Hi. While this blog is a part of Seed Catalyst’s website, I realised over the initial few weeks that a lot of you are first introduced to the firm via the blog rather than our home page.
So to introduce myself - I’m a business consultant working with early stage technology firms to help streamline their strategy and go-to-market approach and support them for fund raising.
With this blog, I aim to capture key market trends that I see in the industry, the ecosystem and cross-plays in some of the more interesting and upcoming sectors, as well as cover interesting companies that I meet.
I will also be addressing vexing and interesting valuation and deal/term-sheet structures that would be of interest to technology start-ups at various stages of their growth.
I recently came across a new term sheet terminology which is very gradually gaining in popularity - ‘Pull up’. The term itself is not new - just that I haven't come across it in any term sheets I've seen. The more frequent in that bracket of clauses is Pay-to-play.
A short background and a brief definition of the terms.
When a company that already has financial investors starts raising finance, evaluators would expect that the existing VCs will also invest in the new round. If not, it raises the huge question of – Why not? After all, they would, in all probability, be on the board of the firm and privy to inside information and hence their intention to invest or not is the clearest indicator of the potential of the firm. And then we come to step 2 - What happens when some of them invest and others don’t.
The term Pay-to-play (P2P for now) came into existence to protect the interests of VCs that are already invested in a firm. In the scenario that some of the existing VCs decide to invest while others decide not to, under the terms of P2P, the latter stand to lose some of the preference terms associated with their stock. For example, it could be that their preferred stock will get converted to common stock or shadow preferred stock, it could be a reduction in the conversion ratio, and it could even be a loss of the right to designate a board member. In effect, the clause is aimed at preventing certain VCs from getting a free ride in an investment which is perhaps not faring as well as expected.
While P2P is punitive, Pull-up is more positive. It aims at allowing returning VCs to pull up some of their junior preferred stock from previous rounds to the new series of preferred stock with more favourable terms. The net effect is the same but while one is a punishment the other is more encouraging.
Of course there is always the fortunate case when a firm is doing extremely well and the new investor may want to invest the entire amount of the financing being raised rather than have the existing investor come in again. That unfortunately is not a problem situation addressed by any term sheet clause. It may lead to some angst but in most cases the problem sorts itself out – after all even VC reputations carry – positive or negative.
Also, I’ve decided that perhaps it would be interesting to tackle a term sheet clause every Wednesday – the definition, what does it entail, what is the median market approach on the clause etc. Hence, we’ll pick this up again next week.
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