Startup Financing: Overview of Preferred Stock

Early Growth Financial Services

Today, we’re tackling participating versus non-participating preferred stock, a fundamental economic term in VC deals that goes to the heart of the business agreement between investors and management in connection with a sale of the company. This post by Ian Engstrand first appeared on Founders Workbench. From time to time on Founders Workbench we give a brief primer on common terms and issues in venture financings.

Common Stock vs. Preferred Stock in Venture Funding Transactions

Growthink Blog

The question is whether they need to issue common or preferred stock. The answer depends on how and what rights are defined in the preferred stock. This is an extremely valuable preference that can best be shown by example.

7 Investor Term Sheet Demands Startups Need Not Fear

Startup Professionals Musings

For later investments, the price is equity, with a percentage of the owner stock to be assigned to the investor. Type of stock assigned to the investor. Investors typically demand preferred stock, to give themselves certain voting and liquidation privileges over later shareholders.

Everything You Ever Wanted to Know About Convertible Note Seed Financings (But Were Afraid To Ask) – Part 1

Scott Edward Walker

ii) why are convertible notes issued instead of shares of common or preferred stock? In the context of a seed financing, the debt typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing.

Bitesize Weekend – quick reads

VC Cafe

Some of the posts that got my attention this week… 5 Ways To Raise Funds for Your Startup – Mashable brings a good reminder on the ways to raise funding: friends/family/fools, incubators, convertible debt, preferred stock and VC.

Founder Liquidity

K9 Ventures

If there is one piece of advice I would give to the founders of BST, it is to consider selling a part of their personal stock in the company at that stage. If things go well, and your company succeeds beyond your wildest dreams, it will end up being the most expensive house ever (because you could have held your stock and made a lot more on it). 3) Setting a precedent for the price of the Common Stock : This is the biggest issue with founder liquidity.

Avoid Offensive Liquidation Preferences

The Startup Lawyer

In most equity financing rounds, an investor will ask for (and get) a term called a liquidation preference. A liquidation preference is the amount that must be paid to a preferred stock holder before any sale proceeds may be paid to the holders of common stock (i.e., The amount of the liquidation preference is usually expressed as a multiple, with the most common liquidation preference being “1X non-participating.” Preferred Stock

Series Seed Documents for Early Stage Startups – V2

VC Cafe

Fred Wilson , Paul Graham and Seth Levine all agree that as an entrepreneur one would prefer uncapped convertible debt to equity, but investors typically won’t go for it. Preferred Stock Purchase Agreement Series Seed Form SPA. B ack in March, Andreessen Horowitz and Fenwick & West, LLP published a series of documents that would help structure early stage investments in startups.

X Does Not Always Equal X

The Startup Lawyer

The deal documents called the preferred stock “Series Seed&# shares but after opening up the documents I quickly realized the deal terms were NOT the same as those in the well-known Series Seed document set. For example, the well-known Series Seed has a 1x non-participating liquidation preference , while the version I reviewed had a 1x participating preference. Preferred Stock

Raising Capital? 3 Tips for Entrepreneurs – Part 2

Scott Edward Walker

Finally, unless the startup is raising at least approximately $750,000, it generally is not in the company’s interest to issue shares of preferred stock. What about issuing shares of common stock?

Model Series Seed Docs

The Startup Lawyer

The board is set up to consist of 3 directors: 1 director elected by the common (founders); 1 directors elected by the preferred (investors); 1 “independent&# director (i.e., 2) Series Seed Stock Preferred Stock Purchase Agreement. Tags: Preferred Stock documents lawyer seed funding

Venture Capital Term Sheets – Redemption Rights

Scott Edward Walker

Here are the issues I have addressed to date: common mistakes dealing with VC’s valuation liquidation preferences stock options exploding term sheets and no-shop provisions anti-dilution provisions dividends Board control protective provisions drag-along provisions pay-to-play and pull-up provisions conversion rights In today’s post, I examine the redemption rights of investors.

Model Series Seed Docs

The Startup Lawyer

The board is set up to consist of 3 directors: 1 director elected by the common (founders); 1 directors elected by the preferred (investors); 1 “independent&# director (i.e., 2) Series Seed Stock Preferred Stock Purchase Agreement. Tags: Preferred Stock documents lawyer seed funding

Model Seed Funding Doc Myths

The Startup Lawyer

A variety of model startup seed funding docs have been released in the past year or so: TechStars Series AA Preferred , YCombinator Series AA Preferred , and TheFunded Founder Institute’s Plain Preferred. For example, a founder stock purchase agreement is 12+ pages long because founders can, have, and will fail and/or bail on startups (hence the vesting schedule & startup repurchase option).

