Venture investment is one of the most effective, although by no means the only method of financing young innovative enterprises (Fig. 1).

Researchers have calculated that, in terms of patenting inventions, one dollar of venture investment in R&D is almost ten times more effective than a dollar invested by a large industrial corporation [1]. Venture investments account for less than 3% of corporate R&D spending, but drive 15% of all industry innovation. Well-known companies such as Intel, Advanced MicroDevices, Apple, Sun Microsystems, Seagate Technologies, Cisco Systems, 3Com, Yahoo!, Amgen, Genentech, and Biogen were funded by early venture capital
its development [2].
Venture capital is commonly referred to as the investment of venture capital funds in fast-growing, high-risk and usually high-tech companies that need capital to
financing the development and promotion of innovative products. Due to the peculiarities of their development model, such enterprises cannot pay interest on debt obligations (because they incur losses at the initial stages of development) and are forced to attract external equity capital [3]. Venture capital fund managers are called venture capitalists. Venture capital investment originated and achieved significant success in the United States. Subsequently, many developed
and developing countries have tried—often unsuccessfully—to replicate these results. Tab. 1 contains information on the size of venture investments made in developed countries.


The task of venture capitalists is to direct institutional and private capital to finance new ventures that find it extremely difficult to obtain funding from other capital providers. The main problem of young enterprises developing innovative products is an extremely high level of uncertainty about the results of their activities, as well as a significant information asymmetry between enterprise management and investors. Entrepreneurs who are well versed in all the intricacies of their business present a business plan to investors who do not have sufficient information about the company, the industry, or the technologies being developed. As a result, an asymmetry in business valuation is created: investors tend to average the value of different enterprises. This leads to the fact that "quality" enterprises (whose investment potential is above average) do not want to receive investments based on undervalued valuations. On the other hand, “low-quality” enterprises (whose investment potential is below average) are happy to accept investments based on an overvaluation. As a result, investors further reduce their average valuation of enterprises,
and the market for financing young innovative companies may not form at all. In this situation, venture capitalists act as well-informed intermediaries between enterprises and investors who eliminate information asymmetry and artificially create a "market" of capital for young enterprises and organizations [5]. In addition, in the field
venture capital, a special system of formal and informal contracts was developed to automatically screen out “low-quality” business projects and finance only “high-quality” business projects (Fig. 2).

 The functional responsibilities of venture capitalists include [6]:
¦ attracting capital for investment in enterprises;
¦ research and generation of new investment opportunities;
¦ assessment of investment opportunities and conducting a comprehensive assessment (due diligence) of enterprises;
¦ implementation of investments, selection of optimal organizational and contractual forms for them;
¦ investment management: monitoring, control and consulting of enterprises, selection of top managers for them;
¦ organization of a successful exit from investments within the planned time frame.
Most venture capital funds are organized as “limited partnerships”1 (Figure 3).

The “general” partner is a corporation founded and managed by a venture capitalist. External investors are "limited" partners and have no direct influence on the activities of the fund. Usually they transfer part of the funds to the venture fund immediately, and they undertake to transfer the other part when worthy funding objects are discovered. Partnership agreements are concluded for up to ten years and are sometimes extended for another three years. At the end of the agreement, the partnership (fund) ceases to operate,
venture capitalists create another venture fund and try to attract new capital into it (Fig. 4).

All funds in the form of money or securities generated from investments in enterprises are transferred to external investors as they become available. For their activities, venture capitalists usually receive 2.5% of assets under management and up to 20% of 

