Buzz

Trends in Legal Terms in Venture Financings In the San Francisco Bay Area (Fenwick & West)

Barry Kramer and Michael Patrick (Fenwick & West)


(Third Quarter 2003)

Background

We analyzed the terms of venture financings for 85 technology companies headquartered in the San Francisco Bay Area that reported raising money in the third quarter of 2003.

Financing Round

The financings broke down according to the following rounds:

Series Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
A 20% 20% 15% 13% 15% 11% 7%
B 30% 24% 28% 20% 19% 32% 36%
C 19% 29% 26% 30% 31% 27% 18%
D 18% 12% 13% 22% 24% 15% 29%
E and higher 13% 15% 18% 15% 11% 15% 10%

Price Change

The direction of price changes for companies receiving financing this quarter, compared to their previous round, were as follows:

Price Change Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
Down 53% 56% 73% 68% 67% 52% 57%
Flat 12% 4% 7% 6% 8% 10% 10%
Up 35% 40% 20% 26% 25% 38% 33%

The percentage of down rounds by series were as follows:

Series Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
B 46% 26% 56% 50% 33% 20% 25%
C 44% 59% 68% 67% 71% 60% 62%
D 53% 64% 100% 78% 77% 73% 84%
E and higher 82% 93% 87% 83% 90% 82% 75%

The direction of price changes in Q3 was generally similar to Q2, with down-rounds continuing to outpace up-rounds, but by a less substantial margin than previous quarters.

Liquidation Preference

Senior liquidation preferences were used in the following percentages of financings:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
57% 55% 68% 64% 60% 56% 62%

The percentage of senior liquidation preference by series was as follows:

Series Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
B 50% 43% 65% 51% 33% 38% 44%
C 56% 59% 73% 67% 55% 55% 62%
D 60% 55% 73% 78% 83% 69% 69%
E and higher 73% 64% 60% 66% 70% 91% 100%

Multiple Liquidation Preferences

The percentage of senior liquidation preferences that were multiple preferences were as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
21% 44% 40% 37% 32% 41% 58%

Of the senior liquidation preferences, the ranges of the multiples broke down as follows:

Range of multiples Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
>1x- 2x 88% 78% 74% 79% 80% 87% 66%
>2x - 3x 12% 11% 16% 14% 13% 13% 27%
> 3x 0% 11% 10% 7% 7% 0% 7%

The reduced use of multiple liquidation preferences is notable.

Participation in Liquidation

The percentages of financings that provided for participation were as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
68% 81% 77% 74% 73% 67% 56%

Of the financings that had participation, the percentages that were not capped were as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
66% 59% 63% 50% 51% 56% 32%

Cumulative Dividends

Cumulative dividends were provided for in the following percentages of financings:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02
12% 4% 8% 9% 13%

(There are no figures for Q2 or Q1 of 2002 as we initiated our analysis of these numbers beginning in Q3 of 2002.)

Antidilution Provisions

The uses of antidilution provisions in the financings were as follows:

Type of Provision Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
Ratchet 8% 10% 16% 18% 15% 20% 29%
Weighted Average 87% 88% 83% 77% 80% 78% 69%
None 5% 2% 1% 5% 5% 2% 2%

The trend toward reduced use of ratchet antidilution protection continued in Q3.

Pay-to-Play Provisions

The use of pay-to-play provisions in the financings was as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
12% 20% 14% 25% 18% 18% 20%

The pay-to-play provisions provided for conversion of non-participating investors' preferred stock into common stock or shadow preferred stock, in the percentages set forth below:

Common Stock

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
80% 84% 50% 75% 71% 50% 56%

Shadow preferred stock

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
20% 16% 50% 25% 29% 33% 22%

Redemption

The percentages of financings providing for mandatory redemption or redemption at the option of the venture capitalist were as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
29% 40% 32% 33% 37% 44% 36%

Corporate Reorganizations

The percentages of post-Series A financings involving a corporate reorganization were as follows:

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
21% 19% 19% 21% 19% 11% 20%

Percentages of these corporate reorganizations involving a:

Reverse split of outstanding stock

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
79% 87% 50% 55% 67% 70% 100%

Conversion of senior securities into more junior securities.

Q3 '03 Q2 '03 Q1 '03 Q4 '02 Q3 '02 Q2 '02 Q1 '02
52% 53% 53% 59% 47% 30% 67%

Conclusion

The overall terms of venture financings in 3Q03 improved mildly. The direction of price changes was similar to 2Q03, but the use of some of the tougher terms such as multiple liquidation preference, ratchet anti-dilution and pay-to-play decreased.

Similar to this trend, we note that various industry publications have reported venture investment in 3Q03 to be generally flat with 2Q03.

Lastly, we note that Nasdaq increased approximately 9% in 3Q03, and that both the number of companies closing IPOs, and the number of companies in registration for IPOs, increased in 3Q03. To the extent these trends continue, we would expect venture terms to continue to improve.


Additional Information

For additional information about this report please contact Barry Kramer at 650-335-7278; bkramer@fenwick.com or Michael Patrick at 650-335-7273; mpatrick@fenwick.com at Fenwick & West. To be placed on an email list for future editions of this survey please go to www.fenwick.com/vctrends.htm.