1.

Negotiation Table

Assessment Negotiating Walk away

Category Term Term Sheet Value
- = + Position position
Pre-money valuation ** $5 million
Investment amount $2 + $1 million
Stock Option Plan ** 20%, no accelerated vesting
Dividend Provision ** 12%
Economic Liquidation preference ** 2X
Participating preferred ** Yes
Antidilution ** Full ratchet

Protection Provisions ** 75%, list unspecified

Board of Directors 4 members
Control 2 investor, 2 company
Compensation committee Outside directors

Management changes (other Replace CEO

covenants) Hire VP eng & sales
Re-vesting of Founders, & repurchase of unvested shares at termination **
Other 100%

Non-solicitation/non- Includes a 2 years non-

disclosure compete
 2. Detailed Explanations

Term Details
A pre-money valuation is a term used in private equity or venture capital that refers to the
valuation of a company or asset prior to an investment or financing.
External investors, such as venture capitalists and angel investors will use a pre-money
valuation to determine how much equity to demand in return for their cash injection to an
entrepreneur and his or her startup company. For example, if an investor makes a $10 million
investment into a company in return for 20% of the company's equity, the implied post-money
valuation is $50 million. To calculate the pre-money valuation, the amount of the investment is
Pre-money valuation1,2
subtracted from the post-money valuation. In this case, the implied pre-money valuation is $40
million.
There are several ways to determine valuation for your startup. Know
that with most of these methods may be difficult to base on objective facts. At the end of the
day you may need to rely on the fairness of your investor to propose a valuation that is
consistent with other known "comps" and also consistent with other relative valuations in
his/her existing portfolio.

The % of the fully diluted shares outstanding post-financing that will be reserved for issuance to
employees and consultants pursuant to a stock option plan. The typical vesting schedule is
ratable over four years with a one year ‘cliff’. Typically one fourth of the options are received
after the first year at the company. Thereafter, vesting would continue at a monthly or quarterly
Stock Option Plan3 rate until the full amount is owned at the end of the fourth year. For example a term may read
as follows "All future option grants shall be subject to four-year vesting at the rate of 25% for
the first year and vesting on a 1/48 per month portion for the remaining three years unless
otherwise authorized by the Board. There will be no provisions providing for acceleration of
vesting upon change of control in the option plan."
Two types of dividends are frequently encountered; a third is possible but rarely used:
Protective dividend provision: In this case, there is no intention of dividends actually being
paid to investors. For obscure legal reasons, such a provision may be included, stating that
these dividends are payable "when and if declared by the board." The presumption, however, is
that the board will not declare such payments.
Dividend Options4 Dividends that accrue: These dividends are not paid in cash, but are included in computing
distribution to investors at exit as a way to enhance potential return to investors without
affecting the "nominal" valuation. More typically, protective dividends are used.

Cash dividends: Rarely contemplated in these types of financings because both investors and
entrepreneurs want to conserve cash to fuel additional growth or to show a better bottom line.

Investors may negotiate a liquidation preference. At exit and after secured debt, trade creditors,
and other company obligations are paid, a liquidation preference determines the relative
distribution between the preferred shareholders (the investors) and the common shareholders.
There are various kinds of liquidation preferences:
Non-participating simple preference (1x): At exit investors must choose between a return
of capital (sometimes partial) and participation with the common shareholders in proportion to
their ownership. If the investors choose complete return of capital, then any remaining proceeds
are divided among common shareholders.
Multiple preference: Works the same as simple preference except that investors get a
multiple of their investment before common shareholders receive anything.
Participating 1x liquidation preference: In this case, the investors first receive their capital
(1x preference) and then their shares convert to common. The concept is to share the gains
between preferred and common by first returning capital to investors and then distributing the
Liquidation Preference4 gains from the sale of the company in proportion to ownership.
High multiple (5x or 7x or more) preferences: These are also used but much less
frequently. Sometimes they reflect creative deal structures (preventing earlier investors from
being washed out while providing a reasonable return to new investors). At other times they are
abusive and might reflect the sharks that surface in a very bad market for raising capital (as
happened after the bubble burst in 2000).