fund's profits2, and only after external investors have returned the entire initial investment amount. Partnership agreements impose significant restrictions on the activities of venture capitalists, including: a ban on the use of loans to replenish the fund, restrictions on investing own funds together with the funds of the fund in the same companies, limits on the volume of investments in one firm,
a ban on investments in other types of securities and types of companies, a ban on organizing a new fund while the old fund still exists [7, 8].
At the center of venture financing is reaching an agreement between the investor and the entrepreneur on the value of the company.
Negotiation process
The negotiation process on financing begins with the clarification of the issue of assessing the value of the enterprise. The leaders of the enterprise (often its founders act in this role) set a certain price and
invite investors to rely on it during subsequent negotiations. As a rule, at this stage there is no "market" or "auction" for an objective assessment of the value of the enterprise. Many investors, realizing that they have competitors, prefer not to participate in financing at all.
enterprises or unite with potential competitors in an investment consortium and make a consolidated offer to the management of the enterprise. Thus, the price of the enterprise is directly formed during the negotiation process between the management of the company and the investor_
mi. The final price is the average between the price offered by management and the price recommended by the investor, and is usually closer to the price offered by the investor. Firstly, a professional investor (venture capitalist) is much more experienced in the field of negotiation and participates in more negotiations in one year than executives.
many companies throughout their lives. Second, in the capital market, investors have a stronger bargaining position. After determining the value of the company, the parties begin negotiations on the terms of investment and draw up the so-called preliminary agreement (termsheet) (see Appendix) - a document in which all the main details of the forthcoming financing are stipulated in a preliminary form.
Pre-investment and post-investment value of the company
When evaluating the value of a business, venture capitalists use the terms "pre-investment value" (pre_money) and "post-investment value" (post_money).
Pre-investment value is the value of the business before the infusion of venture capital. The post-investment value is the pre-investment value together with the value of the investment received. Since the parties agree on how much share capital (equity) will receive
investor in exchange for investment, it is more convenient to start the calculation with the calculation of the post-investment value. For example, if an investor negotiates to receive 1/3 of the company (i.e., its share capital) in exchange for an investment of $1 million, then the post-investment value of the business is $3 million ($1 x?3), and the pre-investment value is $2 million ($3 million - $1 million of investments received). After determining the value of the business, the share price is calculated. If a company already has 500,000 declared common shares in the pre-investment phase, then the investor must receive an additional 250,000 in order to eventually acquire 1/3 of the share capital. Accordingly, the value of one share is $4 ($1 million / 250 thousand)3. The methods for calculating the before and after investment value and share price are shown below [9].
1. Pre-investment value = Number of old shares ?? New share price.
2. Pre-Investment Value = Post-Investment Value – Investment.
3. Post-investment value = Pre-investment value + Investment.
4. Post-Investment Value = Investment / Percentage of Equity Received.
5. Post-investment value = Cumulative number of shares (new and old) x? Share price.
6. Share price = Investment / Number of new shares issued.
7. Share price = Pre-investment value of the business / Number of fully diluted shares (ie shares, options and warrants).
Price increment (step_up) is the process of increasing the price of shares between funding rounds and, accordingly, increasing the value of the company.
1. Price increase = New round share price / Previous round share price.
2. Price increase = Pre-investment value of the new round / Post-investment value of the previous round.
Consider an example. Company N belongs to its founders, who received 6 million shares by investing $50,000 in the company's capital. Additional funds are needed to develop the business. The venture fund agreed to invest $2 million in the company in exchange for 40% of the business (Table 2).

Post-Investment Value = Investment / Percentage Equity Received ($2M / 40% = $5M).
Share price = Investment / Number of new shares ($2 million / 4 million = $0.50 per share).
Post-Investment Cost = Number 

Number of new and old shares x? Share price (10 million x? 0.50 = $5 million).
Pre-investment value = Number of old shares ??Price per share (5 million x??$0.50 = $3 million).
Pre-Investment Value = Post-Investment Value - Investment ($5 million - $2 million = $3 million).
Price Growth = New Round Stock Price / Previous Round Stock Price ($0.50 / $0.083 = 60 times).
Price Growth = Pre-investment value of the new round / Post-investment value of the previous round ($3M / $50K = 60 times).
Phased investment, dilution of shares in subsequent funding rounds and dilution protection in venture capital financing
In staged funding, the venture capitalist invests in stages. The company's business plan includes a schedule for achieving the main intermediate goals. Venture capitalists provide strictly defined amounts, which are only enough to achieve the next intermediate goal recorded in the business plan. Staged financing limits the losses that investors can potentially incur if, for any reason, the company does not live up to expectations. The possibility of termination of financing and the threat of dilution of the share in the capital at each next stage of financing motivate the entrepreneur to realize the potential of the enterprise as quickly as possible. Subsequent stages of funding are carried out at relatively short intervals - always less than one year. Staged financing is usually combined with a gradual increase in control over the enterprise. After the first round of financing, investors do not receive a majority on the board of directors. But on each
At the next stage, the number of seats on the board of directors owned by investors increases, and gradually venture capitalists receive a majority on the board of directors [10, 11].
The downside of staged funding is the potential dilution that occurs when subsequent rounds of funding reduce the equity stake of the original shareholders in the company. In table. Figure 3 provides a real-life example of financing a biotech firm by venture capital fund Versant.

