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