Model Seed Funding Doc Myths

The Startup Lawyer

A variety of model startup seed funding docs have been released in the past year or so: TechStars Series AA Preferred , YCombinator Series AA Preferred , and TheFunded Founder Institute’s Plain Preferred. For example, a founder stock purchase agreement is 12+ pages long because founders can, have, and will fail and/or bail on startups (hence the vesting schedule & startup repurchase option).

New Survey from Fenwick & West Looks at Angel Funding Landscape

ReadWriteStart

The majority of financings was structured as preferred stock (69%), as opposed to convertible note financings (31%), and the vast majority of those (83%) had their conversion price capped. The median amount raised in preferred stock financings was $1.1

What happens when a company is acquired for less money than it raised in funding?

Gust

In some other cases, all Preferred investors are treated pari passeux , so steps 5/6 and 7/8 below would be combined into one.). 5) Senior Preferred Stock and warrants. 6) Any preference multiple on (5). 7) Junior Preferred Stock and warrants.

Model Cap Table

ithacaVC

The model includes a simple waterfall analysis using both participating and non-participating preferred (see line 44 and then columns M and O). The larger the preferred stock liquidation preference the larger the impact of participating preferred. Columns I and J are important as they show the % of preferred stock ownership compared only to preferred stock outstanding.

8 Ways To Nurture New Venture Stock Into A Goldmine

Startup Professionals Musings

I’ll never forget that great sense of excitement I felt when I incorporated my first business, and realized that I was now the proud owner of 10 million shares of common stock. Unfortunately, in my years since as a small business advisor, I have seen too many founders squander this asset through a lack of understanding of some basic legal and operational issues, or by handing out nominally “free” stock to the wrong people at the wrong time.

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How do you pay an early stage board?

Berkonomics

The option price should be set by appraisal under IRS rule 409a, and certainly should be low enough to recognize that common stock options are not worth as much as preferred stock, given the many preferences of the latter.

Ask the VC Bonus Material

Feld Thoughts

Series A Preferred Stock Purchase Agreement. When Jason and I set out to write Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist , we both agreed that we wanted to try to create as useful and durable a reference guide for entrepreneurs interested in raising a round of venture capital as we could. As a result, we created a Resources page on Ask the VC and decided to load it up with legal documents that are part of a venture capital financing.

Is convertible debt with a price cap really the best financing structure?

Startup Company Lawyer

Convertible debt with a price cap seems to be the preferred structure for early-stage financings. A logical alternative to convertible debt is a priced Series A preferred stock financing. Mark Suster does a good job analyzing whether convertible debt is preferable to equity , and concludes that convertible debt is better. Convertible debt with a price cap preserves the investor’s “equity&# ownership, but gives the investor extra liquidation preference.

Management Carve Out Plans

ithacaVC

This typically results when the company has raised a lot of money and the preferred stock liquidation preference would absorb an out sized portion of the exit proceeds. I have posted a few times on management carve out plans (back in February 2011 and November 2011 ; wow, time flies!!). Our portfolio companies routinely adopt carve out plans when the founders/employees equity values are not likely to provide enough incentive to get a company to an exit.

Knowledge Is Power: Convertible Note Financing Terms, Part I

Gust

For a traditional VC financing round structured as a sale of preferred stock, the best resources I can recommend are the Term Sheet Series by Brad Feld and Jason Mendelson and Startup Company Lawyer by Yokum Taku. A term sheet for a convertible note deal may run two or three pages, versus 8-10 pages for a typical Series A Preferred Stock financing. (I’ve

An Alternative to Board Decks Some Seed VCs Actually Prefer

View from Seed

You should still work with your board about what format they prefer.). Examples of housekeeping include the following list, though not every item will appear every time: Finance: Cash out date, burn rate, 409A valuation, cap table, common/preferred stock dashboard.

How to Divide Founder Equity: 4 Criteria to Discuss

View from Seed

Additionally, you should put whatever agreement you reach to paper , even if you have not yet incorporated or had your legal counsel draw up the founder stock paperwork. You can then work with your law firm to formally draw up founder common stock paperwork either then or subsequently.

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Knowledge Is Power: Convertible Note Financing Terms, Part II

Gust

Mandatory Conversion : The Notes and any accrued interest will be converted into the Company’s next issued series of preferred stock resulting in new money of not less than $1,000,000 (an “ Eligible Financing ”) at a discount to the per-share price of such preferred shares of 25% (the “ Conversion Price ” ). per share for 2,000,000 shares of newly issued Series A Preferred Stock.

Learning all about Convertible Note Seed Financing

Business Plan Blog

In the context of a seed financing, the debt typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing.” In layman’s terms, investors will give money to a startup but instead of getting money back, they get preferred stock in return. ii) why are convertible notes issued instead of shares of common or preferred stock?

8 Questions To Help Set Expectations With Investors

Startup Professionals Musings

Most professional investors will expect preferred stock, a board seat, rights to later rounds and perhaps anti-dilution protection. One of the big questions that every entrepreneur struggles with is how much funding they should request from investors in the first round.