From Table. Figure 3 shows how, in the course of subsequent rounds of financing and growth in the value of the company, the share of the fund in its capital decreased. Special attention venture investors
pay to protect their investments in the so-called “down round” financing of the company's value4. There are two main mechanisms to protect against dithering in down rounds: the full ratchet method and the weighted average ratchet method. Under the full ratchet method, if a company issues an additional issue of preferred shares at a price lower than the price of preferred shares of the previous round, then the conversion price (to common shares) changes to match the new lower price. Thus, during the conversion, the number of ordinary shares received increases, and the investor's share in the capital of the company does not change. As a result of this procedure, most
losers are the owners of a class of shares not protected by such privileges - the founders, managers and employees of the company. The weighted average method is considered less harsh on ordinary shareholders. If the size of the new issue is insignificant, then the share of holders
shares of common stock will not decrease as drastically as with the full ratchet method. There are several weighted average formulas, the most common of which is the following: NCC = ACCx(A + C)/ A + D where NCC is the new conversion cost; SCV - old conversion cost; A is the number of authorized shares before dilution; D is the number of shares issued during the dilution;
C is the number of shares that would be issued on the dilution if the share price were equal to the MCV.
Suppose Company N is not yet IPO-ready and needs additional funding, and the original investor is unable or unwilling to provide it. The company finds an investor who is willing to invest $1 million, but only if the price per share is $0.10.
In table. 4. presents the results of using various methods of protection against erosion.

If the full ratchet method is used for protection, the number of shares and equity are calculated as follows: Number of Series A shares = Initial investment / New share price ($2 million / $0.10 = 20 million). When financing is carried out at the price of shares with a decrease, the value of the company decreases. In this case, the price fell from $5 million (post-investment value
after the first round) to $2.6 million (pre-investment value before the second round). This is reflected in the calculations below.
Post-Investment Value = New Investment / New Investment Equity ($1M / 28% = $3.6M)
Post-investment value = New number of shares ?? New share price (36 million ?? $0.10 = $3.6 million).
Pre-Investment Value = Post-Investment Value – New 

investments ($3.6 million - $1 million).
Pre-investment value = New number of old shares ?? New share price (26 million ?? $0.10 = $2.6 million).
In the case of weighted average protection, the new number of Series A shares is calculated as follows: The number of shares before the second round is 10 million; The number of shares that would have been issued in the second round at the old price is calculated as "New investment / Share price after the first round" ($1 million / $0.50) - 2 million. The number of shares actually issued in the second round - 10 million. New conversion cost - (12 million / 20 million) ? ?0.50 = $0.30 per share. New number of Series A shares = $2 million / $0.30 = 6.666667 million shares. In other words, the first investor after the down round should receive an additional 2.666 million 667 shares (in addition to the already existing 4 million shares).
Determining the value of a company using the "venture capital method"
Venture capitalists use a wide variety of methods to value companies. The methodology for determining the value depends on the stage of development of the company and the nature of the data available about it. The value of firms at an early stage of development is most often determined using the “venture capital method”5. This method is based on the calculation of the hypothetical "end value" of the company at the end of the "investment horizon" (usually five years). Then the resulting value of the "final value" of the company is discounted in the current period
using the target internal rate of return (IRR). The target rate of internal return is determined by the stage of development of the company and ranges from 80% per year for companies at the initial stage of development (“seeding”) to 20% at later stages (Table 5).

