Raising Capital - Litton Final Exam Part 2

Pre-Seed

Traction + Key Team + Initial Setup

Company ABC is about to be sold for $2.5 million. Doug and the rest of the co-founders of the company raised only one round of funding. They bootstrapped the company initially and were able to rely on internal cash flow until they raised a round of $1 million at a $10 million post-money valuation. This resulted in the investors owning 10% of the company. The investors in that round also received a 1x liquidation preference. What will the investors receive from the sale of the company?

$1 million

In an initial round of financing, a venture capital firm invests $1 million for a 20% ownership stake. The pre-money valuation is:

$2 million

Company A has a pre-money valuation of $15 million and closes a seed round of financing for $5 million. What is Company A's post-money valuation?

$20 million

According to the Venture Deals text, what is the range of legal expenses for founders on a typical early-stage financing deal?

$20.000 - $40.000

What is the current annual income threshold that an individual must meet for two years to be considered an accredited investor? You can ignore any rule changes that were approved during the course but have not taken affect.

$200,000

What is the average amount an angel investor will invest in an early-stage deal?

$25,000

Company A has a pre-money valuation of $2 million and closes a seed round of financing for $1 million. What is Company A's post-money valuation?

$3 million

In a later round of financing, a venture capital firm leads a syndicate of investors that invest $10 million for a 25% ownership stake. The pre-money valuation is:

$30 million.

Company XYZ is about to be sold for $5 million. Cody and the rest of the co-founders of the company raised only one round of funding. They bootstrapped the company initially and were able to rely on internal cash flow until they raised a round of $2 million at a $10 million post-money valuation. This resulted in the investors owning 20% of the company. The investors also received a 2x liquidation preference. What will the investors receive from the sale of the company?

$4 million

Company ABC is about to be sold for $10 million. Chris and the rest of the co-founders of the company raised only one round of funding. They bootstrapped the company initially and were able to rely on internal cash flow until they raised a Series A round of $5 million at a $20 million post-money valuation. This resulted in the Series A investors owning 25% of the company. The investors in that round also received a 1x liquidation preference. What will the investors receive from the sale of the company?

$5 million

In an initial round of financing, a group of angels invest $2 million for a 25% ownership stake. The pre-money valuation is:

$6 million

Company A has a pre-money valuation of $5 million and closes a seed round of financing for $3 million. What is Company A's post-money valuation?

$8 million

What does the text suggest is the typical vesting schedule for options awarded be early-stage companies?

4 year schedule / 1 year cliff followed by monthly pro-rata

What is a syndicate in the fundraising process?

A group of investors who invest in a startup

Which of the following is the best description for a company raising a seed round?

A recent startup raising $300,000 from a small group of angel investors

What is a term sheet?

A summary document of key terms in contemplation of a financing

Redemptions Right

Allows the investors to sell their shares back to the company for a fixed payout, typically occurring over multiple years

Please match the following term sheet provisions with the best description

Co-Sale Agreement: Provides that if a founder sells stock, then the investors must have an opportunity to participate in the same terms Founders' Activities: Requires founders to devote 100% of their time to the company Proprietary Information and Inventions Agreement: Requires all founders, employees, and basically anyone who has completed work for the company enter into a separate IP assignment agreement Right of First Refusal: Provides investors with the right to participate in future financing rounds

Please match the following term sheet provisions with the best description.

Conditions Precedent: Conditions that must be satisfied before the deal is binding Redemptions Right: Allows the investors to sell their shares back to the company for a fixed payout, typically occurring over multiple years Drag-Along agreement: Requires all shareholders to enter into a separate agreement that forces them to approve a sale of the company if the investors want the deal Exercise Period: Defines how long employees have to exercise their company options.

Conditions Precedent

Conditions that must be satisfied before the deal is binding

Series B or later

Continued growth

In a traditional financing for an early-stage company, investors typically receive which type of security?

Convertible preferred stock

Exercise Period

Defines how long employees have to exercise their company options.

Which of the following are items that the Venture Deals text advises entrepreneurs to avoid / never do in negotiations?

Don't talk when you can listen, Never make the first offer, Never assume the other side has your same ethical beliefs, Don't negotiate the deal point by point (remember the entire deal)

Entrepreneurs-in-Residence

Experienced entrepreneurs who spend time at the firm while considering their next project.

A venture capital firm is investing exclusively the money of its general partners and other team members.

False

As an entrepreneur, you can outsource the fundraising process by hiring an attorney and/or investment banker.

False

If a company sells equity to an investor, it will need to pay back the amount invested plus and interest through regular payments.

False

The following language means the investors will receive nonparticipating preferred. "After the payment of the Liquidation Preference to the holders of the Series A Preferred, the remaining assets shall be distributed ratably to the holders of the Common Stock and the Series A Preferred on a common equivalent basis."

False

Which of the following are items that the Venture Deals text advises entrepreneurs to follow in negotiations?

