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Private Equity Financings

This comprehensive guide explores essential aspects of downside protection in private equity financings. It covers topics like liquidation preference, rights of redemption, and price-based anti-dilution protection. Key negotiation ideas include balancing investor protection with management incentives, the implications of participating vs. non-participating preferred stock, and considerations for mergers and acquisitions. Additionally, it discusses the evolving standards in these financial structures and offers practical tips for achieving favorable outcomes for both investors and company management.

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Private Equity Financings

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Presentation Transcript

  1. Private Equity Financings Downside Protection: What’s Important, What’s Not & Why

  2. Down-Side Protection Liquidation Preference Right of Redemption Price-based Anti-Dilution Protection

  3. Liquidation Preference • The “New” Standard: participating • Issues: • Participating vs Non-Participating • Disincentivize management team, if LP too large • Negotiation Ideas: • Repay Preferred, then pay common, THEN share upside • Balances investor protection with management incentive

  4. Liquidation Preference • Negotiation Ideas cont’d • Balance downside protection with upside benefit • Different LP for M&A vs Liquidation • LP subordinated to retention bonuses • Fixed return for investors for greater downside protection

  5. Liquidation Preference • The New Standard: Priority • Issue: Priority vs Pari Passu • Non-Issue: • Generally, an investor issue -- potential conflict between classes, but money controls • Cal. Corp. Code (§903(b) - Some class protection • Some protection through board/observer rights

  6. Redemption • The New Standard: More common, but not “standard” • Issues: • Jeopardize company if insufficient $$ to repay • Gives investors inordinate bargaining power • Makes company less attractive acquisition candidate

  7. Redemption • Old CW: Non-issue • Push off for 5 years, which was a long time • Within 5 years, company will either exit or fold • Corporations code protection, if company cannot not afford redemption

  8. Redemption • New CW: Issue? • Longer liquidity path - 5 years is “shorter” • Corporations code protection, but • Obligation still affects company’s attractiveness for merger

  9. Redemption • Negotiating Points • Disincentive to Management – fully vest and then diminish value of shares • Essentially converts equity into debt – so use it to bargain on valuation • Push off as far into future as possible, and redeem over time • Might deter future investors – whose proceeds are used to pay redemption • Permit Company to delay redemption for cause • Require “call”, if must have redemption

  10. Anti-Dilution Protection • The “New” Standard: Weighted Average • Issues: • Broad vs Narrow-based • Full Rachet • Negotiation Points • Push hard against full rachet • Disincentive to additional investors • See example • Recommend limited rachet – tied to reduction of risk (e.g., hitting milestones)

  11. Founder Vesting & Acceleration • Issues: • if Founder can’t get liquid, valuation is secondary • Negotiate V&A in context of valuation • Removal by Board for “convenience” • Acceleration on termination “without cause” • Include Constructive Termination • Double Trigger

  12. TERM SHEETS 101 Thursday, march 15, 2001 8:30am- 12:00pm Software Development Forum

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