Join us for the 3rd (and final) installment of our Q&A session with OurCrowd Partners, Zack Miller (Investor Community) and David Stark (Investments), about the fundamentals of deal terms in startup investing.

1. Conquering the Term
Sheet
Everything You Need to Know About Deal Terms
Part 3

2. David Stark
Partner, OurCrowd
@starkupnation
Zack Miller
Partner, OurCrowd
@newrulesinvest

3. OurCrowd
Leading equity
crowdfunding platform
with 8000+ investors
from over 100 countries

4. Mailbox: Liquidation preferences
It depends. Pro rata rights are a right, not an
obligation. Things to remember: Lean on
your winners. Avoid being crushed.
Important note: If you have the opportunity
to buy up, why not?
Q: Should I exercise my
pro rata rights?

5. Quick Review
Lesson 1 - Equity
Valuation
Liquidation preferences
ESOP
Key takeaway
Need to look at the
WHOLE
term sheet to see the full
picture
Lesson 2 - Equity
Pro rata rights
Anti-dilution protection
Control provisions
Key takeaway
Need to have
opportunity to continue
backing your winners

6. Today’s agenda
Convertible notes
Pros and cons (investor/entrepreneur)
Amount/maturity
Interest
Conversion
Discount
Cap
Auto/voluntary conversion
Repayment
SAFE

7. Convertible Notes
Structured as a loan,
converts to equity if
certain events occur
(generally upon a future
financing)

8. Why use a convertible loan?
• Increases STM (Speed to Money)
• Can be a “bridge” to next round, maximizing value creation
and reducing dilution
• Increased flexibility with size of investment, equity stake sold
• Often no control provisions, board representation
The entrepreneur’s Perspective

9. Why use a convertible loan?
• Faster, easier, cheaper
• Enables securing of deal
• Get some built-in upside
• Downside protection
The Investor’s Perspective
• First investment: displaces
valuation discussion onto
larger institutional entity
• Follow on: provide company
with bridge to next round
Use Cases

10. Keeping the faith
Eventual rights and preferences are unknown at the time
of investment…

11. Loan Amount
How much money is going
to be invested by you
+
How much money will be
invested by others
(What is the timeframe for
others to join)

12. Maturity
Length of the loan period
Typically 12-24 months

13. Interest
Convertibles are loans and have interest rate associated with them

14. Secured vs.
Non-secured
Underlying assets to seize
or personal guarantee

15. Prepayment
Note may not be prepaid
without the consent of the
lender

16. Interest
Interest accrues rather than being
paid out
Simple vs Compound Interest
8% interest per annum
Invest $1M,
converts to equity in exactly
one year
Equivalent of having
invested $1.08M
Example
After 2 years: $1.16M vs. $1.1664 M

17. Conversion
Move from debt to equity

18. Automatic vs. Voluntary
Conversion
Exactly as it sounds, some conversions are
forced when certain conditions are met
Others are optional

19. Automatic Conversion
“Prior to the Maturity Date, upon
receiving notice from the Company
that the Company has raised more
than $X million in funds in which it
has issued preferred shares
(“Qualified Financing”), then the
Note will automatically convert all
principal, together with all accrued
and unpaid interest under the Note,
into the shares issued in such
Qualified Financing. The
conversion price will be a price per
share equal to…”

20. Automatic Conversion
“Prior to the Maturity Date, upon
receiving notice from the Company
that the Company has raised more
than $X million in funds in which it
has issued preferred shares
(“Qualified Financing”), then the
Note will automatically convert all
principal, together with all accrued
and unpaid interest under the Note,
into the shares issued in such
Qualified Financing. The
conversion price will be a price per
share equal to…”
Threshold ensures
balance between
institutional lead investor
and pragmatic
fundraising plans

21. Automatic Conversion
“Prior to the Maturity Date, upon
receiving notice from the Company
that the Company has raised more
than $X million in funds in which it
has issued preferred shares
(“Qualified Financing”), then the
Note will automatically convert all
principal, together with all accrued
and unpaid interest under the Note,
into the shares issued in such
Qualified Financing. The
conversion price will be a price per
share equal to…”
Important because
don’t want
common stock

