What are Ratchets?
protective right
Ratchets help to manage risk and payout the investment
One way to implement ratchets: Bonus or malus agreement, allowing investors to convert debt into stock at predefined objectives
Another way to implement: Remaining investments can be terminated or given as convertible debt
Why ratchets? (Theory perspective)
Prevent Moral Hazard
Reduction of risk over time
Why drag-along/tag-along rights?
Drag-along/ tag-along rights help to eliminate potential exit blockers and give both parties a certain confidence that they will realize an exit at some point.
What are drag-along rights?
The drag-along right forces other shareholders to sell shares, if one party decides to sell their stake.
—>Gives an investor the possibility of making a trade sale even if management does not want to sell
Potential effects/ hazards of drag-along rights
Gives an investor the possibility of making a trade sale even if management not involved
Liquidation preferences could be hazardous
What are tag-along rights?
The tag-along right protects (minority) shareholders by enabling them to sell along shares, if one party sell shares
—>It is customary that the investor may sell if the entrepreneur sells
Potential effects/ hazards of tag-along rights
It is customary that the investor may sell if the entrepreneur sells
Why drag-along and tag-along rights? (theory perspective)
Prevent moral hazard
Hidden information
Alignment of interest
What are protective provisions?
A list of actions, which the founders may not execute without the VC’s permission
Protective provisions give a certain direction to management on what and what not to do without consulting the investor
The list of protective provision typically includes actions that will impact ownership of stock and major financial decisions
Potential effects/ hazards of protective provisions
The investor receives the right to authorize certain management activities
Why protective provisions? (Theory perspective)
Hidden intentions
What are redemption rights?
Obligation to repay propietary capital plus dividends after a period
The target grants the investor to redeem the outstanding stock at least at the purchase price plus declared and unpaid dividends
In case of no exit opportunity - A VC fund still must have the opportunity to draw its money ot of an investment and pay back its investors
Usually after certain period of time (sometimes in case of material adverse change)
Potential effects/ hazards of redemption rights
Little used method of reducing the risk of an unacceptably slow company groth rate
Why redemption rights? (theory perspective)
Fund structure
What is board representation or control rights?
Venture capitalist will install a representative into the organs of the company to gain information and control
Potential effects/hazards of control rights?
Usually, a question of how seats on boards are distributed
Constructive collaboration could be difficult
How many board members does a start-up usally have? (Early stage boards, Later stage boards)
Why protective provisions? (theory perspective)
prevent moral hazard
hidden information
alignment of interest
What is an Confidentiality agreement?
Both parties agree to keep all disclosed information cofidential - also referred to as Non Disclosure Agreement (NDA)
What is an Exclusivity agreement?
Both parties agree to not negotiate the/a similar deal with third parties for a predefinied time period due to transaction cost and prevention of bidding processes
Is a term sheet mostly binding or non-binding?
non-binding
When should you prevent a investment from proceeding?
venture is not successfully assessed (due diligence)
documentation is not provided
or VC rights have not been granted
To which conditions should you pay special attentition to?
Approval by investors’ partnerships: Term Sheet has not yet been approved by the issuing investors
Rights offering to be completed by company: VC wants to offer same conditions of current deal to all your previous investors
Employment agreements signed by founders as acceptable to investors: Directly affects your salary and situation if you get fired
What is a non-competition agreement?
Protecting the company knowledge
People involved agree to not step into competition with the company
What are transaction and monitoring fees?
Law firms involved as well as notary and additional transaction fees mount up during the process
In practice, fees will be borne by the company as a consequence of the contemplated financing
What is enforceability?
The term sheet is a non-binding document
It might be transformed into a binding contract by one party, if the term sheet is used to obtain other investors/investment
What are information rights and its potential hazards?
Agreement about how the founder informs the investor
As a rule, the founders have to complete reports required by the contract in addition to those required by law
What are employee options and its potential hazards?
Employees participate financially in the company
Key question is whether employee stock options dilute the entire stock or only that of the founder and management team
What are guarantees and its potential hazards
Guarantees regarding the investment
In general, investors insure themselves with gurantees - these may also be linkes to payments
Measures taken to reduce risks within different stages of the investment?
Last changed9 months ago