What is convertible equity (or a convertible security)?

Startup Company Lawyer

Other folks, such as Mark Suster, have also written about whether convertible debt is preferable to equity. Fred Wilson has been openly critical of convertible debt , and prefers priced equity rounds. Manu Kumar has also indicated that he prefers priced equity rounds to convertible debt. ” As a result, Ted introduced the Series Seed preferred stock documents as an alternative to convertible debt for early stage investments.

8 Ways To Maximize The Value Of Your Startup Stock

Startup Professionals Musings

When an entrepreneur first incorporates his or her business, he or she may find him or herself the proud owner of 10 million shares of common stock, commonly called founder’s shares. Make sure the government waits for a stock sale to collect taxes. This is called stock dilution control.

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The Convertible Note Discount Price Cap

The Startup Lawyer

For this article, let’s assume this equity is the Series A Preferred Stock purchased by a venture capital fund. compensate the angel for the early risk), the convertible promissory note will have an automatic conversion discount feature by which the angel investor will exchange the convertible debt for shares of the Series A Preferred Stock at a discount to the price per share paid by the venture capital fund at a Qualified Financing.

Venture Capital Term Sheets: Conversion Rights

Scott Edward Walker

Here are the issues I have addressed to date: common mistakes dealing with VC’s valuation liquidation preferences stock options exploding term sheets and no-shop provisions anti-dilution provisions dividends Board control protective provisions drag-along provisions pay-to-play and pull-up provisions In today’s post, I examine conversion rights of investors. As many of you know, VC investors are typically issued shares of preferred stock, not common stock.

Avoid New Venture Shortcuts That Scare Away Investors

Startup Professionals Musings

Experienced entrepreneurs understand investor expectations of Board representation, preferred stock, and payments based on interim milestones.

Why Uber is The Revenge of the Founders

Steve Blank

To turn your company’s stock into cash, you engaged a top-notch investment bank (Morgan Stanley, Goldman Sachs) and/or their Silicon Valley compatriots (Hambrecht & Quist, Montgomery Securities, Robertson Stephens). None of this was law, and nothing in writing required this; this was just how these firms did business to protect their large institutional customers who would buy the stock. Founders can now outvote the preferred stock holders (the investors).

Angels and VCs: Don’t be greedy even if you can.

Berkonomics

Most sophisticated investors will take either a promissory note or preferred stock, both of which come before founder or management stock in a sale or liquidation. Further, preferred stock holders can be recipient of accrued dividends in a sale or liquidation.

These 8 Disciplines Define A Fundable Entrepreneur

Startup Professionals Musings

A C-corporation is more complex and expensive, and is recommended only if you expect to pitch to professional investors who demand preferred stock, or to more than 100 potential shareholders. Aspiring entrepreneurs often ask me what to do first when starting a business.

4 Things Every Founder Should Know About Convertible Equity

Early Growth Financial Services

In short, convertible equity is a form of financing that gives investors the right to preferred stock once a triggering event occurs. Lately I‘ve been getting more and more questions about convertible equity: “What is it?” and “Should I use it?” So I figured now’s the right time to answer a few questions and fill in some blanks. So what’s that mean? First some background… Convertible debt Convertible debt is a common feature of startup seed rounds, used in more than ?

Convertible Debt – Conversion In A Sale Of The Company

Feld Thoughts

The potential bad news is that if the merger is an all stock deal, the company will need to find a way to find cash to pay back the loan or negotiate a way for the acquiring company to deal with the debt. In the case of an early-stage startup that hasn’t issued preferred stock yet, the debt converts into stock of the acquiring company (if it’s a stock deal) at a valuation subject to a cap.

Creative Common Stock

ithacaVC

A cap table is a written record (in Excel, for example) of who owns stock in your company. It lists every owner out by amount owned, type of stock (common or preferred), and date purchased. One rule of simple cap tables is to issue “normal” stock to founders (common stock only) and investors (typically preferred stock, but sometimes common stock to early friends and family). I am a huge fan of simple cap tables.

Punch & Pie: How Should Co-Founders Divide Equity?

Agile VC

Additionally, you should put whatever agreement you reach to paper, even if you have not yet incorporated or had your legal counsel draw up the founder stock paperwork. You can then work with your law firm to formally draw up founder common stock paperwork either then or subsequently.

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How to Minimize the Red Tape and Taxes of a Startup

Startup Professionals Musings

If you are certain that you are building a large national corporation with more than 100 investors, and multiple classes of stock, then you might as well start with a Delaware or Nevada C-Corp.

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Convertible Note Seed Financings: Econ 101 for Founders

Scott Edward Walker

ii) why are convertible notes issued instead of shares of common or preferred stock? If the noteholders invested $500,000 and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price of $0.50