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Multimarket Venture Capital Survey Data: Q3 2004 (Fish & Richardson PC)

David Dutil, Jonathan M. Aberman of Fish & Richardson P.C.


Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in five regions during the third quarter of 2004. We looked at financings in the Mid-Atlantic, New York Metro, New England, Southwest, and Southern California regions.

Financing Round

The financings we reviewed ran the gamut from Series A to Series I with a distribution as follows:

Series Q3 '04 Q2 '04 Q1 '04
A 23% 26% 32%
B 34% 33% 32%
C 19% 18% 21%
D or later 24% 23% 14%

Price Direction

Half of financings were Up Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04
Down 26% 29% 36%
Unchanged 14% 23% 11%
Up 59% 48% 53%

There was no significant pattern in the percentage of Down Rounds between the various stages:

Series Q3 '04 Q2 '04 Q1 '04
B 23% 27% 31%
C 29% 33% 41%
D or later 21% 28% 36%

Cumulative Dividends

Again this quarter, Cumulative Dividends were present in approximately half of the transactions, although there was significant regional variation:

Q3 '04 Q2 '04 Q1 '04
43% 44% 46%

There was no significant pattern between the various stages:

Series Q3 '04 Q2 '04 Q1 '04
A 42% 58% 55%
B 29% 49% 43%
C 35% 30% 47%
D or later 67% 36% 36%

Liquidation Preferences Preference Multiples

All but one financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in almost every case the latest round was senior to previous rounds. The preference multiples had the following distribution:

Liquidation Prefs Q3 '04 Q2 '04 Q1 '04
1x 85% 83% 79%
>1x - 2x 13% 13% 20%
>2x - 3x 2% 3% 2%

Participation

While the Liquidation Preference multiples were fairly low, nearly three-quarters of all deals included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04
76% 76% 73%

Redemption

Mandatory or Voluntary Redemption was generally present, although there was significant regional variation:

Q3 '04 Q2 '04 Q1 '04
80% 75% 77%

Antidilution

Full Ratchet Antidilution Protection was rarely used; a few deals had no Antidilution Price Protection:

Antidilution Type Q3 '04 Q2 '04 Q1 '04
Full Ratchet 16% 20% 22%
Weighted Average 81% 78% 75%

Pay to Play

About one in four deals included a Pay to Play provision. Such deals were divided between those that forced conversion to Common Stock and those that forced conversion to a Shadow Preferred Stock:

Conversion to Q3 '04 Q2 '04 Q1 '04
Common Stock 21% 13% 14%
Shadow Preferred 5% 6% 7%

Corporate Reorganization/Recapitalization

A few of the transactions we reviewed included a Reorganization or Recapitalization pursuant to which the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04
9% 10% 13%

The two types of reorganizations that we found were (1) reverse splits (aka combinations), which were present as follows (some transactions included both types):

Q3 '04 Q2 '04 Q1 '04
8% 7% 11%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04
2% 3% 6%

Conclusions

The venture capital market continues its healthy trend, although the most distinguishing characteristic of the past quarter was that it looked a lot like the prior quarter. Arguably we are at an equilibrium point where the supply of capital and interesting companies are resulting in deals being done at "company friendly" terms.

The headline numbers reported by nvca/pwc, VentureOne and others indicate a slowing of the market with fewer deals and a lower aggregate investment amount. Drilling down into the terms behind these figures shows that while volume was low, terms continued to improve from the issuer's perspective. Three-quarters of the transactions we reviewed were Up Rounds or Flat Rounds. Full Ratchets and Multiple Liquidation Preferences continued to decline and the number of Recapitalizations was low ƒ?" in some regions there were none.

We also saw quite a few deals that were single Liquidation Preference, with no Cumulative Dividend and no Participation. These provisions, when taken together, have the effect of putting the investors essentially on par with the founders - something unheard of two years ago.

