A Sample Term Sheet for a Venture Capital Financing in a Technology Startup Involving Series A Preferred Stock

To set the ground work to begin a series of posts on the numerous different terms in a typical venture capital financing involving the sale of preferred stock, below is a sample term sheet to get us started. Some of the terms may not be necessary or appropriate in a certain financing, but, at least, this will help any technology startup familiarize themselves with the possibilities. In the posts to follow, we will talk more specifically about each term and the different possibilities. Any terms in a preferred stock financing will always depend on the specific circumstances of that deal. I hope you find this helpful.

MEMORANDUM OF TERMS

This Memorandum of Terms summarizes the principal proposed terms of the Series A Preferred Stock to be issued in connection with a private placement by TechStartup, Inc., a Delawarecorporation (the “Company”). Except with respect to provisions entitled “Confidentiality,” “Exclusive Negotiations” and “Expenses” this Memorandum of Terms represents only the current thinking of the parties with respect to certain of the major issues relating to the proposed private placement and does not constitute a legally binding agreement among the parties.

Offering

Security: Up to [ ]shares of Series A Preferred Stock (the “Preferred”)

Valuation of the Company: $[ ] pre-money

Price Per Share: $[ ]

Aggregate Offering Price: Up to $[ ]

Capitalization: The pre-financing capitalization and the pro forma capitalization of the Company

following the proposed private placement are summarized on Exhibit A.

Anticipated Closing Date: Initial closing on or before December 31, 2027; one or more additional

closings within 60 days thereafter.

Consideration: Cash

Terms of the Preferred

Dividend Provisions:

(1) Dividend rate: 8%

(2) Cumulation: noncumulative

(3) Priority: pari passu with other series and senior to common.

(4) Participation: after preferred preferential dividends, preferred does not participate in further dividends.

Liquidation Preference:

(1) Amount: original purchase price plus accrued dividends

(2) Priority: pari passu with other preferred series and senior to common

(3) Participation: after preferred preferential liquidation proceeds, preferred does not participate in further liquidation proceeds

(4) A sale of all or substantially all of the assets of the Company or a merger or consolidation of the Company with or into any other company will be treated as a liquidation, dissolution or winding up of the Company.

Redemption: The outstanding shares of Preferred shall not be redeemable.

Conversion: Each holder of Preferred shall have the right to convert shares of Preferred at any time, at the option of the holder, into shares of Common. The conversion rate shall initially be 1:1, and shall be subject to antidilution adjustment as described below.

Automatic Conversion: Each share of Preferred shall automatically convert into Common, at the then applicable conversion rate, upon the earlier to occur of (i) the closing of a firmly underwritten public offering of shares of common of the Company at a per share public offering price (prior to underwriter commissions and expenses) equal to three or more times the purchase price of the Preferred and total gross offering proceeds to the Company in excess of $[ ] million (a “Qualified Public Offering”), or (ii) the affirmative consent of the holders of at least 50% of the then outstanding shares of Preferred.

Antidilution Provisions:

(1) Adjustments. The conversion price of the Preferred shall be subject to adjustment, on a broad-based weighted average basis, to prevent dilution in the event that the Company issues additional shares at a purchase price per share less than the then current applicable Conversion Price.

(2) Exceptions. There will be no adjustment to the Conversion Price of the Preferred for issuances of (i) shares of common stock issued upon conversion of Preferred, (ii) shares issued to employees, consultants or directors in accordance with plans approved by the Board of Directors, (iii) shares issued upon exercise of options or warrants existing on the Closing Date, (iv) shares of common stock issued as a dividend or distribution on Preferred, (v) shares of common stock issued in connection with a Qualified Public Offering, (vi) shares of common stock issued or issuable pursuant to an acquisition of another corporation by the Company, (vii) shares issued or issuable pursuant to equipment lease and bank financing arrangements, (viii) shares of common stock issued to suppliers of goods or services pursuant to transactions approved by the Board of Directors, or (ix) shares of common stock that are otherwise excluded by vote or written consent of holders of a majority of Preferred.

