How to Do a Venture Capital Financing

How to Do a Venture Capital
Financing
Alidad Vakili, Foley & Lardner LLP
June 29, 2023
Silicon Valley: Idea to IPO
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DISCLOSURE
These materials have been prepared solely for educational purposes. The information
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presenter or Foley & Lardner. Specific legal issues should be addressed through
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materials. Attorney Advertising. Prior results do not guarantee a similar outcome.
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to another party any transaction or matter addressed within.
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AGENDA
 Background
 Overview
 Structural Considerations
 Documentation for Founders and Early Personnel
 Financing Options
 Convertible Securities
 Valuation and Dilution
 Overview of Venture Capital Financings
 Getting Investment Ready
 Preparing for Closing
 Common Pitfalls
 Q&A
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BACKGROUND
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 Corporate attorney with a practice focus on Emerging
Growth and Venture Capital.
 I work out of our San Francisco and Silicon Valley
offices and have worked with companies throughout
the US and the world.
 I enjoy working with and helping entrepreneurs on
startup adventures from startup to liquidity.
Alidad Vakili
Of Counsel
+1.415.438.6421
avakili@foley.com

Foley & Lardner LLP
Preparation is key
“Before anything else, preparation is the key to success.“
~Alexander Graham Bell
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OVERVIEW