Fundraising for new venture funds continues to recover, and capital is becoming more available from the institutional investor community. The funds, however, are being concentrated into fewer managers. The average size of venture funds is increasing. Absent a significant change in the supply of promising companies, this concentration of capital will likely cause upward pressure on deal size and valuation, as funds compete to rationalize larger investments. We anticipate that the environment will continue to favor companies, particularly those that can support larger rounds of investment. We also expect continued loosening of deal terms, particularly in the Series B and C rounds.

The fiscal environment and the international market's fixation on the dollar's value carry significant risk of higher interest rates for the US and possibly fragility for the stock markets. A major shift in public market sentiment, accompanied by a higher cost of capital, will drastically change the current venture capital equilibrium. Accordingly, venture investors would be wise to read the Financial Times more closely in the coming year; it might hold better clues for upcoming trends than traditional sources.

For further information please contact

Jonathan Aberman
aberman@fr.com
202-626-7703
David Dutil
dutil@fr.com
202-626-7702

Jonathan and David are attorneys at the Washington, D.C. office of Fish & Richardson P.C.

Methodology

We reviewed Preferred Stock investments made by venture capitalists within the regions broken down on the following pages during the period July 1, 2004- September 30, 2004. For preparation of our survey, we examined publicly available sources and gathered additional information and insights on a confidential basis from market participants. We counted an Antidilution Protection as Full Ratchet even if the ratchet expired after a condition, such as the passage of time, was met. In addition, we did not break down whether Weighted Average Antidilution was Broad or Narrow. Percentages in the charts may not add up to 100% due to rounding. Please see the attached glossary for an explanation of the terms used in this survey.

Mid-Atlantic Venture Capital Survey
NY Metro Venture Capital Survey
New England Venture Capital Survey
Southwest Venture Capital Survey
Southern California Venture Capital Survey
Venture Capital Glossary

Mid-Atlantic Venture Capital Survey

Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in the Mid-Atlantic region during the third quarter of 2004.

Financing Round

The financings we reviewed ran the gamut from Series A to Series E with a distribution as follows:

Series Q3 '04 Q2 '04 Q1 '04 Q4 '03
A 35% 52% 35% 18%
B 40% 20% 38% 33%
C 5% 12% 15% 39%
D or later 25% 16% 12% 9%

Price Direction

The deals were about half Up Rounds and half Down Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04 Q4 '03
Down 50% 50% 17% 52%
Unchanged 8% 0% 11% 19%
Up 42% 50% 72% 30%

There was a greater tendency of later rounds to be Down Rounds:

Series Q3 '04 Q2 '04 Q1 '04 Q4 '03
B 38% 40% 10% 27%
C 100% 67% 25% 69%
D or later 67% 50% 35% 67%

Cumulative Dividends

A significant majority of transactions continued to include Cumulative Dividends:

Q3 '04 Q2 '04 Q1 '04 Q4 '03
60% 76% 73% 58%

There was no discernable pattern within the various rounds:

Series Q3 '04 Q2 '04 Q1 '04 Q4 '03
A 50% 77% 78% 67%
B 63% 80% 20% 45%
C 0% 100% 75% 54%
D or later 67% 50% 67% 33%

Liquidation Preferences Preference Multiples

Each financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in almost every case the latest round was senior to previous rounds. The preference multiples had the following distribution:

Liquidation Prefs Q3 '04 Q2 '04 Q1 '04 Q4 '03
1x 85% 64% 85% 78%
>1x - 2x 10% 16% 15% 3%
>2x - 3x 5% 20% 0% 21%

Participation

While the Liquidation Preference multiples continue to be fairly low, almost every deal included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04 Q4 '03
95% 96% 96% 76%

Redemption

Mandatory or Voluntary Redemption provisions are a staple term of financings in the region:

Q3 '04 Q2 '04 Q1 '04 Q4 '03
80% 84% 81% 73%

Antidilution

Weighted Average was used in most deals again this quarter; one deal had no price protection:

Antidilution Type Q3 '04 Q2 '04 Q1 '04 Q4 '03
Full Ratchet 25% 32% 31% 21%
Weighted Average 75% 68% 65% 76%

Pay to Play

Pay to Play provisions were present in one out of five deals in the most recent quarter. Forced conversion to Common Stock occurred roughly five times as often as forced conversion to a Shadow Preferred Stock:

