Terms and Valuation:
David Kirkpatrick
How Venture Capitalists Structure Investments
Durham, NC 919.530.1177 New York, NY 212.209.3042 www.sjfund.com
Getting Ready for Equity™ Disney Entrepreneur Center Orlando, FL July 23, 2008 >
TERMS AND VALUATION – Session Goals Understand role of term sheet Become familiar with the term sheet and due diligence process Learn how investors think about valuation and the role valuation plays in the deal Gain exposure to typical terms and term sheet issues RESOURCES: Glossary of equity investment terms Sample Series A Preferred equity term sheet Sample term sheet capitalization table 2
© 2008 SJF Advisory Services
TERM SHEET - Overview Defines the principal terms of a proposed investment Investing entities and $ amount being invested Valuation of the company, which determines ownership percentages Other financial terms: dividends, other return enhancers, redemption, dilution, stock option pool… Other conditions: board of directors, management team recruitment requirements, protective provisions …
Part of building a relationship, how it is done is a good indicator for the future Get a good lawyer, who has done venture capital deals 3
© 2008 SJF Advisory Services
TERM SHEETS: A MARRIAGE CONTRACT DATING (BEFORE THE TERM SHEET)
Summary, plan, financials, projections, meetings, conference calls, references
ENGAGEMENT (AFTER THE TERM SHEET) Legal documents, further due diligence
WEDDING (CLOSING AND FUNDING THE DEAL) Not all deals make it to the altar!
MARRIAGE (UNTIL EXIT DO US PART) Board meetings, growth, acquisitions, mis-steps, corrections, additional funding, exit 4
© 2008 SJF Advisory Services
VALUATION CONSIDERATIONS FOR INVESTORS MERGER & ACQUISITION ACTIVITY – WHO IS BUYING AND WHY
Strategic and financial buyers
Valuations of comparable M&A transactions
IPO POTENTIAL OF THE INDUSTRY SECTOR
Valuations of comparable public companies
CONFIDENCE LEVEL IN COMPANY’S FORECAST AT EXPECTED EXIT
Current customer traction & operations as indication
Believability of sales pipeline - Year 5 projections are likely discounted heavily by investors
INVESTMENT RETURN EXPECTATIONS AT VARIOUS PRE-DEAL VALUATIONS 5
© 2008 SJF Advisory Services
M&A TRANSACTION COMPARABLES M&A Transactions of Plastics and Resins Manufacturers (Dollars in Millions)
Seller
Buyer
Acquisition Enterprise Value
Seller LTM Financials: Revs. EBIT EBITDA
Polyurethanes Buss. of EniChem SpA
Dow Chemical Co
$370.0
$500.0
NA
Union Carbide Corp
Dow Chemical Co
$9,539.4
$5,500.0
$740.0
Sybron Chemicals Inc
Bayer AG
$320.2
$282.6
$14.6
Polyvinyl Alcohol Business of APC
Celanese AG
$326.0
$198.0
Geon Co (The)
Hanna (MA) Co
$706.5
$1,261.2
Thermoplastic Polyurethane Business
Huntsman Corp
$120.0
$75.0
McWhorter Technologies Inc
Eastman Chemical Co
$342.0
$450.9
$27.2
Furon Co
Cie de Saint-Gobain SA
$614.1
$487.3
$47.4
Amino Coating Resins Business
Cytec Industries Inc
$43.4
$25.0
Pacific Western Extruded Plastics Co
Eagle Pacific Industries
$79.6
$180.0
$11.9
Essef Corp
Pentair Inc
$428.3
$450.0
$31.6
NA $191.7 NA
NA
NA
0.7 x
NA x
NA x
$1,138.0
1.7 x
12.9 x
8.4 x
$27.5
1.1 x
22.0 x
11.6 x
1.6 x
NA x
NA x
0.6 x
3.7 x
3.0 x
1.6 x
NA x
NA x
$45.3
0.8 x
12.6 x
7.5 x
$71.8
1.3 x
12.9 x
8.5 x
1.7 x
NA x
NA x
$17.7
0.4 x
6.7 x
4.5 x
$44.5
1.0 x
13.6 x
9.6 x
1.1 x
12.2 x
8.7 x
NA $236.1 NA
NA
AVERAGE
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Š 2008 SJF Advisory Services
