Cashing in: Preparing for your Series A round | Drinker Faegre Biddle & Reath LLP
With the Summer 2022 Y Combinator demo day taking place September 7-8, a new group of startups will be approached by investors with term sheets for preferred equity financings. For many companies, the key points of the termsheet will be a breeze, as their main focus will be the proposed amount to invest and the valuation. But what about the rest of the termsheet? Protective provisions, liquidation preference, right to vote, right of registration, right of first refusal, etc. — these concepts may be foreign to some leaders, while others who are more familiar with the concepts may fear accepting terms that are “off the market.”
Fear not: the National Venture Capital Association (NVCA) has produced a standard suite of legal documents that are used to draft the basic legal documents in most venture capital financings. Below, we provide a brief summary of the key documents and workflows you will encounter when completing your initial preferred stock financing.
The table below includes each of the major legal documents that will be executed under your funding, the basic function of each document, and some key considerations related to each document.
Other legal documents
In addition to the above, you may also be required to provide the lead investor with a Letter of Management Rights, which provides the lead investor with additional rights of information and board observership if the lead investor does not there is no candidate sitting on the board. You will also likely enter into a standard indemnification agreement with the lead investor director nominee. At the outset, you should also review your outstanding convertible notes or other investor documents, if any, for any notice or waiver requirements that you need to seek prior to the completion of the financing.
Investor Data Room
Prior to execution of the term sheet, you will answer questions from investors who are considering (and hopefully competing!) to be the lead investor in the funding. These questions often relate to your operations, past results, projections, customer agreements and due diligence concerns. To respond to these requests, most companies set up a data room and give each investor access to a specific file containing the requested documents.
You will need to produce a capitalization table during the term sheet negotiation, as well as a pro forma capitalization table at the agreed pre-money valuation to determine the price per share in the round. The initial capitalization table should include all issued and outstanding common stock, all outstanding stock awards, all shares reserved for issuance pursuant to your stock ownership plan, as well as your outstanding convertible notes and details relating to the conversion of these notes. Once a valuation is agreed, you will need to update the pro forma capitalization table for (a) converting the convertible notes into the round and (b) increasing the share plan pool. This fully diluted total (pre-money total) will then be divided by the agreed pre-money valuation to determine a price per share. Once this price has been determined, the number of shares to be sold in the round is determined by dividing this price by the amount of the proposed investment. By adding the number of shares in the Pre-Money Total with the number of shares sold in the round and multiplying by the price per share in the round, you will get your post-money valuation.
The venture capital firm’s attorney will perform a due diligence review of your cap table to ensure that all securities reflected in the cap table are supported by proper documentation (stock certificates, option awards , convertible notes, etc.) and to confirm that all issued shares, stock awards and notes are reflected in the capitalization table. It may be helpful to conduct your own pre-funding review of your capitalization table to ensure that the appropriate supporting documentation exists and that your capitalization table is accurate. Your lawyer will usually need to provide legal advice on your capitalization, and you’ll want their due diligence done early in the deal process so that no surprises derail the deal.
Form D and government securities filings
You have 15 calendar days after the first investor has contractually irrevocably committed to investing in the financing (usually the day the stock purchase agreement is signed) to file a Form D with the SEC, which is a notice of an exempt offering of securities. If you have not yet filed with the SEC, you will need to file a Form ID with the SEC to obtain the EDGAR codes before filing your Form D, which usually takes two to three business days. In addition, after filing Form D, you must have your attorney make the required government securities filings to comply with applicable fee and notice requirements in the jurisdictions where accredited investors have purchased shares. as part of the funding.
Once funding is complete and required deposits made, you will continue to operate as is, likely with a new board setup and potentially with some ongoing operational updates to comply with the terms of the funding documentation (and with a little extra money in the bank!). Additionally, after taking capital from professional investors, companies typically improve their corporate governance and formalities to ensure that they can meet their investor obligations and lead the company through its next chapter of growth. growth.