wsgr early stage financings for start ups

September 20157645259 v.4

Early Stage Financingsfor Start-ups

Asaf Kharal

WSGR Advise more than 300 public and 3,000 private enterprises

Advise more U.S. technology companies on their initial public offerings thanany other law firm (Capital IQ)

Advise more technology companies on their M&A transactions than anyother law firm (Bloomberg)

Represent more companies that receive venture financing than any other lawfirm (Dow Jones VentureSource/ PitchBook)

Most frequently hired securities litigation firm in the country (SecuritiesLaw360)

Selected for inclusion in the Intellectual Property Hot List (The National LawJournal)

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WSGR

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IPO/Early PublicCompany

Multibillion-DollarGlobal/Mature

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Pro Bono

Consumer Regulatory & Privacy

High Level Trends in Early Stage Financings

Pre-Seed is the new Seed; Seed is the new Series A; Series A is the newSeries B

Massive late stage rounds

New sources of money (China, Russia, Middle East, India)

More international startups

Investors care more about pro rata rights

SAFEs gaining ground

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High Level Trends in Early Stage Financings

Capex costs have decreased, but employee costs are increasing

Traction bar to Series A is higher

Marketing costs increase to achieve traction

Companies need to survive longer (and raise more money) to achievetraction

Series A crunch is more due to an oversupply of seed funded companiesthan a lack of Series A funding sources

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The New Start-up Financing Ecosystem

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Incubation(under $100K)

Pre-Seed(Under $500K)

Seed ($1M-$5M)

Series A ($5Mto $15M)

Series B (Over$15M)

Large VentureFunds

Small VentureFunds

Super Angels& Micro-VCs

Incubators &Accelerators

Pre-Seed is the new SeedSeed is the new Series A

Preparing for Financing

Organization of the company

Founder and team equity

IP protection

– Intellectual property is an important corporate asset, so taking steps to ensurethat it is properly assigned to the company is essential.

Agreements with contractors

assignment of IP by founders

CIIAs and PIIAs

NDAs

Record keeping

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Types of Early Stage Investment

Key Elementsof a Financing

Size – how much money should be raised

Source – where is the money coming from

Type of Security

Valuation required – does the investment require avaluation of the company?

Debt based/interest – does the investment mean agrowing debt load?

Impact on control rights

Liquidation preference

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Types of Early Stage Financings

Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding

Series A Venture Round

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Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Founder funding and self funding• Varies in size based on company’s means

and needs• Type – common stock or promissory notes• Important to document capital contributions

and the expectations for equity, repaymentor conversion

• Expectations of repayment upon a futurefinancing may not be met

• Valuation must be handled carefully


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Converts into later round preferred stock ifsold to investors in connection with laterfinancing

• Intended to solve founder sale of commonat preferred price affecting common FMV

• Must be fully vested (or potentiallyconsidered compensation income)

• Typically, not more than 25% of foundersequity is Series FF

• Cannot be subject to board discretion toallow conversion


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Highly dependent on facts and circumstances• Varies in size though usually less than

$50,000• Type – common stock, promissory notes

(convertible or non-convertible), contributionsto capital

• A valuation may be required• Equity or debt• Usually no impact on control rights• Typically no liquidation preference• Potential downsides

• Risks to personal relationships• Investors usually have no experience to bring

to the table• These investments are usually not sources of

a large amount of money• Familiarity with investors can lead

entrepreneurs into the trap of inadequatedocumentation


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Contracts with lead customers/early adoptersfor funding in exchange for early access tothe developed product or service.

• Varies in size• No Valuation, typically no debt or equity

issued• Later strategic deals may involve ROFR or

ROFN• No liquidation preference• Contracts can raise important issues

including:• Commercial rights and restrictions• Ownership and rights in intellectual property• Confidentiality• Early strategic agreements can make or

break a company


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Common stock at founder price• Plus convertible equity for $15-$100K• YC, AngelPad, TechStars• Avoid creating a high common stock FMV• Additional “blind pool” financing


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Size – $50,000 to $1M• Source –a single investor or a group of

affiliated investors• Type – common stock, convertible debt,

promissory notes• Valuation – depends on if debt or equity

based• Control rights – depends on the size of the

round, may include a board seat, protectiveprovisions and participation rights

• Liquidation preferences – yes if preferredstock


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Simplified series A financing documentsavailable at http://www.seriesseed.com/