This methodology allows you to bypass the issue of negative cash flows at the initial stage of the company's development. Another hallmark of the venture capital approach is valuation based on the projected dilution of the equity stake in subsequent funding rounds. Estimating the value of a company using the venture capital method takes place in seven stages [13].
First stage: calculation of the future value (forward value) of the planned investment. At this stage, the future value is calculated by the formula: FV = PV (1 + r), where r is the target rate of return;
N is the time horizon of the investment (time to exit the investment and realize the profit).
Example A: With a 35% annual IRR and a time horizon of five years, the future value of a $1M investment is $4.5M. FV = $1M ??(1 + 0.35)5 = $4.5M.
The second stage: calculation of the final value (terminal value) of the company when exiting the investment. You can calculate the final cost of a company using the method of comparison with peer companies. Projected EPS is multiplied by the average share price-to-earnings ratio for peers. To make comparisons, VCs select a number of mature and liquid companies whose characteristics best fit the profile of the company the young firm wants to become. It should be noted that the choice of peer companies can have a significant impact on the valuation. Therefore, some analogue firms may suit investors more, while others may suit the founders of the firm.
Example A (continued). If the net income expected to be generated in five years is $1 million, and the average price-to-net income ratio for peers is 15, then in five years the value of the company should be: TV = $1 million ??15 = $15 million.
Example B. Projected net income in seven years is $20 million, and the multiplier (ratio) of price to net income for comparable companies of peers is 15 (times ). Thus, the projected final value of the company in seven years is $300 million ($20??15 times).
The third stage: determining the required share in the company's share capital (ie, the share of ownership). Divide the future value of the investment (Stage 1) by the projected end value of the company upon exit from the investment to determine the equity stake an investor needs.
Example A (continued). Equity (share of ownership) is calculated as follows: $4.5 million / $15 million = 30%. Alternatively, you can calculate the required share of equity by dividing the investment amount by the present value of the final cost.
Example A (continued). In this case, the present value - PV(TV) - of the company's ultimate value is $3.34 million: $15 million / (1 + 0.35)5= $3.34 million. Thus, the required equity stake is 30%: $1 million / $3.34 million = 30%.
Example B (continued). For the second company, the target IRR is 50% per year. In this case, the present value of the company's ultimate value, PV(TV), is $17.5 million: $300 million / (1 + 0.50)7 = $17.5 million. The investor plans to invest $5 million. Therefore, the equity stake is 28. 5%: $5M / 17.5M =
= 28.5%.
Fourth stage: calculation of the number 

the number of new shares required for the investor and the price
stock. The number of new shares for a venture investor is calculated as follows:
Equity share = Number of new shares / (Number of new shares + Number of old shares).
Example A (continued). 30% = NA / (NA + CA), where NA is the number of new shares; SA is the number of old shares. It follows from this formula that NA = CA ??[0.3 / (1 - 0.3)] = 0.43 ??CA. Suppose
that the company owns 1 million old shares. Then there should be 430,000 new shares. The price of a share is the result of dividing the investment by the number of shares required: $1 million / 430,000 = $2.33 per share.
Example B (continued). The company owns 500 thousand shares. In order for the investor to receive a 28.5% share in its capital, the total number of shares must be 500 thousand / 71.5% = 700 thousand. Of these, 200 thousand shares must belong to the investor. The price of one share is $25: $5 million / 200 thousand = $25.
Fifth stage: calculation of the pre-investment and post-investment value of the company.
Example A (continued). The total post-investment value of the company, 30% of which the investor purchases for $1 million, is $3.33 million: $1.00 / 0.30 = $3.33 million. The pre-investment value of this company is $2.33 million: $3.33 – $1 million ( investment) = $2.33 million
Example B (continued). The preinvestment value of the company is calculated as follows: 500,000 shares x $25 per share = $12.5 million. And its postinvestment value is $17.5 million: 700,000 shares x $25 per share = $17.5 million. Figure 5 shows the average post-investment value of companies for the first and subsequent funding rounds.