Voting Rights: The holder of each share of Preferred shall have the right to a number of votes equal to the number of shares of common issuable upon conversion of the Preferred. The Preferred shall vote with common on all matters except as specifically provided herein or as otherwise required by law.

Protective Provisions: Consent of holders of 50% of the Preferred, voting as a class, shall be required for any action which (i) materially alters or changes the rights, preferences or privileges of the Preferred as a class it being understood that creation of a new series of Preferred Stock that is not senior to the Preferred in rights of liquidation, dividends or redemption shall not be deemed adverse to the Preferred, (ii) increases the authorized number of shares of preferred stock, (iii) creates any new class or series of shares having rights, preferences or privileges senior to or on a parity with the Preferred, (iv) approves any merger, sale of assets or other corporate reorganization or acquisition, (v) approves the purchase, redemption or other acquisition of any common of the Company, other than repurchases pursuant to stock restriction agreements approved by the Board of Directors that grant to the Company a right of repurchase upon termination of the service or employment of a consultant, director or employee, (vi) authorizes the payment of a cash dividend to any holders of any class or series of capital stock, (vii) results in the transfer of material assets of the Company to any person other than a wholly-owned subsidiary of the Company, or (viii) approves the liquidation or dissolution of the Company.

Information Rights: So long as a holder of Preferred holds at least 250,000 shares of capital stock of the Company, (i) the Company shall deliver to such holder audited annual financial statements within 120 days following year-end and unaudited quarterly financial statement within 45 days following quarter-end; (ii) the Company will furnish such holder with annual business plans showing monthly projected financials, plus monthly updates; and (iii) such holder shall be entitled to inspection. These rights shall terminate upon the initial public offering of the Common.

Registration Rights: The investors shall have the following registration rights:

(1) Demand Rights: Holders of at least 50% of the Preferred and common issued upon conversion of the Preferred (collectively, the “Registrable Securities”) shall be entitled to demand that the Company effect up to two (2) registrations of at least [ ]% of the Registrable Securities (or such lesser number of shares as shall have an aggregate price to the public of at least [$ ] million) at any time following the earlier of (i) three (3) years following the Closing Date, or (ii) six (6) months following the effective date of the Company’s initial public offering. The Company shall have the right to delay such registration under certain circumstances for up to two (2) periods not in excess of ninety (90) days each in any twelve (12) month period.

(2) Company Registration: The holders of Registrable Securities shall be entitled to “piggyback” registration rights on any registered offering proposed to be effected by the Company on its own behalf or on behalf of selling shareholders (other than an offering related solely to employee benefit plans or a Rule 145 transaction). In an underwritten offering, however, the managing underwriters shall have the right, in the event of marketing limitations, to limit the number of shares included in the offering on behalf of holders of registrable securities. In the event of such marketing limitations, each holder of Registrable Securities shall have the right to include shares on a pro rata basis as among all such holders and to include shares in preference to any other holders of Common. No person shall be granted piggyback registration rights on parity with or superior to those of the investors without the consent of holders of at least 50% of the Registrable Securities.

(3) S-3 Rights: Holders of Registrable Securities shall be entitled to an unlimited number of demand registrations on Form S-3 (if available to the Company) so long as such registered offerings are each for common having an aggregate offering price of not less than [$1,000,000]; provided, however, that the Company shall not be required to file more than [two (2)] such Form S-3 registration statements in any twelve (12) month period. The Company may defer an S-3 filing for up to 90 days once during any 12-month period.

(4) Expenses: [The Company shall bear the registration expenses (exclusive of underwriting discounts and commissions) of all demands, piggybacks and S-3 registrations, provided that the Company shall not be required to pay the fees of more than one counsel to all holders of Registrable Securities.] [The Company shall bear the registration expenses (exclusive of underwriting discounts and commissions) of all demand and piggyback registrations. The Investors shall bear the expenses, pro-rata, of all S-3 registrations. The Company shall not be required to pay the fees of more than one counsel to all holders of Registrable Securities.]