• Designed to save time and money relative totraditional equity based financing documents,they omit specific provisions in an effort tosimplify

• What they’re missing relative to traditionalseries A documents

• Dividend preference• Registration rights• Anti-dilution protection and other protective

provisions• Voting agreements• Comprehensive representations and

warranties


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Size – roughly $500,000, typically not largerbecause of investors’ desire for protectiveprovisions

• Source – Angels, Friends and Family• Type - preferred stock• Valuation required – yes• Debt based/interest concerns – no• Control rights given up – often include a

board seat, participation rights and protectiveprovisions

• Liquidation preference – yes 1x non-participating typical


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Lots of groups call their own documents“series seed” and these can differ from thestandardized documents. Be wary.

• The provisions are relatively inelastic andcannot be easily customized

• They contain fewer investor protections bydefault

• New documents often have to be drafted forlater rounds and things like the certificate ofincorporation must be amended


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• A promissory note for the full investmentamount with an interest rate and a maturitydate

• Typical maturities are one year• Automatic conversion on a “qualified

financing”• Optional conversion on other financings• Discount and/or warrants on conversion• Premium on a change of control• Valuation caps for conversion• The larger the convertible debt financing, the

less likely it is to be combined with the newmoney in a preferred stock financing


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Essentially a convertible note that lacks andinterest rate provision or maturity date

• Not debt, the instrument is bestconceptualized as a placeholder for which theinvestor pays full value up front in exchangefor a future security at a later date

• Perceived to be founder friendly


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• SAFE: Simple Agreement for Future Equity• Another form of convertible security• Like convertible security it strips the debt like

attributes from the convertible note• Drafted to be layperson friendly as

accessibility is prioritized overcomprehensiveness as the document is only6 pages long

• It has the backing of Y Combinator and itspartners


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Size – varies• Source – angel investors; accelerators• Valuation – no• Debt based – no• Control rights given up – typically no• Liquidation preference – yes


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• The practice of funding a project or ventureby raising money from large numbers ofpeople, typically over the internet

• It can be conceptualized in two differentcontexts

• Preselling a product – pebble smartwatch,Shenmue III

• Selling equity in a company• This is an evolving area of the law. The

passage of the Jumpstart Our BusinessStartups Act (JOBS Act) in 2012 createdopportunities for funding based on the sale ofequity or debt through the internet, but detailsand a clear regulatory structure have beenslow to emerge.


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Dangers of Crowdfunding:• Securities laws are complicated and securities

offerings are subject to strict reportingrequirements. Failure to comply withsecurities laws can lead to penalties andproblems down the road with future offerings

• Be cautious with Crowdfunding websites.Some websites allow the dissemination ofinvestment information to anyone browsingthe internet. This can constitute a securitieslaw violation. It’s best to know the website youare dealing with and know who yourinformation is being disseminated to

• Since it involves disclosing your company andidea, this funding is more appropriate forsome types of start-ups than others

• Established sites that limit access toaccredited investors are preferred


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• Size – varies. Typically $2-10 million• Source – venture capital investors, often

several• Type – preferred stock• Valuation – Yes• Debt based – Not typically• Control rights given up – Yes, at least a board

seat• Liquidation preference – Yes

Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding



Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Choosing the right VC Partner• What network does the specific partner you

are working with bring to bear?• What past experience does that partner have

that might be helpful if on your board?• Speak to members of that partners current

and past portfolio• or her?• How involved will the VC Partner want to be in

your company


Bootstrapping

Founder Preferred

Friends and Family

Customer Funding

Incubators

Angels

Seed Rounds

Convertible Debt

Convertible Equity

SAFE Instruments

Crowdfunding


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• Key Parts of a Series A Term Sheet:• Valuation• Pre and Post Money Valuations• Liquidation Preference• Initial Preference• Participating or non-participating• Participation caps• Option Pool• Board Composition• CEO seat• Founder Vesting

ASAF KHARAL

Wilson Sonsini Goodrich & Rosati, P.C.

650 Page Mill Road, Palo Alto CA 94304

Direct: 650-320-4557

[email protected]

Thank You

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