The reading level for this article is Novice

January 22, 2003

VC Valuation & Deal Structure

BUSI 299Q – Kenan Flagler Business School

Intersouth Partners
 

Current events in VC

Freedom of Information Act (FOIA) – information on investments (and VC funds) must be disclosed.

But few standards in reporting that can provide for consistency. Most important non-standard is valuations since there is no liquid market for private securities.

 Problem since start-up companies do not want their valuations to be revealed.

Anatomy of a Venture Capital Deal

Chris Lynch; Wyrick Robbins Yates & Ponton LLP

The art is in finding out the consistencies among the desires on both parties.

Priority in Liquidation (if go bankrupt then order of getting money)

¨       Senior debt

¨       Subordinated debt

¨       Trade debt

¨       Venture Capital Preferred Stock

¨       Common Stock

Venture capital preferred as some downside protection and an unlimited upside potential.


Major Term Sheet Issues

Essential terms of deal in term sheet

I.        Core Economics

  1. How much money needs to be raised
    1. Founder’s percentage (100% minus VC percentage)
    2. VC Percentage (Money invested as a percentage of pre-money valuation plus money invested)
    3. As an entrepreneur take as little money as you need to get through (but take enough to get through upcoming rounds). General consensus now is if you can get the money take it, but if you can, take money later when your valuation is higher (and you have to sell off less of company to get same amount of money).
    4. Should have at least 12-18 months operating capital.
    5. How many customers do you have (has the idea been validated).
  2. Pre-money valuation (what is company worth before investment)
    1. Subjective process
    2. Little leverage as an entrepreneur until you have a successful track record
  3. Fully Diluted Shares Outstanding
    1. Everything gets converted to a per-share price
    2. Price per share = Pre-money valuation divided by shares deemed outstanding (current outstanding plus future outstanding shares)
    3. Includes reserve for future incentive stock for employees and consultants

Ex. Founders                      1,000,000 shares                      40%

      Investors                      1,000,000 shares                      40%

      Future Options                  500,000 shares                      20%

 

II.          Preferred Stock Characteristics (much different than Public Company preferred)

a.      Conversion Rights

b.      Liquidation Preference (after debt but before common stock)

                                                              i.     Participating Preferred (protection for VC against early sale)

c.      Antidilution Rights (cannot sell stock later at lesser price)

d.      Redemption Rights (forcing company to buy back stock)

e.      Dividends

f.        Protective Provisions (so you won’t sell the company without consent)

III.                 Liquidity

a.      Registration Rights

b.      Co-Sale Rights

c.      Redemption Rights

IV.               Control

a.      Board of Directors Composition

b.      Founders Stock Vesting (get stock over time)

c.      Use of Proceeds Covenants

d.      Other Affirmative and Negative Covenants (won’t violate foreign corrupt practices act)

V.                 Closing Conditions

a.      Satisfactory due diligence

b.      Obtaining minimum dollar investment

c.      Other company-specific condition

d.      You get the money

This MBA Series Notes article was written by Intersouth Partners, taken by Ryan Allis on 2/28/2005

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