(5) Transfer of Rights: Registration rights may be transferred by a holder of Registrable Securities to current and former partners and members, and affiliates of that holder and to other persons acquiring at least [____________] shares of the Company’s outstanding capital stock, provided the Company is given written notice thereof.

(6) Standoff Provision: Holders of Registrable Securities shall agree not to sell any of the Company’s capital stock within one hundred eighty (180) days following the initial public offering by the Company, provided that all officers and directors (and related funds) of the Company are similarly bound [and that the Company uses all reasonable efforts to obtain a similar covenant from all holders of at least 1% of the Company’s outstanding securities]

(7) Other Provisions: Such other provisions shall be contained in the Investor Rights Agreement with respect to registration rights as are customary, including cross-indemnification, underwriting arrangements and the period of time in which the Registration Statement shall be kept effective (which period shall be no less than [120] days or such shorter period during which the distribution described in the registration statement shall have been completed). Registrable Securities shall not include shares held by any holder of less than 1% of the outstanding common stock of the Company if such shares are available for sale pursuant to Rule 144 (except to the extent the standoff provision limits the holder’s rights to sell following the offering).

Other Matters

Vesting of Employee Shares: Subject to the discretion of the Board of Directors, shares issued to employees, directors and consultants pursuant to the Company’s employee stock option plan shall be subject to four-year vesting, with 25% of the shares vested upon the first anniversary of the commencement of service and the remaining shares subject to monthly vesting thereafter. If the Board allows an option holder to exercise an option prior to full vesting, the unvested shares shall be subject to a repurchase option in favor of the Company which shall provide that upon termination of employment with or without cause, the Company may repurchase, at cost, any unvested shares held by such shareholder.

Board Representation: The holders of the Preferred shall be entitled to [ ] representative(s) on the Board of Directors. The Company and its principal shareholders will enter into a voting agreement to elect to the Board of Directors such representatives of the Preferred plus [ ] representatives of holders of common stock and [ ] additional mutually agreed independent industry persons. The representatives of the Preferred shall be entitled to customary indemnification from the Company and reimbursement of reasonable costs of attendance at meetings of the Board.

Right to Maintain Proportionate Ownership: Each holder of Preferred shall have a right of participation to purchase a share of any offering of new securities of the Company (other than securities issued to employees, directors or consultants or pursuant to acquisitions, equipment lease or secured debt financings, and other customary exceptions) equal to the proportion which the number of shares of the Preferred held by such holder (on an as-converted basis) bears to the Company’s fully-diluted capitalization (on an as-converted and as-exercised basis). Such right shall terminate immediately prior to closing of a Qualified Public Offering.

Co-Sale Agreement: The investors in the Preferred will have the right to participate on a pro rata basis (as among holders of Preferred) in any proposed transfers of shares by specified members of management, other than transfers to affiliated persons and entities or gifts to members of the immediate family or family trusts, provided that the recipient agrees to be bound by the co-sale agreement with respect to subsequent transfers. This right will terminate on a Qualified Public Offering.

Right of First Refusal on Sales by Management: Key members of management shall enter into an agreement with the Company and the holders of the Preferred pursuant to which the Company (first) and holders of the Preferred (second) shall have a right of first refusal, with respect to any proposed transfer of capital stock of the Company by any such shareholder, to purchase the offered stock at the offered price (on a pro rata basis among the holders of the Preferred (if the Company does not elect to purchase all of the offered stock).

[Drag-Along Right: So long as the Investors own shares of Preferred Stock representing at least 25% of the Company’s common stock on a fully-diluted basis, the Investors shall have drag-along rights with respect to securities of any of the key members of management in the event of a proposed sale of the Company to a third party (whether structured as a merger, reorganization, asset sale or otherwise). Such right will terminate at and upon a Qualified Public Offering.]