Acquisition Enterprise Value to: Revs. EBIT EBITDA
PUBLIC COMPANY COMPARABLES Company
Ticker
Exchange
Stock Price
A. Schulman, Inc.
SHLM
OTC
$13.05
$458.4
$979.0
$59.6
0.47 x
7.7 x
Georgia Gulf Corporation
GGC
NYSE
$16.14
$1,167.4
$1,529.2
$177.0
0.76 x
6.6 x
InterSystems, Inc.
II
AMEX
$0.28
$27.2
$17.5
$3.0
1.55 x
9.2 x
Landec Corporation
LNDC
OTC
$4.50
$102.6
$225.2
$5.7
0.46 x
18.1 x
Planet Polymer Technologies
POLY
OTC
$0.36
$2.7
$0.5
($1.4)
5.06 x*
NM x
Polymer Group, Inc.
PGI
NYSE
$3.10
$1,142.9
$831.3
1.37 x
8.3 x
Polymer Research Corp. of America
PROA
OTC
$0.90
$1.2
$5.2
0.22 x
NM x
PolyOne Corporation
POL
NYSE
$10.25
$1,549.9
$2,252.0
$112.7
0.69 x
13.8 x
PVC Container Corporation
PVCC
OTC
$3.16
$59.7
$89.5
$7.7
0.67 x
7.8 x
Rogers Corporation
ROG
NYSE
$26.55
$405.4
$240.2
$38.2
1.69 x
10.6 x
Spartech Corporation
SEH
NYSE
$22.96
$940.8
$986.8
$141.2
0.95 x
6.7 x
Wellman, Inc.
WLM
NYSE
$16.42
$894.6
$1,131.2
$126.8
0.79 x
7.1 x
AVERAGE
0.87 x
9.6 x
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Š 2008 SJF Advisory Services
Enterprise Value ($MM)
LTM Financials: Revenues EBITDA ($MM) ($MM)
$137.7 ($0.2)
Enterprise Value to: Revenues EBITDA
DETERMINING PRE-DEAL VALUATION Prospect's LTM Financials
Prospect's Enterprise Valuation
Prospect's Equity Valuation
Less, Net Debt
M&A Industry Multiples
Revenue
1.1
x
$
5,138,000
=
$ 5,651,800
-
$ 500,000
=
$ 5,151,800
EBITDA
8.7
x
$
585,000
=
$ 5,089,500
-
$ 500,000
=
$ 4,589,500
Public Company Multiples
Revenue
0.9
x
$
5,138,000
=
$ 4,624,200
-
$ 500,000
=
$ 4,124,200
EBITDA
9.6
x
$
585,000
=
$ 5,616,000
-
$ 500,000
=
$ 5,116,000
AVERAGE EQUITY VALUATION
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$ 4,745,375
PRE-DEAL VALUATION AND VC OWNERSHIP
A
PRE-DEAL EQUITY VALUATION
B
VC INVESTMENT
C
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4,000,000
4,500,000
5,000,000
5,500,000
6,000,000
+
2,000,000
2,000,000
2,000,000
2,000,000
2,000,000
POST-DEAL EQUITY VALUATION
=
6,000,000
6,500,000
7,000,000
7,500,000
8,000,000
VC OWNERSHIP
=B/C
© 2008 SJF Advisory Services
33%
31%
29%
27%
25%
VALUATION AND CAP TABLE 9/10/2007
Green Company, Inc. Capitalization Table Prior to Series A Issuance
Company Shareholder Founder A Founder B Employee stock option plan Preferred A shareholders
% of fully diluted shares 51.00% 44.00% 5.00% 100.00%
After Series A Issuance
Number of Shares 2,550,000 2,200,000 250,000 5,000,000
% of fully diluted shares
Number of Shares
34.00% 29.33% 10.00% 26.67% 100.00%
Extra 500,000 shares added to option plan ($500,000 value) $2MM in VC financing for 26.67% ownership (after option plan included) $5MM pre-money valuation, $7.5MM post-money valuation 7,500,000 shares outstanding at $1/share 10
© 2008 SJF Advisory Services
2,550,000 2,200,000 750,000 2,000,000 7,500,000
CONDITIONS TO TYING THE KNOT
ADDITIONAL DEBT FINANCING EQUITY CO-INVESTORS OR SYNDICATE MANAGEMENT CHANGES OR NEW RECRUITS USES OF FUNDS – Acquisitions, marketing, expansion DUE DILIGENCE