The sixth stage: prediction of the retention ratio. Most companies go through several rounds of financing before investors exit the stake. Future investors will receive a certain equity stake and dilute the original investors' stake. Retention ratio = [1 / (1 + percentage in the capital of the future issue for future investors)].
Example A (continued). Investors in future funding rounds are expected to receive 10% of the company. Therefore, the retention rate is 90.9%. ([1 / (1+0.1)] = 90.9%).
Example B (continued). In the future, presumably 10% of the shares will be sold to managers and employees of the company, and then during the IPO, 30% of the shares will be offered for public offering on the stock exchange. In this case, the retention rate is 70%: 1 / [(1+0.1)(1+0.3)] = 70%.
Step 7: Calculate the required equity and share price adjusted for projected dilution. Dilution-Adjusted Equity Required = Initial Equity / Per Retention Ratio.
Example A (continued). In this example, the required dilution-adjusted equity stake is 33% (30% / 90.9% = 33%). In this case, if the investor in the first round gets 33% ownership and then diluted by 10% before exiting the investment, then the final equity stake will be 30%. share.
Example B (continued). In this case, the required dilution-adjusted equity stake is 40.7% (28.5% / 70% = 40.7%). In other words, in order to maintain the target share in the capital of 28.5% when entering the IPO, the investor must receive 40.7% of the shares during the first round of financing. Therefore, the number of new shares during the first round should be
343.373 thousand: 500 thousand / (1 - 40.7%) - 500 thousand = 343.373 thousand. The price of one share is $14.56: $5 million / 343.373 thousand = $14.56.
The main vehicle used by venture capitalists to finance young companies7 is convertible preferred shares8. Typically, these shares involve obtaining special rights and privileges that protect investors from the possible loss of invested funds and guarantee a profit. As a rule, holders of such shares can convert them into ordinary shares at any convenient time. Upon conversion, the venture capitalist loses all rights and privileges associated with preferred shares. However, investors convert their shares
into common stock if it would benefit them more than keeping the preferred stock. During an IPO, preferred shares are automatically converted into ordinary shares. However, when
selling a company, venture capitalists have a choice:
¦ convert preferred shares into ordinary shares and share the proceeds with the holders of ordinary shares;
¦ keep preferred shares and receive the share of proceeds from the sale of the company due to holders of preferred shares. As can be seen from fig. 6, a significant proportion of portfolio firms exit the venture phase through a sale and merger with a larger company. Moreover, in modern conditions, the strategy of selling a portfolio firm is the main one.

One of the main privileges of preferred shares is liquidation.
Lee A qualifying privilege is the right of a shareholder to receive a certain amount upon liquidation of a company before any payments are made to the holders of ordinary shares. Liquidation in venture financing refers to a wide range of transactions9 (merger, reorganization, sale of shares or company assets, any other transaction or series of transactions), as a result of which those who previously held the majority of the shares lose the majority of votes. Thus, in venture financing, the liquidation of a company can occur both with its complete bankruptcy and with its achievement of grandiose success. The liquidation preference is usually defined as a factor by which the initial investment is multiplied. For example, “double liquidation privilege” means that when the company is liquidated, the investor has the right to first receive an amount that exceeds the amount of the investment twice. After payment of the liquidation preference, the remaining funds from the sale of the company are distributed among the holders of ordinary shares on a pro rata basis. The liquidation privilege protects investors in the event that the management of the enterprise is going to liquidate it. More than 98% of all investment contracts give venture capitalists a liquidation privilege, meaning that for each preferred share they can receive a certain amount, which is usually equal to the amount of the initial contribution. More than 83% of funded companies give venture capitalists the right to participate in the distribution of proceeds from the liquidation of the company (the right to participate - participating right), which remain after the payment of liquidation privileges. Preferred shares are divided into several categories [15].
Nonparticipating preferred shares. These are preferred shares that do not give the right to participate in the distribution of funds remaining after the payment of the liquidation privilege. For example, a venture capitalist invests $10 million in a company in exchange for
Non-participating preference shares with a one-time liquidation preference. Assume that after conversion into common stock, they represent 50% of the total common stock of the company. In this case, the venture capitalist should only convert the preferred stock into common stock if the firm is being sold for more than $20 million. Only if the company's price is over $20 million will 50% of the common stock yield more than a one-time liquidation preference. Price
company from $10 million to $20 million is a “zone of indifference” for a venture capitalist: his share of proceeds from the sale of this company is $10 million over the entire interval. This example illustrates the main disadvantage of non-participating preferred shares: in the "zone of indifference"
the venture capitalist is not interested in maximizing the value of the company and his interests diverge from the interests of other shareholders.
Fully participating preferred shares (fully participating preferred).
These are preferred shares, the holders of which, having received a liquidation premium, participate in the distribution of all remaining funds on an equal basis with ordinary shareholders, and at the same time the same proportion is observed as if the preferred shares were converted into ordinary shares. The venture capitalist never converts his fully participating preferred shares because it is better to receive the liquidation premium and then his share of the remaining funds anyway. Fully participating preferred shares are considered to provide maximum protection for the rights of venture capitalists.
Preferred shares with limited participation (participated preferred subject to a cap). This is the most common type of preferred stock. This category of shares gives the right to receive a liquidation privilege, and then participate in the distribution of the remaining funds, up to
until a certain "ceiling" (cap) is reached, after which the owners of ordinary shares receive all the remaining funds. For example, if a venture capitalist invests $10 million in a company with a one-time liquidation privilege and three-time restricted participation, they can receive up to $30 million in the liquidation of the company, after which all remaining funds will go to ordinary shareholders. Assume that the preferred shares on conversion will be
50% of equity (i.e. of the final number of ordinary shares). If the company was sold for $60 million, then the preferred shareholders will first receive a $10 million liquidation preference. The next $40 million will be split 50/50 between the common and preferred shareholders (and the VC share will reach the “ceiling”, i.e. e. $30 million). The remaining $10 million will be paid to ordinary shareholders. But if the company is sold for $70 million, then the calculations change. In this case, the venture capitalist must convert his shares into common stock. After the conversion, he becomes the owner 