Conversion to Q3 '04 Q2 '04 Q1 '04 Q4 '03
Common Stock 10% 16% 19% 15%
Shadow Preferred 10% 0% 4% 6%

Corporate Reorganization/Recapitalization

More transactions we reviewed this quarter included a Reorganization or Recapitalization pursuant to which the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04 Q4 '03
0% 16% 15% 6%

The two types of reorganizations that we look for are ( 1 ) reverse splits (aka combinations), which were present as follows (transactions in some quarters included both types):

Q3 '04 Q2 '04 Q1 '04 Q4 '03
0% 12% 8% 6%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04 Q4 '03
0% 4% 12% 3%

Methodology

We defined the Mid-Atlantic region as North Carolina, Virginia, Washington, DC, Maryland, Delaware and the area of New Jersey and Pennsylvania south of Princeton.

NY Metro Venture Capital Survey

Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in the NY Metro region during the third quarter of 2004.

Financing Round

The financings we reviewed ran the gamut from Series A to Series F with a distribution as follows:

Series Q3 '04 Q2 '04 Q1 '04
A 7% 33% 48%
B 14% 38% 19%
C 43% 8% 19%
D or later 36% 21% 12%

Price Direction

A majority of the financings were Up Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04
Down 15% 25% 38%
Unchanged 31% 38% 0%
Up 54% 38% 62%

There was no pattern of Down Rounds among the stages:

Series Q3 '04 Q2 '04 Q1 '04
B 0% 33% 20%
C 17% 50% 40%
D or later 20% 0% 67%

Cumulative Dividends

Half of the transactions included Cumulative Dividends:

Q3 '04 Q2 '04 Q1 '04
57% 54% 48%

There was no discernable pattern within the rounds:

Series Q3 '04 Q2 '04 Q1 '04
A 50% 63% 50%
B 50% 44% 20%
C 50% 50% 60%
D or later 80% 80% 67%

Liquidation Preferences Preference Multiples

Each financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in almost every case the latest round was senior to previous rounds. Most deals were done at a 1x preference. The preference multiples had the following distribution:

Liquidation Preference Q3 '04 Q2 '04 Q1 '04
1x 86% 92% 72%
>1x - 2x 14% 0% 28%
>2x - 3x 0% 8% 0%

Participation Liquidation Preference multiples were very low, and only about half included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04
64% 58% 80%

Redemption

Mandatory or Voluntary Redemption provisions are a staple term of financings in the region although the decline in redemption provisions continued this quarter, and this may suggest a greater comfort with the availability of exits:

Q3 '04 Q2 '04 Q1 '04
64% 63% 68%

Antidilution

Every deal used weighted average:

Antidilution Type Q3 '04 Q2 '04 Q1 '04
Full Ratchet 0% 13% 20%
Weighted Average 100% 83% 72%

Pay to Play

Pay to Play provisions were rarely present in the most recent quarter:

Conversion to Q3 '04 Q2 '04 Q1 '04
Common Stock 7% 17% 10%
Shadow Preferred 7% 4% 0%

Corporate Reorganization/Recapitalization

Few of the transactions we reviewed included a Reorganization or Recapitalization where the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04
14% 4% 10%

The two types of reorganizations that we look for are (1) reverse splits (aka combinations), which were present as follows (in some quarters transactions contained both types):

Q3 '04 Q2 '04 Q1 '04
14% 4% 10%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04
0% 0% 5%

Methodology

We defined the NY Metro Region as the state of New York and the area of New Jersey and Pennsylvania north of Princeton.

New England Venture Capital Survey

Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in the New England region during the third quarter of 2004.