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TERM SHEET: Team Issues CEO, FOUNDER, FAMILY MGMT ISSUES NEW RECRUITS MANAGEMENT CONTRACT, NON-COMPETES STOCK OPTION PLAN
Incentives available for additional mgmt team members or full team
BOARD OF DIRECTORS 12
Designate seats for management, investors, independent directors Voting rights for management and investor classes Establish committees © 2008 SJF Advisory Services
THE BELLS AND WHISTLES DIVIDENDS 7% to 15% is common, cash or stock, sometimes compounding, usually accrues and paid at exit event
LIQUIDATION PREFERENCE Venture capitalists often get one times their investment back before participating pro-rata with other shareholders
ANTI-DILUTION RIGHTS FOR FUTURE FINANCINGS IF THEY OCCUR AT A LOWER VALUATION Weighted average ratchet adjustment is most common
CONVERSION RIGHTS Ability to convert preferred stock to common stock in event of IPO or other exit valuation hurdle 13
© 2008 SJF Advisory Services
THE BELLS AND WHISTLES, continued REPS AND WARRANTIES
Statement of facts, opinions, estimates
WARRANTS
Additional stock purchase options at predetermined price or valuation adjustments based on milestones
FEES
Legal fees typically paid by company out of investment proceeds, sometimes additional management fees
NO SHOP
Prevents company from negotiating with other investors during a specified due diligence period
RIGHT OF FIRST REFUSAL, TAG ALONG OR CO-SALE
Investors’ rights to participate in future financings
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FRIENDLY DIVORCE? Æ REDEMPTION CLAUSE Defines right of investor to redeem investment, typically five years Not typically exercised, right time to exit usually evident to all If exercised, what are the teeth? How is the price set – greater of purchase price + dividends, market valuation, valuation multiple? Term for the pay-out if a recapitalization? How about a call as well as a put? 15
© 2008 SJF Advisory Services
PROTECTIVE PROVISIONS ACTIONS THE BOARD MUST APPROVE, SUCH AS…
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Creating new series or classes of equity or changing their rights Pay dividends or repurchase securities Amend the Certificate of Incorporation or Bylaws Incur debt or capital expenditures over a certain amount Merge, consolidate, lease license or sell significant assets File for bankruptcy, dissolve, or liquidate Increase or decrease size of Board of Directors Hire or fire executive officers
© 2008 SJF Advisory Services
VALUATION RESOURCES FOR ENTREPENEURS Mergerstat (www.mergerstat.com) SEC Filing (www.sec.gov/edgar/searchedgar/companysearch.html) Analysts’ Research Reports (http://screen.yahoo.com/reports.html) Yahoo Finance (http://finance.yahoo.com) Alumni database resources - business schools Ask VC funds for their comps & analysis
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© 2008 SJF Advisory Services
David Kirkpatrick
THANK YOU! Durham, NC 919.530.1177 New York, NY 212.209.3042 www.sjfund.com
Getting Ready for Equity™ Disney Entrepreneur Center Orlando, FL July 23, 2008 >