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STRUCTURAL CONSIDERATIONS
Key Issues
 Entity type
 Jurisdiction
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DOCUMENTATION FOR FOUNDERS AND
EARLY PERSONNEL
 Proper Documentation is Key
 Confidentiality
 Intellectual Property Assignments (IP Assignments, CIIAAs (aka PIIAAs))
 Vesting of Securities
 Stock Options
 Restricted Stock
 Transfer Restrictions
 Shareholder Agreements
 Restrictions in Bylaws
 Stock Purchase Agreements
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FINANCING OPTIONS
 Convertible Debt
 Convertible notes (also sometimes referred to as bridge notes)
 Convertible Equity
 SAFEs (Simple Agreement for Future Equity)
 Equity / (priced equity or venture rounds)
 Series Seed, Series A, Series B, Series C, …
Note: There are other financing options that are beyond the scope of this presentation (e.g., grants,
loans, etc.)
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CONVERTIBLE SECURITIES
 Convert to future equity securities at a negotiated discount to a future
qualified equity financing
 Pros:
 Avoids valuation
 Easier to document
 less expensive
 Cons (at least typically for Convertible Notes):
 This is debt and may be required to be paid at some point
 Extra liquidation preference (i.e., creditors get paid first)
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 Maturity*
 Interest Rate*
 Conversion Terms
 Amendment Terms (e.g., majority in interest to amend)
 Remaining Terms
 Not typically subject to a lot of negotiation
*For Convertible Notes, not SAFEs
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• Mandatory conversion at a discount of price paid in Next Qualified Financing
 Series Seed/Series A needs to meet the definition of a “Qualified
Financing”
• Equity financing
• Minimum size (e.g., “$2,000,000”)
 Discount should be reasonable (20-25% typical)
 Conversion Price Cap (aka valuation cap)
 Conversion upon a change of control/sale/liquidation
 Optional maturity conversion
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CAPITALIZATION
To Give or not to Give?
 Striking the right balance when allocating equity
 Capitalization
 Think backwards when planning
 Ownership
 Control
 Dilution (plan for it – it’ll happen)
 Incentivize your team
 Proper documentation
 Vesting
 Repurchase rights
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FOUNDATIONAL BASICS – VALUATION AND
DILUTION
 Pre-money valuation – the value of the company before the next round of investment.
 Post-money valuation – the value of the company after the round of
investment (post-money valuation + investment = post-money valuation).
 Issued and outstanding basis – all stock issued and outstanding.
 Fully-diluted basis – all stock issued and outstanding, plus all securities that can
be converted to common, plus (typically) the shares reserved for equity
compensation.
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FOUNDATIONAL BASICS – VALUATION AND
DILUTION
 Simple Example (not factoring in the option pool or any other convertible equity)
 Pre-money $10,000,000
 10,000,000 shares split among three equal founders
 Founder A = 3,333,333 shares or 33%
 Investment $3,000,000 at $1.00/share ($10,000,000 pre-money/10,000,000
outstanding shares) (Post-money is $13,000,000)
 Founder A = 3,333,333 of ~25% with a paper value of $3,333,333
 3,333,333/13,000,000 = 0.2565 ~25%
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FOUNDATIONAL BASICS – EXAMPLE CONT.
 Basic Examples with Convertible Securities
 If there had been a $450,000 convertible security with 25% discount only,
holder would have received 600,000 shadow shares. $450,000/((1-
.25)*$1.00)
 This example ignores the circular math: in determining the price
the new money will pay and on which the discount will be applied,
the investor will include the shadow shares in the fully diluted
basis.
 If there had been a $450,000 convertible security with $5MM cap only, holder
would have received 900,000 shares. $450,000/(5,000,000/10,000,000)
 This example also ignores that the investor will include the shadow
shares in the fully diluted basis, which will change the price per
share the investor pays
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OVERVIEW OF VENTURE FINANCINGS
 Have a credible business plan with milestones
 Perfect your pitch
 Run a Systematic Process
 Have more than enough capital from your earlier seed rounds
 Connect with the right Investors
 Understand your ideal term sheet
 Prepare for thorough diligence
 Have good corporate hygiene
 Be prepared for cleanup
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OVERVIEW OF VENTURE CAPITAL
FINANCINGS
Understand your ideal term sheet:
 How much of the company is being sold
 Dividends
 Liquidation preferences
 Voting Rights
 Protective provisions
 Optional and Mandatory Conversion
 Antidilution protection
 Vesting for founders
 Documentation
 Attorneys Fees
 No Shop and Confidentiality Provisions
 Whether investors will get a board seat or observer rights
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OVERVIEW OF VENTURE CAPITAL
FINANCINGS
 Term Sheet
 Diligence process
 Documentation Process
 NVCA - https://nvca.org/model-legal-documents/
 Series Seed - https://www.seriesseed.com/
 Proprietary forms
 Pre-Closing
 Closing
 Post-Closing Items
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GETTING INVESTMENT READY
 Clean company records
 Make sure you have the proper documentation in order
 Make sure you have documents to support your cap table for a cap table tie out
 Organize documents and information in an investor friendly way
 Set up a data room and keep it updated
 Create and maintain information that will be needed for investor’s diligence
 Become familiar with the NVCA model financing agreements
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ALWAYS BE CLOSING (ABC)
 Do your homework
 Get your Company’s house in order BEFORE you talk to investors
 Cap table
 Proforma
 Data room
 Do your own diligence on potential investors
 Prepare for your closing from Day 1
 Create your team (internal and external)
 Set a reasonable timeline
 Organize and divide tasks appropriately
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COMMON PITFALLS
 Not setting up the entity properly (type of entity, jurisdiction)
 Not having proper documentation for founders, employees, consultants
 Failure to own the technology/IP that is critical to the business
 Not having proper vesting for equity grants
 Undocumented stakes in the company
 Non-Compliance with Securities Laws
 Not managing the company’s cap table
 Not having clean corporate records and an organized data room
 Thinking that there are “standard” or “boilerplate” terms
 Finders
 Side Letters
 Failure to obtain proper corporate authorization
 Risk of employment-law issues
 Tax issues – e.g., federal, state, local
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PARTING THOUGHTS…
Do your homework
Prepare in advance
Dream backwards
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Q&A
Alidad Vakili
avakili@foley.com
June 30, 2023
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Foley & Lardner LLP
About Foley
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ATTORNEY ADVERTISEMENT. The contents of this document, current at the date of publication, are for reference
purposes only and do not constitute legal advice. Where previous cases are included, prior results do not guarantee
a similar outcome. Images of people may not be Foley personnel.
© 2023 Foley & Lardner LLP
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How to Do a Venture Capital Financing

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