Financing Round

The financing rounds broke down as follows:

Series Q3 '04 Q2 '04 Q1 '04
A 32% 22% 26%
B 21% 33% 24%
C 21% 28% 24%
D or later 26% 15% 26%

Price Direction

There were more Up Rounds than Down Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04
Down 15% 28% 35%
Unchanged 15% 17% 11%
Up 69% 56% 54%

There was no statistically significant variation in the percentage of Down Rounds within the various stages:

Series Q3 '04 Q2 '04 Q1 '04
B 25% 20% 33%
C 0% 21% 50%
D or later 20% 43% 23%

Cumulative Dividends

Less than a majority of transactions included Cumulative Dividends:

Q3 '04 Q2 '04 Q1 '04
37% 41% 54%

There was no discernable pattern within the various rounds:

Series Q3 '04 Q2 '04 Q1 '04
A 33% 50% 26%
B 0% 67% 75%
C 25% 14% 50%
D or later 80% 29% 23%

Liquidation Preferences Preference Multiples

Each financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in almost every case the latest round was senior to previous rounds. The preference multiples had the following distribution:

Liquidation Preference Q3 '04 Q2 '04 Q1 '04
1x 84% 98% 76%
>1x - 2x 11% 2% 22%
>2x - 3x 5% 0% 2%

Participation

While the Liquidation Preference multiples were low this quarter, most deals again included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04
63% 70% 60%

Redemption

Mandatory or Voluntary Redemption provisions were widely used this quarter:

Q3 '04 Q2 '04 Q1 '04
95% 63% 90%

Antidilution

Full Ratchet Antidilution Protection was not used in a significant number of deals:

Antidilution Type Q3 '04 Q2 '04 Q1 '04
Full Ratchet 5% 15% 24%
Weighted Average 89% 85% 76%

Pay to Play

Pay to Play provisions were present in one in five deals this quarter and such deals were divided between those that forced conversion to Common Stock and those that forced conversion to a Shadow Preferred Stock. This term is much more common in New England than in the other regions.

Conversion to Q3 '04 Q2 '04 Q1 '04
Common Stock 16% 20% 12%
Shadow Preferred 5% 13% 14%

Corporate Reorganization/Recapitalization

A few of the transactions we reviewed included a Reorganization or Recapitalization pursuant to which the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04
10% 9% 12%

The two types of reorganizations that we look for are (1) reverse splits (aka combinations), which were present as follows (transactions in some quarters included both types):

Q3 '04 Q2 '04 Q1 '04
5% 9% 10%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04
5% 0% 4%

Methodology

We defined the New England region as the states of Massachusetts,Maine, New Hampshire,Vermont, Rhode Island, and Connecticut.

Southwest Venture Capital Survey

Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in the Southwest region during the third quarter of 2004.

Financing Round

The financing rounds broke down as follows:

Series Q3 '04 Q2 '04 Q1 '04
A 7% 21% 39%
B 43% 33% 44%
C 7% 3% 11%
D or later 43% 38% 6%

Price Direction

A majority of financings in this region were Up Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04
Down 15% 26% 36%
Unchanged 8% 21% 27%
Up 77% 53% 36%

Down rounds by stage:

Series Q3 '04 Q2 '04 Q1 '04
B 17% 25% 25%
C 0% 0% 50%
D or later 17% 33% 100%

Cumulative Dividends

Cumulative Dividends were present in significant numbers this quarter:

Q3 '04 Q2 '04 Q1 '04
29% 33% 39%

There was no discernable pattern by round:

Series Q3 '04 Q2 '04 Q1 '04
A 100% 40% 43%
B 33% 38% 50%
C 0% 0% 0%
D or later 17% 60% 0%

Liquidation Preferences Preference Multiples

Each financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in every case the latest round was senior to previous rounds. The preference multiples had the following distribution:

Liquidation Preference Q3 '04 Q2 '04 Q1 '04
1x 93% 75% 89%
>1x - 2x 7% 21% 6%
>2x - 3x 0% 0% 6%

Participation

While the Liquidation Preference multiples were fairly low, many included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04
79% 83% 89%

Redemption

Mandatory or Voluntary Redemption is a staple term for deals in the region:

Q3 '04 Q2 '04 Q1 '04
64% 58% 78%

Antidilution

Full Ratchet Antidilution Protection was rarely used:

Antidilution Type Q3 '04 Q2 '04 Q1 '04
Full Ratchet 29% 25% 17%
Weighted Average 71% 71% 83%

