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Private Equity Financings

Private Equity Financings. Downside Protection: What’s Important, What’s Not & Why. Down-Side Protection. Liquidation Preference Right of Redemption Price-based Anti-Dilution Protection. Liquidation Preference . The “New” Standard: participating Issues:

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Private Equity Financings

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  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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