NewCo Term Sheet Negotiation: A Case Study

An interactive case study on venture finance, IP licensing, and negotiation for law students and tech entrepreneurs.

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Module 2: The Deal - Deconstructing the Term Sheet

Learning Concepts Learning Objectives
Term sheet components: valuation, anti-dilution, liquidation preference (implied), IP licensing vs. assignment. Define and analyze the key financial and control terms within a venture financing term sheet.
Equity financing and its dilutive effects. Calculate the impact of anti-dilution provisions on the company’s capitalization structure.
Key license terms: exclusivity, field of use, term, royalties/milestones. Differentiate between an IP license and an IP assignment and articulate the strategic advantages of each for both parties.
Investor rights: pro-rata rights, information rights, board seats/observer rights. Evaluate how investor diligence and control terms (e.g., board observation, reporting) affect a startup’s operations.

Resources

The following are some really good resources for understanding term sheets and the mechanics of what’s going on here. There are a lot of specialized words going on here. Things like “Exclusive License”, “Field of Use”, “Non-Dilution” (more on this later), and others. It can be overwhelming if you are new to the language.

Brad Feld. Venture Deals. This book is written for entrepreneurs to help them better under the legal issues underlying typical term sheets. It is a short(ish), fast read and has great detail and stories.

A Primer on Negotiating Term Sheets. This is a summary of a presentation on the context of how many of these terms arise.

The Term Sheet

CONFIDENTIAL NewCo Exclusive License Term Sheet - For discussion purposes only 01 Feb 2017

Term Proposal
Licensed IP P294: NF FIRMWARE IMPLEMENTATION (PAT/File Opened) P573: NF CLOUD ARCHITECTURE (PAT/Filed) C483: FRAMEWORK FOR CONTROL OF NF’S BEHAVIOR (CRT/File Opened)
Ownership of Licensed Software C483 is owned by BigTech.
Grant Exclusive license to make, use, and sell products in designated fields of use.
Field of Use Networking
Term Life of patents
Milestone Fee Upon reaching $10M in sales in a given year, a onetime 2% milestone payment for the sales that year.
Equity Equity position of 15%.
Company shall issue to BigTech shares representing 15 percent (15%) of the Fully-Diluted Shares Outstanding as of the date of execution.
Company agrees that BigTech’s Share Percentage shall be maintained at 15 percent (15%) until Company receives, in the aggregate, in a single transaction or a series of related transactions, at least $2.0M of Equity Financing.
Patent Reimbursement No payment for past patent costs ($20,000 limit) - future patent costs to be paid by NewCo. Current patent costs total: $19,971.
Diligence Requirements <ol><li>An updated business plan on the 1-year anniversary of the agreement.</li><li>Consolidated financial statements annually provided to BigTech.</li><li>Development plan due with the execution of the license and development reports due every six months.</li><li>First commercial sale ($650K in product revenue) by 1 May 2019.</li><li>If not being developed or no sales for 1 year, license converts to non-exclusive.</li><li>BigTech has the option to be a Board Observer.</li></ol>
Future Securities Offerings If NewCo offers to sell any equity securities, BigTech shall have a preemptive right to acquire such Equity Securities as may be issued or proposed to be issued by Company from time to time. Such preemptive right shall apply with respect to any Equity Securities issued by Company after the Effective Date, whether such additional Equity Securities constitute a part of the Equity Securities presently or subsequently authorized or constitute Equity Securities held in the treasury of Company. BigTech shall have the right to acquire Equity Securities of the type being issued in an amount equal to the product of (i) BigTech’s Share Percentage immediately prior to such issuance, multiplied by (ii) the number of Equity Securities of the type that are to be issued to all Persons pursuant to such issuance. If BigTech decides to participate in the “A” round, BigTech will have an option to take a board seat.