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CHECKLIST

ALTERNATIVE TERM SHEET PROVISIONS



Following are alternative provisions you can use to modify a term sheet depending on whether your company is investing or is seeking capital. Consider the explanations of each provision before integrating it in your Term Sheet Agreement. And dont forget to ask your lawyer to review it!


DIVIDEND 

The directors need not pay a dividend unless they wish to pay dividends on Common Stock in the same year. In a scenario more favorable to investors, dividends may be participating (i.e., preferred stockholders to receive additional dividends ratably with common stockholders once all preferences have been satisfied) and/or cumulative (i.e., unpaid dividends will be added to the liquidation amount and the redemption price of the preferred stock and all accrued dividends for past as well as the current year must be paid prior to payment of dividends on common stock


LIQUIDATION PREFERENCE

Alternatively, terms may be structured so that preferred stockholders may get back only their original investment or they may retain their original investment plus all accrued but unpaid dividends for every years or they may share the remainder ratably on an as-converted basis with common stockholders only after their preferences and all common stock liquidation amounts have been paid. In subsequent financings, new series of preferred stock may have a superior position on liquidation or be on a pari passu footing with this series with respect to liquidation. Liquidation may be defined in the term sheet to include acquisition of the Company or its merger into another entity, with the classification of such event as a liquidation or not at the investors' option at time of the merger.


REDEMPTION

While going public or an acquisition usually connote a clear "success, the investor must also consider the case in which the Company only achieves moderate success and management is content to keep things going as a private Company. According to these terms, the company must redeem at a specified amount which provides investors with some guaranteed return on their investment. Alternatives include: (a) a provision stating that the Company may not call the Preferred Stock for redemption nor may the investors require the Company to redeem their stock and (b) optional redemption after a certain date by either the Company or the investors. If the Company may call the Preferred Stock at its option, it could potentially call once the common price exceeds the redemption price and force the investor to take a mediocre repayment on his investment or convert to common and lose his preferred position in the Company.


REGISTRATION RIGHTS

In order to have a public offering the Company must file a registration statement with the SEC. Because the investor can not be assured of controlling the Board of Directors of the Company (after all that is what the entrepreneur fears will happen), the investor usually negotiates for "demand registration rights" under which the Company contractually agrees to file a registration statement on the demand of the investor. The number of "demands" is negotiated, with the Company saying that one is enough and the investor arguing for two or more. 
Conceptually the granting of demand registration rights is a big deal for the Company because of the time and cost involved if those rights are invoked C it can easily cost $200,000 or more to file a registration statement. In reality, it is a rare case when registration is demanded against the desires of management C after all management has to go on the "road show" and make a good presentation to the mutual fund managers and brokers who will be buying the stock. 

In addition, the investor usually receives "piggyback" registration rights under which the investors shares are included in any "primary registration" statement (where the company is selling its own stock) or in any "secondary registration" where the Company is filing a registration statement to permit others to sell.


PRE-EMPTIVE RIGHTS

This right is typically granted to investors to ensure that the Company does not negotiate new financings with new players without offering to deal with the present investors. Sometimes investors are required to take "all or none" of the new financing.


AUTOMATIC CONVERSION

Because the control and others terms of a venture capital preferred are not consistent with public market securities, the Preferred Stock has to disappear (i.e., be converted into Common Stock) at the Initial Public Offering.


ANTI-DILUTION

Antidilution adjustments increase the amount of stock received by an investor if the Company issues additional stock at prices which are lower than that paid by the investor. Because there is no readily ascertainable independent market price for the stock, investors believe that they should be protected against having overpaid. Another rationale is that the entrepreneur should pay if he does not increase the value of the Company by the next round of financing. However, from the entrepreneur's side a decrease in the value of the Company could result from events beyond the entrepreneur's control- e.g. a stock market crash or a change in the law. Having said this, antidilution adjustments are almost always present in one form or another.

Note that the formulae used in these provisions decrease the conversion price of the Preferred Stock resulting in more shares of common stock per share of Preferred Stock upon conversion. The weighted average antidilution formula considers the total number of shares being issued as well as the per share price; contract this to the full rachet antidilution formula which automatically reduces the conversion price to the price at which a new issued is sold, even if only a small number of shares are issued.


MANAGEMENT OPTIONS

Investors usually factor the option pool size into their valuation of the Company and assume that the full amount of the option pool is taken into account in determining the pre-money valuation of the Company.


STOCK RESTRICTION AGREEMENT

Investors will want to ensure that the present management of the Company has an incentive to remain there; rewarding continued work at the Company by appreciation in the value of stock and discouraging the individual's leaving by the buyback provisions detailed above are effective mechanisms to encourage longterm commitment.

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