Example: Angels invest $1 million for 25 percent of a company without a liquidation

preference, and the company is later sold for $2 million. In this example, the investors would
get only $500,000, losing half of their capital, and the entrepreneurs would pocket $1.5 million.
If the investors negotiate a 1x simple preference, however, they would get $1 million off the
top, and the common shareholders would get the remaining $1 million. Finally, if investors
negotiate a 1x participating preference, they would get $1 million off the top plus another
$250,000 (25 percent of the remaining $1 million). The common shareholders would receive
$750,000.
 2. Detailed Explanations

Term Details
These clauses are intended to protect the VC from dilution during "down" rounds (rounds at a
lower valuation). There are two main types of anti-dilution methods:

Ratchet: lowers VC's per-share price to new share price being offered (tends to be highly
dilutive to common shareholders). In a ratchet, the investor is given additional shares of stock
for free if the company later sells shares at a lower price. The number of free shares the
investor receives is enough to make the investor’s average cost per share (counting all of his
purchased and free shares) equal to the lower price per share given to the later investor. What
makes the ratchet so powerful is that the first investor is given these extra shares regardless of
the number of shares purchased by the later investor. Example: For example, if an investor
who has a ratchet purchases 100,000 shares of company stock for $200,000, or $2 a share,
Antidilution Methods5,6 and the company later sells another investor 100,000 shares for $1 each, the first investor
would receive another 100,000 shares for free. The result would be the same if the second
investor bought only one share for $1.

Weighted Average: re-prices VC's shares by taking into account their number of shares and
the number of new, lower-priced shares. There are two methods:
i. Broad-based anti-dilution method: investor’s shares are repriced to the weighted average
of their shares and the new down-round shares, using the fully-dilutive weighted average
shares (better for the common shareholders)
ii. Narrow-based anti-dilution method: calculates the weighted average only using current
common shares outstanding (better for the VC)

Such provisions require the company to obtain approval of the investors as a group before
taking certain actions, such as changing auditors, shareholder rights, the size of the board, or
the nature of the business; creating new securities; amending the bylaws or certificate of
Protection Provisions4
incorporation; repurchasing company shares; agreeing to a merger or acquisition; increasing
the employee stock option pool; selling the company's intellectual property; issuing options or
shares to executives or directors, or incurring indebtedness above a threshold.

Rights an employee receives for working at a company a specified length of time. The rights
normally include such things as pension payments, participation in stock plans, and profit
sharing. The term is often associated with the period that it takes for an employee or founder to
have the right to own the shares they have been granted. As an example, an investor may want
to keep a founder working at a company for a certain period, say four years. To accomplish this,
the investor might insist that as part of funding, the founder would become entitled to 25
Vesting8
percent of their shares every year, thus it takes four years to own the stock. Sometimes this
can be done retroactively; that is, even if the founder put up the seed money and owns the
stock, there can still be a period of “re-vesting.” This process is often referred to as “Golden
Handcuffs.” For employees, the same process is often applied; their stock options might vest
over a number of years. Re-vesting enables the company to repurchase a certain amount of the
founders shares at a nominal price for a period.
 References
1 http://en.wikipedia.org/wiki/Pre-money_valuation
2 http://www.startupventuretoolbox.com/Valuation%20Advisor.htm
3 http://www.naffziger.net/blog/2007/04/05/startup-stock-options-vesting-schedules-acceleration/
4 http://startups247.com/files/art_investmentvaluationsseed.pdf
5 http://constable.net/participants/giffc/writings/vcstructures.html
6 http://www.growco.com/gcg_entries/ratchets1.htm
7 http://timwolters.blogspot.com/2006/02/term-sheet-terms-repurchase-rights.html
8 www.bergerlewis.com/download/stock.pdf