Pay to Play

Pay to Play provisions were present in about one in three financings in the most recent quarter. When reviewing such deals we also consider whether they forced conversion to Common Stock or forced conversion to a Shadow Preferred Stock:

Conversion to Q3 '04 Q2 '04 Q1 '04
Common Stock 29% 17% 22%
Shadow Preferred 0% 0% 0%

Corporate Reorganization/Recapitalization

Two of the transactions we reviewed included a Reorganization or Recapitalization pursuant to which the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04
7% 8% 33%

The two types of reorganizations that we found were (1) reverse splits (aka combinations), which were present as follows (one transaction included both types):

Q3 '04 Q2 '04 Q1 '04
7% 4% 28%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04
0% 8% 17%

Methodology

We defined the Southwest Region as the states of Texas, Oklahoma, New Mexico, Arkansas, and Louisiana.

Southern California Venture Capital Survey

Set forth below are our findings based on a review of the publicly reported venture capital financings that took place in the Southern California region during the third quarter of 2004.

Financing Round

The financing rounds broke down as follows:

Series Q3 '04 Q2 '04 Q1 '04
A 21% 14% 24%
B 46% 38% 39%
C 21% 16% 27%
D or later 13% 32% 6%

Price Direction

More than half of the deals were Up Rounds:

Price Change Q3 '04 Q2 '04 Q1 '04
Down 31% 25% 44%
Unchanged 16% 34% 15%
Up 53% 40% 44%

There was no statistically significant variation in the percentage of Down Rounds within the various rounds:

Series Q3 '04 Q2 '04 Q1 '04
B 18% 29% 50%
C 60% 33% 33%
D or later 33% 17% 50%

Cumulative Dividends

Cumulative Dividends were relatively rare in this market:

Q3 '04 Q2 '04 Q1 '04
33% 24% 33%

There was no discernable pattern within the various rounds:

Series Q3 '04 Q2 '04 Q1 '04
A 40% 20% 25%
B 9% 29% 38%
C 60% 17% 33%
D or later 67% 25% 50%

Liquidation Preferences Preference Multiples

Each financing had a Liquidation Preference for the most recent round that was at least pari passu with previous rounds, and in almost every case the latest round was senior to previous rounds.Most deals were done at a 1x preference. The preference multiples had the following distribution:

Liquidation Preference Q3 '04 Q2 '04 Q1 '04
1x 79% 78% 76%
>1x - 2x 21% 22% 21%
>2x - 3x 0% 0% 3%

Participation

While the Liquidation Preference multiples were fairly low, many included participation for the most senior series of Preferred Stock:

Q3 '04 Q2 '04 Q1 '04
71% 76% 79%

Redemption

Mandatory or Voluntary Redemption provisions were present in about half the deals this quarter:

Q3 '04 Q2 '04 Q1 '04
79% 57% 61%

Antidilution

Full Ratchet Antidilution Protection was rarely used:

Antidilution Type Q3 '04 Q2 '04 Q1 '04
Full Ratchet 21% 19% 15%
Weighted Average 79% 81% 82%

Pay to Play

Pay to Play provisions were present in one in three deals in the most recent quarter and such deals were divided between those that forced conversion to Common Stock versus those that forced conversion to a Shadow Preferred Stock:

Conversion to Q3 '04 Q2 '04 Q1 '04
Common Stock 29% 8% 15%
Shadow Preferred 4% 8% 6%

Corporate Reorganization/Recapitalization

Only a few of the transactions we reviewed included a Reorganization or Recapitalization where the outstanding capital of the company was significantly changed at the time of the financing:

Q3 '04 Q2 '04 Q1 '04
13% 11% 3%

The two types of reorganizations that we found were (1) reverse splits (aka combinations), which were present as follows:

Q3 '04 Q2 '04 Q1 '04
13% 5% 3%

and (2) forced conversion of senior securities into junior securities:

Q3 '04 Q2 '04 Q1 '04
4% 5% 0%

Methodology

We defined the Southern California Region as the area between the northern edge of Los Angeles County and the border with Mexico.