Focus on economic and control issues, Know the people you will be negotiating with, Generate lots of interest and competition for your deal, Know which terms are important to you and which ones you will concede

Jody just raised a Series A round with a venture capital firm. They are negotiating the anti-dilution provision which provides the investor protection in case Jody's company raises funding in a later round at a lower price point. The protection will adjust the conversion price of the Series A shares based on the lower price of any new round. If the company issues shares in a future round at a price lower than the Series A price, how will the different types of anti-dilution provisions protect the Series A investors?

Full Ratchet: Series A conversion price will match price of new round, regardless of how many shares are sold, Broad-based weighted average: Series A conversion price is adjusted through a weighted calculation assuming all convertible securities are exercised, Narrow-based weighted average: Series A conversion price is adjusted through a weighted calculation ignoring all convertible securities

Assume you are negotiating a seed round investment that will involve a convertible note with both a discount and valuation cap. Which of the following answers accurately describe a valuation cap?

If the pre-money valuation of the company is lower than the valuation cap, then investors will choose to convert using the discount If the pre-money valuation of the company is higher than the valuation cap, then investors will choose to convert at the cap

How does the employee option pool provision matter to founders? Please select all that apply.

It directly impacts the price/valuation and it impacts the ability of the company to recruit key employees moving forward

Principals/Directors

Junior deal professionals with some deal responsibility but still requiring oversight of someone more senior

Which of the following are ways that venture capital funds make money?

Management Fees and Carried Interest

Please select the correct description for each role described in the Venture Deals text in a typical venture capital firm.

Managing Director/General Partner: Members of the VC firm who make final investment decisions and sit on the boards of directors of portfolio companies Principals/Directors: Junior deal professionals with some deal responsibility but still requiring oversight of someone more senior Associates: Members of the firm who help with a variety of tasks, Typically assigned to one more senior member of the firm. Analysts: The most junior team members who typically focus their time on analyzing numbers and writing memos. Entrepreneurs-in-Residence: Experienced entrepreneurs who spend time at the firm while considering their next project.

Managing Director/General Partner

Members of the VC firm who make final investment decisions and sit on the boards of directors of portfolio companies

Associates

Members of the firm who help with a variety of tasks, Typically assigned to one more senior member of the firm.

Which of the following are reasons that both entrepreneurs and investors will not want to use convertible notes in an early stage round of financing?

Misaligned incentives, future financing challenges, outsized liquidation preference

The Venture Deals text describes three approaches to calculating the shares for noteholders after the next round of financing is complete. Please match the answers to the correct approach.

Pre-Money method - Founder friendly Percentage owned method - Investor friendly Dollar invested method - Compromise between the two other approaches

Please put the following stages of financing in the correct order:

Pre-Seed(1), Seed(2), Series A(3), Series B(4), Series B-2(5), Series C(6)

Please match the appropriate use of proceeds (i.e., how the money raised will be used by the company) with the correct stage of financing:

Pre-Seed: Traction + Key Team + Initial Setup Seed: Production + Sales + Hiring Series A: Scale operations Series B or later: Continued growth

Seed: Production + Sales + Hiring

Production + Sales + Hiring

Which of the following best describes the purpose of the Information Rights provision?

Provides investors access to certain company information within a specific timeframe

Right of First Refusal

Provides investors with the right to participate in future financing rounds

Co-Sale Agreement

Provides that if a founder sells stock, then the investors must have an opportunity to participate in the same terms

Proprietary Information and Inventions Agreement

Requires all founders, employees, and basically anyone who has completed work for the company enter into a separate IP assignment agreement

Drag-Along agreement

Requires all shareholders to enter into a separate agreement that forces them to approve a sale of the company if the investors want the deal

Founders' Activities

Requires founders to devote 100% of their time to the company

Series A

Scale operations

Broad-based weighted average

Series A conversion price is adjusted through a weighted calculation assuming all convertible securities are exercised

Narrow-based weighted average

Series A conversion price is adjusted through a weighted calculation ignoring all convertible securities

Full Ratchet

Series A conversion price will match price of new round, regardless of how many shares are sold,

Which of the following are generally true for founders who raise outside capital? Please select all that apply.

They lose some level of control to investors and they give up equity/ownership of their company, Carried interest (or the "carry") represents the profit after returning the initial investment to investors and is typically an 80-20 split between the investors and VC fund.

It is possible for founders and investors to reach a win-win transaction.

True

The following language means the investors will receive nonparticipating preferred. "In the event of any liquidation, dissolution, or winding up of the Company, the holders of Series A Preferred Stock will be entitled to receive, in preference to the holders of Common Stock, an amount equal to the Original Purchase Price plus accrued and unpaid dividends. Thereafter, the remaining assets of the Company will be distributed ratably to the holders of Common Stock."

True

When a term sheet says something is calculated on a "fully diluted basis", it means the calculation assumes that all convertible securities (e.g., options, warrants) have been converted into common stock.

True

Which of the following are reasons that both entrepreneurs and investors will want to use convertible notes in an early stage round of financing

Valuation, Speed, Cost