eat 50% of the common stock and lose the liquidation privilege, but get 50% of the proceeds, or $35 million. As the company's capital structure becomes more complex, so do the calculations. To model the distribution of proceeds with a complex capital structure, special computer programs are used. As an example, we present calculations for a company whose capital structure consists of ordinary shares and three series of preferred shares (Table 6).

In this case, the first $20 million will be used to repay the liquidation privilege. Thereafter, all funds will be distributed pro rata between the ordinary and preferred shareholders until Series A holders receive $10 million, Series B holders receive $30 million, and Series C holders receive $60 million. After that, all remaining funds will be paid to ordinary shareholders.
Series Holder Conversion Decision
"BUT". If the company is sold for less than $20 million, the preferred shareholders receive less than the liquidation privilege and the common shareholders receive nothing. Therefore, the conversion is not profitable. With a company value of $20 million or more, preferred shareholders will return the initial investment, i.e. $20 million, and receive additional profit. If the company is worth $60 million, Series A holders will hit the ceiling of $10 million10. This is the maximum amount they can receive as preferred shareholders. For Series A, the company's value of $60 million is the cap point. If the value of the company rises from $60 million to $68 million, Series A holders will still receive $10 million as preferred shareholders, which is in any case more than they could have received by converting their shares to common stock. Finally, if the company's price is above $68 million, Series A shareholders will get more by converting their shares into common stock. So for Series A, $68 million is the “conversion point.” Series A shareholders are indifferent to
the price of the company, which is in the range from $60 million to $68 million, so this interval for them is the “indifference interval”. Similarly, "capping points" and "conversion points" are calculated for series "B" and "C" stocks. For Series B, the “cap” is the company price of $98 million and the “conversion point” is the price of $112 million. The “cap” for Series C stock is $132 million and the “conversion point” is $150 million .The interval between the "limit point" and the "conversion point" is the "indifference interval" for the holders of the relevant stock series. The capital structure of the company, and accordingly "points of limitation" and "points of conversion", affect the distribution of income
from the sale of the company at different prices between different categories of shareholders. For example, in the range of $20–60 million, shareholders divide the proceeds in a ratio of 1:2:3:4. However, in the "indifference interval" of series "A" ($60-68 million), the proceeds are divided between ordinary shareholders and
holders of series "B" and "C" (series "A" does not receive additional income in this interval) in the proportion of 1:3:4. If the price is above $68 million, the income distribution ratio again becomes 1:2:3:4.
In the second part of the article, we will consider the main contractual restrictions used in venture financing, as well as the features of corporate governance in companies with venture financing.
Issuer: New company (hereinafter referred to as the Company).
Company outstanding outstanding securities: 1.5 million fully diluted common shares of the company12.
Investor: A&B venture fund (hereinafter referred to as the Investor).
Investment size: $1 million per 1 million Series A convertible preferred shares, par
the cost of which is equal to $0.01 (hereinafter the series "A").
Price per share: $1.00.
Minimum purchase block size13: 250,000 shares ($250,000)
The minimum amount to close a deal14 is $750,000. The placement of all Series A shares may require several stages of the deal15.
Closing of the deal: The deal is currently expected to close no later than _____________, 2006.
Conditions for closing the deal. Any investment must meet the following conditions:
¦ satisfactory implementation of the standard due diligence procedure;
¦ receipt by investors of all necessary documentation;
¦ negotiation and subsequent conclusion of an agreement on the purchase of convertible preferred shares, signing all the necessary documents;
¦ fulfillment of other conditions generally accepted when concluding transactions of this kind.
Description of the "A" series
1. Regulations on dividends. Holders of Series A shares will receive an 8% non-cumulative dividend,
if the board of directors decides to pay them. Prior to the payment of 8% dividend on Series A shares, no
