Transcript
VC LINGOBy Lucas Nelson
What’s wrong with this picture?
You just lost money!
Though the exit was successful the investor lost money
Ways VC’s protect their capitalThe Agenda:
Types of Securities Ways to Protect the Down Side Vesting Other Rights
The typical types of securities
If you had bought convertible preferred shares:
This time the investor gets their money back
If you had bought participating preferred shares:
We call this:Having your cake and eating it too!
Down rounds are bad Definition: When another round of
investment is necessary, and the company is valued at a lower price than the previous round.
An example: A VC offers to invest, but thinks the company is only worth $3M This implies that our 49% stake is only worth
$1.5M Our ownership will be diluted badly
Two common dilution protection methods: Full ratchet anti dilution
The investors percentage ownership before the new round remains the same
Example: If the value for the first round was $2 a share, and the new round is $1 a share, then the number of shares the investor owns would be doubled so that their ownership would still be 49%
Weighted average is kinder to the entrepreneur Weighted average ratchet anti dilution
Less harsh for the entrepreneur, this method takes into account the ratio of the amount of money diluting the original investment
The actual formula can be simple or complex
Liquidation preferences Another way to protect down side risk Receive a multiple on the investment if
preferred stock is not converted
Example: You invest $2M into FastSell with 1.5x
liquidation preference
If you had bought with a 1.5x liquidation preference:
This time the investor gets nothing
How to use vesting to solve the problem Many times the entrepreneurs shares
will vest over time Each month the entrepreneur earns
more shares
For instance: The entrepreneur would have 75% of their stock vesting over the next 3 years (25% a year)
If you had bought common with vesting:
This time the entrepreneur get’s $750K
Other rights Board seats
VC’s will almost always request a board seat
Number of seats should be pro rata with ownership
Sale Rights A majority of preferred must vote to allow
the company to sell
Other rights (cont.) Dividends
Preferred shares can have accruing in-kind dividends
Has the effect of transferring ownership to preferred
There are many others that attempt to align the investors with the management
What did we learn? In VC the lingo is much more difficult
than the concepts There are a few common scenarios that
one should be familiar with There are many uncommon scenarios
that ones lawyers should be familiar with
Make sure you understand what will happen in down round This is where entrepreneurs get screwed
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