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B: M&A > L2 - Venture Capital > Flashcards

L2 - Venture Capital Flashcards

1
Q

Which financing stage is there in the concept/research stage?

A

Seed stage

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2
Q

Which financing stage is there in the business planning stage?

A

angel investors

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3
Q

Which financing stage is there in the product development stage?

A

angel + early stage investments

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4
Q

Which financing stage is there in the first commercial deals stage?

A

early stage

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5
Q

Which financing stage is there in the fully commercial stage?

A

round 1/A

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6
Q

Which financing stage is there in the fully commercial/expansion stage?

A

Round 2/B

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7
Q

Which financing stage is there in the expansion stage?

A

Round C

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8
Q

Which financing stage is there in the ready for IPO stage?

A

Mezzanine

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9
Q

What are the equity forms given to companies?

A

Buy-outs
Growth investments
minority investments (investor takes a non-controlling stake)
Venture Capital

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10
Q

How to decide between internal vs. external equity? Sample questions

A

If answered with ‘yes’ then external equity is worth considering

Does the company have a product with a competitive edge or unique selling point?
Can it be protected by intellectual property rights?
Is there a realistic exit opportunity?
etc.

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11
Q

Which six legal documents are there?

A
  1. term sheet
  2. participation agreement
  3. shareholder agreement
  4. articles of association
  5. rules of procedure
  6. ancillary agreements
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12
Q

term sheet

A

A term sheet is a nonbinding agreement that shows the basic terms and conditions of an investment. The term sheet serves as a template and basis for more detailed, legally binding documents.

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13
Q

participation agreement

A

participation agreement (investment contract)

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14
Q

shareholder agreement

A

The shareholders’ agreement / participation agreement regulates the conditions of the investor’s entry (company valuation, amount of investment through equity capital, including premiums / agio and debt capital, usually shareholder loans, or mezzanine capital as well as guarantees from the existing shareholders). Furthermore, the modalities of the investor’s influence in Germany are standardised through special control and information rights as well as restrictions on disposal. Finally, the exit of the financial investor is also ensured through co-sale obligations, purchase options (put and call options) and liquidity preferences.

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15
Q

ancillary agreement

A

An ancillary agreement, or ancillary contract, is any legal agreement established in addition to a pre-existing contract. To be an ancillary agreement, the agreement must include terms relating to the original contract.

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16
Q

does the valuation of a startup actually mean how much it is worth?

A

No. In early-stage companies the valuation is a negotiated number and does not really mean anything about what the business is worth

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17
Q

convertible note

A
  • in certain events debt holder can convert the obligation for repayment into equity security
  • loan will be replaced by the instrument of the financing round issued (e.g. series A preferred)
  • valuation and share price for the issuance/conversion is set by the company and the new investor
  • note holder will get a discount on the share price (approx. 20-30%)
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18
Q

Types of preferred shares

A
  • participating preferred
  • non-participating preferred
  • capped participation preferred
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19
Q

Liquidation preference meaning

A
  • investors will get their funds back before the founder or other shareholders receive anything.
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20
Q

Non-participating preferred stock

A
  • preferred holders receive an amount equal to [1x to 3x] the initial investment plus accrued and unpaid dividends
  • holders of common stock receive the remaining proceeds
  • if holders of common stock would receive more per share than holders of preferred stock, holders of preferred will convert their preferred shares into common stock (convertible preferred stock)
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21
Q

Disadvantages of Non-Participating Preferred Stock

A

The downside of owning this type of stock is that the elimination of a participation right limits the price that an investor can obtain by selling these shares to a third party, since the shares are less valuable.

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22
Q

Advantages of Non-Participating Preferred Stock

A

The upside of this situation is that the holders of the preferred stock have a preference right, under which they will be paid before the holders of common stock. This preference right also applies when previous dividends have not been paid - all preferred dividends must be paid before any dividends are paid to the holders of common stock.

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23
Q

participating preferred stock

A
  • preferred holders receive an amount equal to [1x to 3x] the initial investment plus accrued and unpaid dividends
  • thereafter, preferred holders and common stock holders participate in the remaining proceeds pro rate on as-converted basis.
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24
Q

Why do investors prefer participating preferred shares?