[Company Right of First Refusal on Investor Sales: The Company shall have a right of first refusal to acquire all securities proposed to be transferred or sold by an investor, subject to customary exclusions.]

Stock Restriction Agreements: Key members of management shall enter into agreements pursuant to which the Company will have an option to repurchase at cost the shares of common stock held by such person in the event that such shareholder’s employment with, or consulting to, the Company is terminated prior to the expiration of four years from the date of purchase of the Preferred or the date of first employment or consulting, whichever date is later. Assuming the shareholder’s continuous status as an employee or consultant does not terminate, the shares subject to the Company’s repurchase option shall vest and be released from the repurchase option in accordance with the following schedule: (i) 25% of the shares shall vest on the anniversary of the closing of the sale of the Preferred, and (ii) 1/48th of the shares shall vest on the first day of each month, beginning on the first month following the anniversary of the closing of the sale of the Preferred.

Proprietary Information Agreements: Prior to closing, the Company will enter into Proprietary Information Agreements with all employees. The Proprietary Information Agreements will contain provisions satisfactory to the Investor with respect to confidentiality, corporate ownership of inventions and innovations during employment, and noncompetition and nonsolicitation of employees and customers’ covenants during and after employment.

Purchase Agreement: The investment shall be made pursuant to a Preferred Stock Purchase Agreement which shall contain, among other things, appropriate representations and warranties of the Company, covenants of the Company reflecting the provisions set forth herein, and appropriate conditions of closing, including an opinion of counsel for the Company. The Purchase Agreement shall provide that it may only be amended with the approval of the Company and holders of more than 50% of the Preferred (and common issued upon conversion of the Preferred).

[Key Man Life Insurance: The Company shall have obtained and maintain a key man life insurance policy on each of __________ in the amount of [$2,000,000], with proceeds payable to the Company.]

[Exclusive Negotiations: From the date of this memorandum of terms until the earlier of (1) _________ or (2) mutual termination of our negotiations, neither the Company nor any of its directors, officers, employees or representatives will solicit or participate in negotiations or discussions with any person or entity other than ______________ with respect to any investment in, or acquisition of the Company.]

Finders: The Company and the investors each shall indemnify the other for any finder’s fees for which they are respectively responsible.

Affiliated Parties: For purposes of determining rights pursuant to share thresholds, an investor shall be entitled to aggregate all shares held by affiliated funds and constituent partners and members.

Legal Fees and Expenses: Upon closing, the Company shall pay the reasonable fees and expenses of a single counsel to the investors up to a maximum of $[ ]. Such fees will be payable at closing by wire transfer or payable upon demand if the Company elects not to proceed with this transaction.

Confidentiality: The existence and terms of this term sheet and the fact that negotiations may be ongoing with the Investors are strictly confidential and shall not be disclosed to any third party without the consent of the Company and the lead Investor, except that the Company and the Investors may disclose the terms and conditions described in this term sheet including its existence to their respective officers, directors, employees, attorneys and other advisers, provided that such persons agree to the confidentiality restrictions contained herein.

Conditions Precedent: The investment contemplated under the proposed terms would be subject to customary closing conditions, including but not limited to, the following conditions:

(1) The business, assets, financial condition, operations, results of operations and prospect of the Company are substantially as have been represented to the investors and no change shall have occurred which, in our sole judgment, is or may be materially adverse to the Company.

(2) Successful completion of any and all due diligence which the investors believe appropriate.

(3) Negotiation and execution of a definitive agreement setting forth representations and warranties of the Company and shareholders, covenants and other provisions customary in transactions of this nature.

Date: _____________________

 

TechStartup, Inc. (“Company”)

By: _______________________

Name: ____________________

Title: _____________________

 

Sandy Hill Ventures

By: _______________________

Name: ____________________

Title: _____________________

 

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