1

Grab them or lose them. Your may have a dynamite team, unassailable market niche, revolutionary product, disruptive technology. But investors may not hear about them, unless you lead with the 4-6 points that differentiate your venture and make it an attractive investment. The elevator pitch should be the first slide in your Powerpoint, and the lead paragraph in your executive summary.

2

Authors of best-selling novels understand. Of the year or more that authors devote to writing best-sellers, they may spend 10% or more on the first sentence, and another 10% or more on the balance of the first paragraph. Why? Because people go to the best-seller rack, take down a book, read the first sentence, and if that grabs them, read the rest of the paragraph, and if that grabs them they usually buy; but if either fails to engage them, they turn to the next book.

3

In English for laypersons. Unless your audience can explain your venture, you have lost them. How often do you think investors tell their associates or spouses: -- I saw this great venture today, but I can't tell you what they do.

4

Exclude fluff and hype. Replace all superlatives ('unique', 'revolutionary', 'best', 'fastest', etc) with specifics; e.g., "priced 40% below market leader" is substantive, where "lowest cost" tells me little.

5

Relevance. Avoid the unimportant; e.g., founded in May, offices in Los Angeles, Delaware C-Corporation. Make sure it's not only unique, but relevant; that the names of all six founders start with 'J' may be unique, but hardly relevant.

6

There is no pat answer. Often I am asked "What should be included in the elevator pitch?" as if there were a standard set of points. Focus on what differentiates your venture and makes it an attractive investment. Below is a list of just a few of the items to consider:

1

A Strong management team with appropriate experience. We expect you to explain the experiences and positions of your team. If your team is incomplete, we expect you to recognize that fact and explain what is needed to complete the team.

2

Products that meet existing needs. Products should have a targeted market rather than being a technology in search of a market.

3

Niche dominance.Your company should plan to have or already have at least a 25% market share in a well-defined area or niche, and you must be able to show how to sell cost-effectively into that niche. The niche can be within an existing market or can be a new niche. Please note that grand visions of multi-billion dollar markets are not realistic and not attractive unless you can convincingly show how you will dominate that market.

4

High growth potential. Your business may be in either a developing market or in an existing market. You must present a credible, realistic, supportable plan for achieving high growth.

5

Sustainable competitive advantages. Some examples of this would include: a "blocking patent" (that can keep out competition); a vanity phone number (eg 1-800-WEDDING); a domain name (e.g., buy.com); "first-to-scale" advantage (i.e., show you already are the first company to achieve some scale in a new niche).

1

Valuation. Your company's valuation must fit within our risk/reward expectations for the investment. We typically look for pre-money valuations of up to $5 million. We would not consider a higher pre-money valuation unless the situation is exceptional, such as a company with existing revenues or an Internet company with a large existing base of subscribers.

2

Full-dilution. In determining the Company's valuation, we take into account all commitments to issue shares. This is called the "full-dilution" number of shares. Specifically, the full-dilution number of shares would include all shares that you would issue if all unconditional and contingent commitments to issue shares were exercised. This could include exercise of options and warrants, conversion of preferred shares, exchange of debt for equity, etc. We expect a reasonable number of shares to be reserved and counted as part of full-dilution for key management and for other employee stock options.

3

Pre-money valuation. The pre-money valuation is the value you put on your company before getting the capital you seek. To compute, multiply the full-dilution shares immediately prior to the proposed financing by the price/share of the proposed financing. Example: 1 million full-dilution shares x $1 price/share of the proposed financing = pre-money valuation of $1million. If you add the proposed financing amount (e.g., $500K) to the pre-money valuation you will get the post-money valuation ($1.5 million in this example).

4

Pre-money valuation based on percent of company. Some entrepreneurs think in terms of offering some percent of their company for some amount of financing. To compute, divide the proposed financing ($500K) by the offered percentage (33 1/3%) to get the post-money valuation ($1.5 million), and subtract the money ($500K) from the post-money ($1.5 million) to get the pre-money valuation ($1 million). Note that these are just two different ways to compute the valuation and yield the identical results.

5

Share value vs company valuation. Two valuations are critical in trying to estimate the return to the investors for their money: future value of shares, and future value of the company. The company is expected to increase in value, given future developments and financings. The shares that the current round investors bought are also expected to increase in value. The increase in share value will rarely be the same as the increase in the company's valuation. In fact, the difference between the two increases may be a factor of 3:1 or even 10:1 in highly successful companies, but can be much worse for poorly performing companies.

6

In the above example (at 1 million shares after the funding at $1/share), there will be two kinds of events that lead to additional dilution for the investor in the future: (1) Additional shares may be issued or committed to be issued due to future financings; and (2) Issuing of shares or new commitments to issue additional shares to employees and other non-funding events. These events will cause the company's valuation and the shares' valuation to change in differing ways.

1

Definition. The Term Sheet is a preliminary, non-binding agreement outlining the terms that the company has agreed to with respect to the proposed investment. One or more of the CRA members that are prospective sponsors of your company will negotiate the terms with you.