A

because they receive preferred return over both low and high exit values

25
Q

capped-participating

A

First pay [X] times the original purchase price (plus accrued dividends and unpaid dividends) on each share of Series A Preferred. Thereafter, Series A Preferred participates with Common Stock pro rate on an as-converted basis until the holder of Series A Preferred receive an aggregate of ( ) times the original purchase price (including the amount paid pursuant to the preceding sentence).

26
Q

Argument against participating preferred stock

A

When a company is sold shortly after the investment, the founders, who likely paid much less than holders of preferred stock, can get a significant return on their investment, while preferred stockholders get little return. This is especially true if there is a “1x” liquidation preference (sometimes if a company is distressed at the time of a financing, the liquidation preference is much higher, often 5x)

27
Q

Argument for participating preferred stock

A

Common stockholders might argue that participating preferred allows the holders to essentially double-dip into the proceeds.

28
Q

Liquidations preferences are designed to protect who?

A

The investor

29
Q

For whom can preferred participation create unfair scenarios?

A

For entrepreneurs

30
Q

example capped participation

These days, payout caps are typically around 3x the investment amount. An investor committing $1M with 1x participating liquidation preference on a 3x cap will receive up to

A

$3M in total proceeds ($1M liquidation preference + $2M in participation) if he/she does not convert.

An investor must choose to convert fully to common to receive any payout higher than its cap.

31
Q

What should founders avoid?

A

Founders should avoid participating liquidation preferences as this will always generate a larger exit value for the investor (thus, smaller for the founder) than non-participating liquidation preferences.

32
Q

Are dividends material in VC?

A
  • typically low cash flow of the target
  • immaterial relative to liquidation preference
  • more material if
    i) large investment
    ii) low IRR
33
Q

What are information rights?

A
  • Right to receive financial statements, inspect premises

- usually not controversial - may be subject to share % threshold

34
Q

What is the most important thing to control?

A

Business plan budget (CAPEC etc.)

35
Q

What are covenants/ veto rights about?

A
  • change the terms of stock owned by the VC
  • authorize the creation of more stock
  • buy back any common stock
  • sell the company
  • change the certificate of incorporation or bylaws
  • change the size of board of directors
  • pay or declare a dividend
  • borrow money (often tied to some threshold)
36
Q

Is the size of the board of directors important?

A

Yes.

  • A smaller board (~5 than pre-IPO/PubCos (9) speeds decisions
  • plan for future funding rounds
  • observers - additional voices = potential confusion
37
Q

How does the board of directors get reimbursed?

A

Often expense reimbursement, but rarely other than cash

38
Q

What is diution?

A

That a shareholder’s ownership percentage in a company decreases because of a new issuance of shares

39
Q

Full-ratchet

A
  • conversion price of the existing preferred is reduced to the price at which new shares are issued in a later round

e.g. Investor A bought in at 160 per share and a down round later occurs in which stock is
Full-ratchet
issued at 128 per share, Investors A price will convert to 128 per share.

–> this means that each preferred share of investor A now converts into 1.25 common shares

40
Q

For whom is the full ratchet most advantageous?

A

for investors

41
Q

What is the weighted average

A

Conversion price will be reduced on the basis of the average of the share prices in each financing round and subject to the relevant volume

42
Q

disadvantage of full ratchet

A

Including a full ratchet provision in the company’s charter documents may deter some potential new investors from investing in the company. The company will appear less attractive to invest in since the anti-dilution provision only protects the current shareholders and puts any burden of dilution on the new shareholders.

43
Q

Pay to play

A

requires existing investors to invest on a pro rata basis in subsequent financing rounds or they will lose some or all of their preferential rights.

44
Q

what are the preferential rights an investor has

A
  • anti-dilution protection
  • liquidation preference
  • voting rights
45
Q

How do investors lose their preferential rights if they do not pay? Two mechanics

A
  • conversion into a shadow series of preferred stock (with the applicable rights stripped-out)
  • conversion into common stock, resulting in the loss of all preferential rights (strongman pay-to-play)
46
Q

In which context is pay to play negotiated?

