Orrick's Mock Series A Term Sheet negotiation takes people on step-by-step process

If you’re keeping up with the tech scene these days, you won’t hear Mock Series A Term Sheet Negotiations too often. It may be your first time to hear it, as we did, so we went to Orrick’s Total Access last August 24 at CBS to find out how it would unravel for us.

http://blogs.orrick.com/totalaccess/events/event/new-york-mock-series-a-term-sheet-negotiation/

Chris Austin, partner at Orrick, presided over the mock negotiation with Liz Wessel, CEO of WayUp and Ellie Wheeler, principal of Greycroft Partners. Wessel and Wheeler wheeled and dealt their way to the mock negotiation of term sheets, talking about how allocate value, manage the company, investors’ rights and miscellaneous terms as if we were eavesdropping on two people’s conversations.  It’s a good exercise for anyone curious about how a startup founder interacts with an investor.

With Austin as the moderator, the two talked their way through allocating value, covering valuation, capitalization, liquidation and dividends. Questions about board composition, protective provisions and drag along rights were also discussed.

Austin suggested 3 to 5 board members for obvious reasons—to avoid deadlocks with 4 board members. Wessel said she would have herself, a co-founder, Wheeler and someone who can serve as an “independent” seat. It’s important to point out why Wessel added Wheeler; it’s common for a VC (venture capitalist) to ask for 1 to 2 seats. The VC will ask for special provisions, preferred director consent. But at Series A, keep in mind that a VC need not be in board majority.

Austin said higher valuation is not always the best. “Look for a good fit, strategic value, understanding of the business.”

For founder vesting, standard schedule is a four-year term with a one-year cliff.  For the stock option, the key issue you need to answer is what you will need to compensate your employees between this round and the next. It will depend on the current team.

As for dividends, the advice is to stay away from cumulative dividends. Current market standard is “as if and when declared.”

At liquidation/dissolution, keep in mind that a VC gets the right to receive proceeds first. Also before you can sell, you must give company and investors the right to buy. And if the investors and the company decline to buy, then the founder must give investors a right to participate in the sale.

Elaborating on drag along rights, the discussion veered toward drag-along rights.  Investors, it turns out, can force Common stockholders to participate in a sale of the company while also pointing out that drag-along rights are not present in every deal, but becoming more frequent.

Recommendations in terms of managing the company included protective provisions like questioning your ability to satisfy business objectives; consider class voting; and keep standard market terms. If you don’t manage the company well, investors can ask your company to return the money to investors at a specified time. This can be in 7 years or so when the VC comes knocking on your door to ask for their money back. But try to push for exclusion of this term. If not possible, have the terms provide your company enough runaway, say, 5 to 10 years; redeeming investors only receive what they paid plus dividends, or see a higher approval threshold (but other investors must consent).