Question

Suppose a startup is looking to raise capital for a growing tech company. The founders are presented with term sheets from two different venture capital firms. The following highlights contain the main details and terms contained within each potential deal structure.

Investor A
Investment amount: $4,000,000
Investors: Investor A
Type of Security: Non Participating Preferred Equity
Postmoney Valuation: $9,000,000
Option Pool: 25% of post money value
Liquidation Preference: 1X
Anti-dilution: Weighted Average
Board Structure: Board of 3 members; Investor A holds 1 seat
No Shop Clause: 30 days

Investor B
Investment amount: $6,000,000
Investor Split: $3,000,000 by Investor B and $3,000,000 by Investor C
Security Type: Participating Preferred Equity
Premoney Valuation: $6,000,000
Option Pool: 15% of postmoney value
Liquidation Preference: 1X with 2.5X participating cap
Anti-dilution: Full Ratchet
Board Structure: Board of 3 members; each investor holds 1 seat
Pay-to-play: All investors required to purchase shares during any future down round or forfeit board seat
No Shop Clause: 6 weeks

Suppose the company is sold for $6,000,000. How much money would the founder get if they had signed a deal with Investor B?

What is the minimum amount the company would have to be sold for, in order for Investor A to get more than their $4,000,000 investment back?

Suppose the company is sold for $20,000,000. How much money would Investor A and C (combined) get paid?

Answer 1

Ans:

$		A	B&C
Investment amount		40,00,000	60,00,000
Security		Non-Participating Pref Stock	Participating Pref Stock
Post Money Valuation		90,00,000
Premoney Valuation			60,00,000
Option Pool		25% Post Money	15% Post Money
Liquidation Preference		1X	1X with 2.5X participating cap
Anti - Dilution		Weighted Average	Full Ratchet
Board Structure		Total 3; A holds 1 seat	Total 3; B & C holds 1 seat, each
No Shop Clause		30 days	6 weeks
Based on the above:
Total Stake		90,00,000	1,20,00,000
Investor Stake		40,00,000	60,00,000
Investor Stake %		44.4%	50.0%
Option Pool		22,50,000	30,00,000
Option Pool Stake %		25.0%	25.0%
Founder Stake		27,50,000	30,00,000
Founder Stake %		30.6%	25.0%

Q: Suppose the company is sold for $6,000,000. How much money would the founder get if they had signed a deal with Investor B?

Ans: Incase of deal with Investor B, the liquidation preference is agreed at 1X with participating cap at 2.5X; In this case, Investor B (along with Investor C) have right to claim 1X of their investment i.e., $6,000,000 and further they shall participate in the remaining proceeds till they get the return of 2.5X.

Given this, if the company is sold for $6,000,000, entire amount shall be taken by Investor B and Founder shall get nothing from the Proceeds of sale;

Q: What is the minimum amount the company would have to be sold for, in order for Investor A to get more than their $4,000,000 investment back?

Ans: Investor A has invested $ 4,000,000 (44.4%) thru non-participating Pref stock; The Liquidation preference is agreed at 1X;

Liquidation preference clause determines the payout process or the distribution of stocks if the company pays dividends, enters into a merger, or liquidates the company. Liquidation preference means the company's investors or the preferred stockholders receive their investment back first in case the company liquidates.

This clause is applicable when the company is liquidated or sold or declares bankruptcy.

In this case, if the company is sold at $4,000,000, as per the liquidation clause, the proceeds are taken by Investor A; This is the minimum amount at which the company need to be sold; If valuation is more than $9,000,000, the Investor A, might not claim the Liquidation Preference clause and might convert Preferential stake to common stake further to claim his 44.4% stake, which shall fetch for him more than his investment amount.

Q: Suppose the company is sold for $20,000,000. How much money would Investor A and C (combined) get paid?

Ans: I believe there is mistake in this question; The options given are either Investor A or Investor B (along with C); Assuming that the above question is on Investor B and C, the answer is as below:

Liquidation preference agreed with Investor B & C is at 1X with participating cap till 2.5X; Considering the total Proceeds from the sale, the investors shall choose either to consider Liquidation Preference or not; If the sale proceeds are significantly higher, the investors shall choose to convert the pref stake in to common stake and further liquidate to enjoy their share; Otherwise, they shall trigger Liquidation clause to reap maximum benefit from the proceeds of sale;

			$
Company Sold For			2,00,00,000
Option 1: Investor Stake %		50%	1,00,00,000
Liquidation Preference	1X	60,00,000	60,00,000
Balance Proceeds			1,40,00,000
Participating Cap	2.5X	50% stake from balance Proceeds	70,00,000
Option 2: Opting Liquidation Preference results in:
	1X, plus		60,00,000
	Participation - 50% stake	70,00,000
			1,30,00,000
	Cap 2.5X		1,50,00,000
Total paid to Investors B&C		1,30,00,000