22. Automatic Conversion
“Prior to the Maturity Date, upon
receiving notice from the Company
that the Company has raised more
than $X million in funds in which it
has issued preferred shares
(“Qualified Financing”), then the
Note will automatically convert all
principal, together with all accrued
and unpaid interest under the Note,
into the shares issued in such
Qualified Financing. The
conversion price will be a price per
share equal to…”
Well, it’s just automatic

23. Automatic Conversion
“Prior to the Maturity Date, upon
receiving notice from the Company
that the Company has raised more
than $X million in funds in which it
has issued preferred shares
(“Qualified Financing”), then the
Note will automatically convert all
principal, together with all accrued
and unpaid interest under the Note,
into the shares issued in such
Qualified Financing. The
conversion price will be a price per
share equal to…”
See Lesson 1,2 of
our lecture series
Get rights and
preferences of equity
round

24. So, now you know which shares
you’ll receive.
But what are you paying for them??

25. Conversion Price
The conversion price will be a price per share
equal to the lower of:
(i) y% of the price paid in the Qualified Financing
(ii) a price per share reflecting a company pre-
money valuation of $X
Discount
Cap

26. Conversion Price
Discount to the price/share paid in the next equity
round
Typically 10%-30% (most often 20%)
Discount
Cap
“(i) y% of the price paid in the Qualified Financing”

27. Conversion Price
Discount
Cap
“(i) y% of the price paid in the Qualified Financing”
Time-triggered discount: no discount if next
round w/in 90 days from closing
Escalating discount: 15% within 90 days, 25%
after 90 days but prior to 180 days, 35% after 180
days
Examples of variations

28. Real Life Example
Conversion Price
20% discount:
next round = $1.00 per share, then the note will
convert into the same shares at a 20%
discount, or $0.80 per share.
$500,000 convertible note —> 625,000 shares
($500,000 / $0.80)
New $500,000 equity investor —> 500,000
shares ($500,000 / $1.00)
Discount
Cap

29. Conversion Price
Discount
Cap
(ii) a price per share reflecting a
company pre-money valuation of $X
Maximum conversion valuation
(regardless of valuation of next round)

30. Conversion Price
Discount
Cap
(ii) a price per share reflecting a company pre-money
valuation of $X
breakeven point is $X/Y%
eg. lower of 80% of pps or $20M cap —>
$20M/8% = $25M
<$25M 20% discount
>$25M
$20M cap
(discount > 20%)
Next round valuation

31. Conversion Price
Discount
Cap
Importance of a cap for investors
• Protect upside on risk-adj basis
• Align interests
• Protection vs. tail risk
Balance with management not wanting cap to
set next round’s valuation

32. Non Qualified
Financing
Financing round that doesn’t
meet the criteria
Can voluntarily convert

33. M&A prior to conversion
Don’t want to just get repaid
1. Receive multiple of investment (e.g. 2x or 3x)
2. Convert at a discount to purchase price
3. Convert at predetermined price (e.g. last
round’s post money)
3 options

34. What happens at maturity?

35. What happens at maturity?
Repayment or Conversion at Predetermined Price
Repayment (w/ option to convert):
• entrepreneur can view as ticking time bomb
• investor unlikely to get repaid anyways
• inability to repay = insolvency
Automatic Conversion @ Predetermined Price:
• valuation signal when trying to raise equity
round?

36. Issues with Convertibles
• have more downside protection than full ratchet
(Lesson 2!)
• can result in >1x liquidation preference (Lesson
1!)
• have features of debt even though intention is
equity

37. Alternatives

38. Priced
Convertible
Debt
Floor to go with the ceiling

39. SAFEs:
Simple Agreement for Future Equity

40. SAFEs

41. Next step?
Thanks for joining us for our Term
Sheet series
OurCrowd.com
Check out our real-life
term sheets by
accrediting on our
website