no other dividends will be paid to holders of ordinary shares. Dividends on ordinary shares
can not exceed $0.0816.
12 Fully diluted shares - all shares of the company plus options and warrants on ordinary shares, as well as
blocks of shares reserved for issuance in the future for certain groups of employees of the company.
13 The minimum block of shares that one investor can buy.
14 The minimum amount guarantees that the company will receive at least the amount specified in the paragraph when closing the transaction.
15 A time frame is often set within which all stages of financing must be completed (usually from
30 to 120 days).
16 Dividends are usually set at or below 10%. Series A holders will only receive dividends if the board of directors decides that the payment of dividends is in the best interest of the company. Because young
the company needs financial resources to develop and promote its products, the board of directors will most likely not decide on the payment of dividends until the company's shares are listed on the stock exchange. Cumulative dividends, unlike non-cumulative ones, will accumulate during this time. In this case, if the company goes into liquidation, the accumulated unpaid cumulative dividends will add to the sum of the liquidation privileges.
17 It is generally stated that the share buyback will take place over a period of two or more years. This is done to mitigate the impact
to the company. Also, with the consent of the holders of series "A", the repurchase of shares can be canceled.
18 Alternatively, investors could require that the new ratchet conversion price be fixed in the agreement.
19 This paragraph establishes a threshold price for an IPO that is high enough to give venture investors a guarantee of a successful investment. If the IPO does not fall under the definition of a "qualified public offering", then venture capitalists may not agree to the conversion, which will give them additional advantages in possible negotiations to change the conversion price.
2. Liquidation privilege. In the event of liquidation, dissolution of the company or termination of its activities,
Series A holders are first entitled to receive $1.00 per preferred share
plus any declared but unpaid dividends (liquidation amount). Upon payment of this liquidation preference, Series A holders, as well as ordinary shareholders, are entitled to receive all remaining proceeds from the liquidation of the company and intended for its shareholders, in proportion to the number of preferred shares, as if they were converted into ordinary shares. stock.
At the discretion of the Series A holders, a sale of the Company or a merger with another company may be considered liquidation.
3. Repurchase of shares (redemption). Not earlier than three years after the completion of the transaction (mandatory redemption date), at the request of those who hold at least 600,000 Series A shares, the Company undertakes to redeem for cash all (not less) Series A shares and pay the liquidation amount for them17.
The Company undertakes to notify and redeem shares from all other holders of Series A shares. If at any time the Company does not have sufficient funds to obligatory buy back shares of the series
"A", then in the future all funds received by the company should be used to buy back shares until
until all the Series A shares are redeemed.
4. Conversion. Holders of Series A shares may, at any time they wish, convert
their shares into ordinary shares. The number of shares of common stock into which one preferred share is converted is determined by dividing $1.00 (original price) by the conversion price. In the future, the conversion price will change during dilution in accordance with the weighted average formula18, as well as in standard situations of share splits, recapitalizations, etc. An issue of 250,000 or less ordinary shares for the purpose of motivational incentives for personnel will not be considered dilution.
5. Automatic conversion. The outstanding Series A shares will be automatically converted into
ordinary shares upon completion of an initial public offering of ordinary shares at a public offering price of but not less than $4.00 per share and total proceeds from the sale of shares of at least $10 million, and a capitalization of the company after the offering of at least $25 million (the so-called qualified public offering)19. The conversion will take effect the day following the Qualified Public Offering.
6. Registration rights. Holders of Series A shares may request two times to register the shares at the expense of
Companies, and also have unlimited "co-registration" rights, provided that investors do not