A

Pay-to-play provisions are often hotly negotiated in the context of a “down” round, particularly where a subset of existing investors is leading such a round and requires the other existing investors to participate or, in effect, be punished. (That’s called “eve of financing” pay to play).

Pay-to-play provisions can, however, be drafted to apply to any future financing, regardless of whether it is a down round or not, to ensure the future support of all investors.

47
Q

Redemption

A
  • right of the preferred stockholder to cause the company to redeem all shares of the preferred stock for its original purchase price plus accrued and unpaid dividends
  • like a put right
48
Q

Rationale of redemption

A
  • exit option for investors in sideways situation

- leverage over company and management

49
Q

subscription

A

A subscription right is the right of existing shareholders in a company to retain an equal percentage ownership by subscribing to new stock issuances at or below market prices. The subscription right is usually enforced by the use of rights offerings, which allow shareholders to exchange rights for shares of common stock at a price generally below what the stock is currently trading for.

50
Q

subscriptions subject to exclusions in two cases

A
  • option pool issuance

- strategic alliances & licenses

51
Q

Right of first refusal

A

In venture capital deals, the right of first refusal is a term sheet provision permitting existing investors in a company to accept or refuse the purchase of equity shares offered by the company, before third parties have access to the deal. The main goal of the provision is to allow investors to prevent ownership dilution as the company raises additional capital. Typically, the provision will exempt certain types of shares, such as those in an employee pool, or shares issued to equipment loaners or lessors.

52
Q

Drag right

A

FORCES founders and other shareholders to sell their shares along with the investor to a third party

A drag along right allows a majority shareholder (ie usually a shareholder holding more than 50% of shares in a company that have voting rights attached) of a company to force the remaining minority shareholders (ie usually a shareholder holding less than 50% of shares in a company that have voting rights attached) to accept an offer from a third party to purchase the whole company.

The majority shareholder who is ‘dragging’ the other shareholders must offer the minority shareholders the same price, terms and conditions that the majority shareholder has been offered.

53
Q

Tag right

A
  • gives investors the right to sell shares pro rata if a founder sells shares to others

Tag along rights are also known as ‘co-sale rights’ are the inverse of drag along rights. When a majority shareholder sells their shares, a tag along right will entitle the minority shareholder to participate in the sale at the same time for the same price for the shares. The minority shareholder then ‘tags along’ with the majority shareholder’s sale. Tag along rights are usually worded to state that if the tag along procedures aren’t followed then any attempt to buy shares in the company is invalid and won’t be registered.

54
Q

piggyback rights

A

Piggyback registration refers to a method of selling shares through an initial public offering (IPO). It is typically used by early investors, founders, and other company insiders who negotiated the right to sell their shares as part of any future IPO.

55
Q

IPO lock-up

A

An initial public offering (IPO) lock-up period is a caveat outlining a period of time after a company has gone public when major shareholders are prohibited from selling their shares. During the IPO lock-up company insiders and early investors cannot sell their shares, helping to ensure an orderly IPO and not flood the market with additional shares for sale.

56
Q

When are preferred shareholders forced to convert their stocks to common stocks?

A

Preferred stockholders can be forced to convert their preferred stock to common stock in a few situations: IPO. When a company holds its initial public offering (IPO), it is expected that all outstanding preferred stock will convert to common stock immediately before the IPO.

57
Q

no shop agreement

A

A no-shop clause is a condition in an agreement between a seller and a potential buyer that prevents the seller from getting an offer from another buyer.

58
Q

vesting meaning

A

Vesting is a legal term that means to give or earn a right to a present or future payment, asset, or benefit.

  • if founders leave the company, investor has an option to repurchase the shares

Vesting is the process where an employee or founder earns shares over time. This means rather than having immediate equity in a company, you earn a percentage of shares on a monthly (or quarterly) basis over time.

B: M&A (4 decks)

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