Demystifying Startup Equity Investment Terms:

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Demystifying Startup Equity Investment Terms:

January 23, 2024

In this article, we aim to delve into key concepts, shedding light on the language that shapes the startup investment landscape.

1. Premoney Valuation:

Premoney valuation, the estimated value of a company before external funding, sets the stage for investment negotiations. If a startup is valued at $5 million before a funding round, its premoney valuation is $5 million.

2. Post Money Valuation:

Post money valuation reflects the company’s worth after external financing is injected. If the startup secures $2 million in funding, its post money valuation becomes $7 million ($5 million premoney + $2 million investment).

3. Restricted Shares of Promoters:

Founders often hold restricted shares with limitations on transfer or sale, aligning their interests with the company’s long-term success.

4. Anti-Dilution Protection for Investors:

Protecting investors from dilution in down-rounds, anti-dilution mechanisms like Weighted Average and Full Ratchet adjust conversion prices to maintain ownership percentages.

Weighted Average vs. Full Ratchet in Antidilution:

Weighted Average:

Considers both old and new shares for a more balanced adjustment.

Offers a compromise between investor protection and company impact.

Full Ratchet:

Adjusts conversion price to the lowest new share issuance, potentially increasing investor ownership significantly.

Can be more impactful, protecting investors but potentially straining relations with founders.

5. Board Seat:

Determining board composition ensures balanced decision-making, representing the interests of investors, founders, and independent members.

6. ROFO vs. ROFR:

  • ROFO (Right of First Offer): Grants investors the first chance to invest in new securities or buy secondary shares.
  • ROFR (Right of First Refusal): Allows investors to match third-party offers.

7. Tag, Drag, and Information Rights:

  • Tag-Along Rights (Tag): Enables minority shareholders to participate in majority-initiated share sales.
  • Drag-Along Rights (Drag): Empowers majority shareholders to force minority shareholders to sell.
  • Information Rights: Investors negotiate access to key company information for transparency.

8. Exit, EOD, and Consequences:

Exit involves investors cashing out through acquisition or IPO. EOD provisions set action timelines, with consequences for missed deadlines.

9. Reserve Matters and Fall Away Thresholds:

Reserve Matters: Important decisions requiring specific shareholder consent.
Fall Away Thresholds: Conditions where certain provisions or rights cease to apply.

10. Liquidation Preference:

Specifies the order in which investors receive proceeds in a liquidation event, ensuring they recoup their investment before other shareholders.

Understanding these terms empowers stakeholders to navigate negotiations and strike agreements that align with the collective interests of both founders and investors in the dynamic world of startup equity investment.

Author: Prashant Kumar Jain, Managing Partner

Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at info@samistilegal.in

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