The following is a general review based upon standard practice among venture capitalists and does not constitute an opinion or legal advice. Many of the terms are loosely defined in practice and there are exceptions to every rule, but we have created definitions based upon the most common usage. For further information please contact Jonathan Aberman at aberman@fr.com; 202-626-7703 or David Dutil at dutil@fr.com; 202-626-7702 . Jonathan and David are attorneys with the Washington, D.C. office of Fish & Richardson P.C.

Antidilution Protection

Broadly, purchasers of shares in venture financings look for protection against subsequent offerings at lower prices, as well as structural protection against changes in a corporate structure (such as a stock split or recapitalization) affecting in itself the pro rata portion of the company originally purchased. Antidilution Price Protection gives investors in early rounds the benefit of a reduced effective price per share if the company later has a Down Round. Antidilution Price Protection is accomplished by changing the Conversion Ratio and comes in two basic flavors, Weighted Average and Full Ratchet.

Full Ratchet Antidilution Price Protection

"Full Ratchet" (sometimes called "Ratchet") Antidilution provisions reduce the effective per share purchase price of the investor's shares purchased in a round to the actual, lower price set in a later offering or event (for example, a subsequent financing round or issuance of shares as consideration for a transaction) thereby raising the number of shares of Common Stock into which the investor's Preferred Stock will convert. Full Ratchet is more favorable for the investors who receive it and can result in significant dilution for founders and other holders of Common Stock in the event of a Down Round.

Weighted Average Antidilution Price Protection

Weighted Average Antidilution provisions reduce the effective purchase price per share of the investor's shares purchased in a round by a weighted percentage reduction determined by reference to the price decrease and the comparative number of cheaper shares issued to the total number of shares outstanding.

There are subcategories of Weighted Average Antidilution Price Protection, Narrow Based and Broad Based and each of these two terms has fairly loose definitions. Generally the main difference is in the definition of outstanding shares, with a more broad definition having the result of lessening the price effect of a Down Round on the effective price of an earlier offering. For example, a Narrow Based Weighted Average Antidilution Price Protection Provision might include only Common Stock and convertible Preferred Stock then outstanding, while a Broad Based Weighted Average Antidilution Price Protection Provision would include Common Stock outstanding or issuable upon conversion or exercise of all Preferred Stock, warrants, convertible debt, options and any other contingent right to Common Stock.

To summarize:

Broad Based Weighted Average - most favorable to company/founders
Narrow Based Weighted Average - in the middle
Full Ratchet - most favorable to investors

Antidilution Protection of a non-price based nature would be protection against changes to the Conversion Rate in the event of a stock split, stock dividend or similar reorganization. Normally, when investors and venture market participants talk about "Antidilution Protection" they are referencing Antidilution Price Protection.

Common Stock

The standard unit of equity in a company. Common Stock is generally held by founders and some angels. Employee options typically convert into Common Stock. Common Stock is usually the type of security issued in a public offering.

Conversion Rate

The ratio at which each share of Preferred Stock converts into Common Stock. Venture Capitalists typically purchase Preferred Stock that converts into Common Stock at a stated ratio, usually one to one, which then may adjust based upon triggering events such as a Down Round in accordance with Antidilution Protection.

Cumulative Dividends

Dividends that accrue at a fixed rate until paid are "Cumulative Dividends" which are payments to shareholders made with respect to an investor's Preferred Stock. Generally, holders of Preferred Shares are contractually entitled to receive dividends prior to holders of Common Stock. Dividends can accumulate at a fixed rate (for example 8 %) or simply be payable as and when determined by a company's Board of Directors in such amount as determined by the board. Because venture backed companies typically need to conserve cash, the use of Cumulative Dividends is customary with the result that the Liquidation Preference increases by an amount equal to the Cumulative Dividends. Cumulative Dividends are often waived if the Preferred Stock converts to Common Stock prior to an ipo but may be included in the aggregate value of Preferred Stock applied to the Conversion Ratio for other purposes. Dividends that are not cumulative are generally called "when, as and if declared dividends."