require registration of shares earlier than through two years after the completion of the investment transaction. Any registration requirement is only valid if it comes from a majority of the holders of the outstanding shares.
series "A".
7. Voting rights. Series A holders are eligible to vote as a single class together
with the owners of ordinary shares on any issues at all times, except for 1) election of members of the board of directors and
2) the situations specified in the paragraph "Protection provisions". Holders of Series A shares have voting rights in accordance with the size of the block of ordinary shares into which the Series A preferred shares will be converted.
8. Protective obligations. Without the consent of at least the majority of Series A shareholders (voting as a single class), the Company may not:
1) to issue securities that are equal to or “higher” than series A shares in respect of dividends, liquidation rights and redemption rights;
2) sell all or substantially all of the assets of the Company or its subsidiary, consolidate or merge the Company or its subsidiary;
3) change or supplement the text of the Company's charter and the agreement on its establishment;
4) redeem the shares of the Company, with the exception of the shares referred to in paragraph 3 of this agreement;
5) take any other action that may materially affect Series A shares. The company does not have the right to allow its subsidiary to carry out all of the above.
Information rights. As long as at least one Series A share is outstanding, the Company undertakes to provide each holder of these shares with its annual and quarterly financial statements,
as well as other necessary information at their request. Holders of Series A shares are also entitled to
advise the Company on management matters, and discuss the Company's affairs with its key employees.
Use of investments. Funds received from the sale of Series A shares will be used to replenish working capital and for the purposes specified in the Company's business plan.
Participation in the board of directors. According to the terms, which will be fixed in the company's charter, it must establish a board of directors of five people. Series A shareholders have the right to appoint two board members
directors. The company undertakes to pay all expenses of directors for participation in meetings of the board of directors,
as well as all costs associated with the performance of their functions.
Shareholders' agreement. All shareholders of the Company (owners of ordinary shares and holders of series "A") will be required to enter into a "Shareholders Agreement" (Shareholders Agreement), giving them the right of first
refusal of shares that any of them plans to sell. Investors will also receive joint sale rights when shares are sold by any shareholder of the Company. In addition, the shareholder agreement will fix the right of the Company's shareholders to buy out the shares of managers in the event of termination of employment. Number of shares and
the price per share will depend on the reasons for termination of employment. Each investor has the right to buy a share
any new issue of shares in proportion to its share in the Company. The Shareholders' Agreement will cease to have effect upon the completion of a qualified public offering of shares, or upon a merger or sale of substantially all of the Company's assets.
Employment agreement. Manager A and Researcher B (key employees) will be required to enter into individual labor agreements with the Company, as well as sign a non-compete agreement20 for the Company's financing arrangements through the placement of Series A shares to come into effect.
Insurance of key employees. The company undertakes to acquire and maintain a life insurance policy for key employees of the company, manager A and researcher B, in the amount of not
less than $1 million each with all insurance payments in favor of the Company.
Share purchase agreement. The purchase of Series A shares will be made after the conclusion of an agreement on the purchase of preferred shares. This agreement shall contain all necessary guarantees for investors and the Company, as well as obligations (covenants) of the Company and investors, reflecting the provisions of this preliminary agreement, as well as other negative and positive obligations generally accepted for such transactions21. Until the share purchase agreement is signed by the Company and the investors, the parties have no obligations to each other.
Costs. The Company undertakes to fully compensate investors for the services of one legal adviser involved in the preparation of the necessary documentation referred to in this document, not
exceeding $15 thousand