Deal Terms
Anti-dilution Protection: Anti-dilution protection is protection from dilution when shares of stock are sold at a price per share less than the price paid by earlier investors. This is known as price-based anti-dilution protection. Anti-dilution protection, along with the liquidation preference, are two of the fundamental features distinguishing preferred stock typically sold to investors from common stock generally held by founders and employees.
Break-up Fee: A breakup fee, or termination fee, is required to compensate the prospective purchaser for the time and resources used to facilitate the deal. Breakup fees are normally 1-3% of the deal’s value.
Change of Control: A change of control occurs when the ownership changess (often a change of more than 50% of a company’s ownership is considered a change of control). Usually a change of control of a company occurs as part of an M&A.
Co-sale: Co-sale is a contractual obligation used to protect a minority shareholder (usually in a venture capital deal). When a majority shareholder sells stake, the minority shareholder has the right to join the transaction to sell.
Contingency Payment: Contingency payment in a M&A deal, is a portion of the purchase price that depends upon the acquired company’s reaching specific performance targets.
Covenant: A covenant is an indenture that states certain activities will or will not be carried out. The purpose of a covenant is to protect the lender. Covenants can cover everything from minimum dividend payments to working capital level.
Double Trigger Acceleration: A double trigger acceleration is when two events are required to accelerate the vesting schedule of a stock option or restricted stock. Typical triggers include acquisition by another company and termination of employment without cause.
Drag Along Right: A drag along right is a right that enables a majority shareholder to force a minority shareholder to join in the sale of a company. The majority owner doing the dragging must give the minority shareholder the same price, terms, and conditions as any other seller.
Earnout: An earnout is a portion of the purchase price that is contingent on future performance. It is payable to the seller after certain predefined levels of sales and/or income are achieved in the years after the sale.
Full Ratchet: Full ratchet is an anti-dilution provision that, for any shares of common stock sold by a company after the issuing of an option (or convertible security), applies the lowest sale price as being the adjusted option price or conversion ratio for existing shareholders.
Generational Changes: Change of control of the private company may also take place without an M&A transaction due to the death of the private company’s Founder and passage of the company to the next generation.
Go-shop: Go-shop is a provision that allows a public company that is being sold to seek out competing offers even after it has already received a firm purchase offer. The original offer then functions as a floor for possible better offers. The duration of a go-shop period is usually about one to two months. Go-shop agreements may give the initial bidder the opportunity to match any better offer the company receives and may pay the initial bidder a termination fee if target companies are purchased by another firm.
Indemnification: Indemnification is the process of securing an agreement between two parties to compensate for any damages or losses.
Indemnity: Indemnity is a contractual agreement made between different parties to compensate for any damages or losses.
Information Rights: Information rights are rights (usually a clause in a venture capital investment agreement) that an investor must demand to receive regular updates from the private company about its financials and operations.
Invention Assignment: An invention assignment is a legal document that acknowledges all IP developed by an employee is property of the company and not the individual.
Investor Rights Agreement: An investor rights agreement details rights a VC typically expects with an investment. It often entails: (1) The right to elect directors to the company’s board of directors; (2) The right to receive various reports and information; (3) The right to have its stock registered for sale in a public offering at the company’s cost; (4) The right to maintain its percentage share ownership in the company by participating in future equity issuances; (5) The right to participate in the sale of any shares made by the founders of the company (“co-sale”)
IPO Participation Rights: IPO participation rights are often sought by pre-IPO venture capitalist investors in order to take advantage of escalating first day trading prices when the company conducts an initial public offering. These participation rights, whether in the form of a firm option or a best efforts undertaking, grant the recipient the right to purchase shares offered in the company’s IPO on the same terms as other IPO participants.
Liquidation Preference: Liquidation preference is used in VC contracts to specify the order and amount each investor get paid in a liquidation event such as a sale. VCs are usually repaid before holders of common stock and before the company’s original owners and employees. for example the VC first must receive 2 or 3x their original investment before all stockholders (including the VCs) in the private company start sharing the proceeds of a sale equally.
Lock-up Period: A lock-up period is a window of time in which investors of a hedge fund or other closely-held investment vehicle are not allowed to redeem or sell shares. The lock-up period helps portfolio managers avoid liquidity problems while capital is put to work in sometimes illiquid investments.
No-shop Clause: A no-shop clause is a clause preventing the owner of the target company from attempting to sell the business to someone else while the two named parties are negotiating. The no-shop provision is good for a set period negotiated between the parties.
Non-compete Clause: A non-compete clause or covenant not to compete, is a term used in contract law under which one party (usually an employee) agrees not to pursue a similar profession or trade in competition against another party (usually the employer).
Non-solicitation: Non-solicitation is an agreement that restricts an individual (usually a former employee) from soliciting either (a) employees or (b) customers of a business after leaving the business.
Pro rata: Pro rata (directly defined as proportionately or in proportion) refers to the allocation of materials or resources to multiple holders based on a proportional scale of ownership
Right of First Refusal (ROFR): Right of first refusal is a contractual obligation by an owner of an asset to offer the initial purchase option to the holder of the rights prior to offering the asset for sale to third parties, allowing existing investors to purchase an asset before it is made available for purchase to others.
Shareholders Agreement: The shareholders agreement is a document that governs the relationship between the startup company and the shareholders. The agreement details the rights of the shareholder with regards to first refusal, transfer rights, and redemption rights.
Single Trigger Acceleration: Single trigger acceleration is a clause in the vesting agreement that shortens the vesting schedule by a pre-designated time after a single event occurs such as a acquisition by another company.
Technology Transfer Agreement: A technology transfer agreement is a purchasing agreement for the rights to own, utilize, and possibly produce technology that was previously owned by another.