Down Round

Issuance of shares at a later date and a lower price than previous investment rounds.

Issue Price

The price per share deemed to have been paid for a series of Preferred Stock. This number is important because Cumulative Dividends, the Liquidation Preference and Conversion Ratios are all based on Issue Price. In some cases, it is not the actual price paid. The most common example is where a company does a bridge financing (a common way for investors to provide capital without having to value the company as a whole) and sells debt that is convertible into the next series of Preferred Stock sold by the company at a discount to the Issue Price.

Liquidation Preference

The amount per share that a holder of a given series of Preferred Stock will receive prior to distribution of amounts to holders of other series of Preferred Stock or Common Stock. This is usually designated as a multiple of the Issue Price, for example 2x or 3x , and there may be multiple layers of Liquidation Preferences as different groups of investors buy shares in different series. For example, holders of Series B Preferred Stock may be entitled to receive 3x their Issue Price, and then if any money is left, holders of Series A Preferred Stock may be entitled to receive 2x their Issue Price and then holders of Common Stock receive whatever is left. The trigger for the payment of the Liquidation Preference is a sale or liquidation of the company, such as a merger or other transaction where the company stockholders end up with less than half of the ownership of the new entity or a liquidation of the company.

Participation

Describes the right of a holder of Preferred Stock to enjoy both the rights associated with the Preferred Stock and also participate in any benefit available to Common Stock, without converting to Common Stock. This may occur with Liquidation Preferences, for example, a series of Preferred Stock may have the right to receive its Liquidation Preference and then also share in whatever money is left to be distributed to the holders of Common Stock. Dividends may also be "Participating" where after a holder of Preferred Stock receives its Cumulative Dividend it also receives any dividend paid on the Common Stock.

Preferred Stock

The unit of equity in a corporation that is typically sold to venture and other institutional investors. Preferred Stock will usually have preferential rights over the Common Stock with respect to dividends, liquidation, voting, redemption and/or Antidilution Protection. There is nothing automatically "preferred" about Preferred Stock, but rather it has whatever rights are associated with the particular class or series as described in the company's certificate of incorporation. Preferred Stock can be subdivided into one or more different classes or series. Typically, the first series sold to investors will be designated Series A, the next will be Series B and so on. Series A is not necessarily better than Series B, rather the relative rights are governed by the company's certificate of incorporation and one series may have a better dividend preference while another may have a better liquidation preference. However, it is important to note that within a series all shares must have identical rights and be treated equally by the company.

Pay to Play

A "Pay to Play" provision is a requirement for an existing investor to participate in a subsequent investment round, especially a Down Round. Where Pay to Play provisions exist, an investor's failure to purchase its pro rata portion of a subsequent investment round will result in conversion of that investor's Preferred Stock into Common Stock or another less valuable series of Preferred Stock.

Redemption

The right or obligation of a company to repurchase its own shares.

Mandatory Redemption

is a right of an investor to require the company to repurchase some or all of an investor's shares at a stated price at a given time in the future. The purchase price is usually the Issue Price, increased by Cumulative Dividends, if any. Mandatory Redemption may be automatic or may require a vote of the series of Preferred Stock having the redemption right.

Voluntary Redemption

is the right of a company to repurchase some or all of an investor's outstanding shares at a stated price at a given time in the future. The purchase price is usually the Issue Price, increased by Cumulative Dividends.

Reorganization or Corporate Reorganization

Reorganizations are significant changes in the equity base of a company such as converting all outstanding shares to Common Stock, or combining outstanding shares into a smaller number of shares (a reverse split). A Reorganization is frequently done when a company has already had a few rounds of venture financing but has not been able to successfully increase the value of the company and therefore is doing a Down Round that is essentially a restart of the company.

Round

Investors typically buy a series of Preferred Stock within a short time frame and frequently all at once. Each of these investment periods is a Round and will generally be associated with a specific security. For example, a "Series A Round" is when a company sells its Series A Preferred Stock. A Round may be open for a stated period of time to enable the company to accommodate investors who require additional time and investors who may want to put their money to work sooner.