2

General concepts. We have developed standard terms for financings, which will summarize what is expected and what is prohibited. Most companies agree to the terms, once they understand their intent. The expression of these fairly simple terms usually takes many pages of legalese, which can appear overwhelming. Companies without experience in VC financings may find that the "standard" term sheet appears to leave the company in an "inferior" position and allows the investor to take advantage of the company. However, you should realize that VCs and the CRA will accept being in the "inferior" position to "new money" from investors in subsequent financing rounds. In other words, later rounds of financing will receive the same kind of preferences over CRA that CRA gets over the company in the current round of financing. We are not asking for something that we are not willing to accept ourselves. The key provisions that CRA expects in a Term Sheet are fairly standard and have been used by VCs for many years:

3

Preferred Shares. The issuance of preferred shares rather than common shares allows the investor to have certain rights and protections as spelled out in the agreements. Typical preferential provisions are described below.

4

Liquidation preference. One of the key preferences is in liquidation. This includes sale or acquisition of the company, and generally provides that the investors will recover their principal or invested amount, at a minimum, before management receives any part of the distribution from the sale or acquisition. Without a liquidation preference, investors may receive little or no return on their investment, while Common shareholders may do well. To illustrate, if the investors put in $1 million for a third of the company, and the company is liquidated or sold three months later for $2.4 million, without a liquidation preference, the investors would get one third of the proceeds or $800K and lose 20% of their investment. The founders would pocket $1.6 million. The liquidation preference is intended to protect the investors from such an outcome.

5

Participatory preferred. Provides investors with a return on their investment in case of liquidation due to sale or acquisition. The investors will first receive their principal or invested amount before any distribution to the Common shareholders, then the investors receive a pro rata distribution along with Common shareholders until some threshold or agreed-upon amount or percentage of return is reached. In the above example, even if the investors got their money back, the founders would still pocket $1.6 million. A typical Participatory Preferred arrangement would provide that investors first get their investment back with a nominal amount of interest, and then their Preferred shares are converted into Common shares, where they participate pro rata as other Common shareholders.

6

Anti-dilution (basic). This term adjusts the conversion rate of Preferred into Common to compensate for Common stock splits, stock dividends, reverse stock splits, etc. It normally starts at 1:1.

7

Anti-dilution (from future financings). This protects investors when a future round of financing is done at a lower share price than the investors' share price. There are various methods of computing this anti-dilution. CRA usually uses weighted average, which partially compensates for the lower price. For these calculations, you should always think in terms of price/share and not company valuation. The price/share is the true measure of value to the investor. If the overall company valuation goes up, the share price can go up, remain the same, or drop. Investors can essentially be "washed out" of their stock position if there is no anti-dilution provision. For example, in a company without an anti-dilution provision, with management and founders still controlling the company by owning more than 50% of the voting shares, the management and founders can get rid of investors by doing a "washout" round (say 1 cent/share, when investors had come in at $5/share), diluting investors out of the picture; then granting new options to management to bring them back to a dominant position. Anti-dilution makes management responsible for meeting their business plan, and requires them to suffer the consequences for serious under-performance. Most good entrepreneurs accept these terms. If they do not manage the company well enough and additional money has to be raised at a LOWER price per share, they will be additionally diluted. That seems fair from both sides of the table.

8

Anti-dilution weighted-average formula and terms.

• PCPnew is the new Preferred Conversion Price after adjustment for dilution
• FDpre is equal to the number of full-dilution shares immediately before the particular funding event
• PCPcurr is the Preferred Conversion Price immediately before the closing of the particular funding event
• IC is the Immediate Cash to be received at the closing of the particular funding event. It expressly excludes any cash that might be received in the future from warrants, options, etc.
• FDpost is equal to the number of full dilution shares immediately after the closing of the particular funding event.
• Full dilution counts all shares that would be issued if all events (contingent and otherwise) were to take place such as exercise of options and warrants, conversion of preferred shares, exchange of debt for equity, etc

9

Trigger for anti-dilution provision. This anti-dilution provision is triggered if a given financing is to be done at a lower price/share than the current conversion-price for the investors' preferred shares. Note that some anti-dilution provisions only trigger if the price/share equals or exceeds the current preferred conversion price and ignore options and warrants. This provision is flawed as illustrated in the following example: The current conversion price for preferred is $1/share; the company sells shares at $2/share with each share including 5-year warrants to purchase 100 shares at $2/share. Such a funding would fail to trigger some anti-dilution provisions, but would effectively "washout" the preferred investors. The trigger should include only the cash to be immediately received, but include full dilution shares from the funding in question. In other words, the imputed price/share of the funding should be computed using only the cash to be received immediately but divided by full dilution shares, assuming that all future options and warrants are exercised, but excluding any cash from option/warrant exercise.

10

Trigger for anti-dilution formula.

• EPP is the Effective Purchase Price
• IC, FDpost and FDpre are as defined in point 8 above.

11

Board seats or other forms of voting control. This is done to keep management from acting against the interest of investors, such as changing the terms of the Preferred stock after the fact or issuing shares to "wash out" investors. Typically, a vote of the Preferred is required to increase authorized shares.

12

Registration rights. There may be instances where management creates success, but does not provide liquidity for the investors. Investors will then find themselves locked in without a return on their investment, as management reaps the rewards of high salaries and bonuses. Registration rights are rarely invoked, especially since the advent of Rule 144, which allows holders of unregistered shares to sell as if they were registered after two years of holding period, of course providing the company has done an IPO.

13

Escrow and schedule for disbursements. This is for shares of founders or current key executives whose shares are not already within a vesting program. In order to protect investors and other founders from early departure of key executives who have substantial percentage of shares, an escrow is set up and shares released over time in a manner similar to option grants and vesting for new employees.