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JG
JG, Attorney
Category: Business Law
Satisfied Customers: 281
Experience:  Worked for large NYC law firm, state judge and in-house counsel. Published in top legal journals.
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I am founder in a new startup company with a billionaire investor

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I am founder in a new startup company with a billionaire investor who is investing $2 million (250K, 250K, 750K, 750K) of the $2.15 million we have raised. We are trying to keep him from getting over 50% even after his final round, and try to find other investors to dilute him moving forward so he remains under 50%. We need to work the term sheet with such provisions.
Submitted: 5 years ago.
Category: Business Law
Expert:  JG replied 5 years ago.
Are you willing to return the investor's money as new investments come in? Otherwise why would this investor agree to have his interest diminished?
Customer: replied 5 years ago.
If we find a new investor to come in and, let's say, invest on top of the $2.15million at a higher valuation, then the original main investor and we founders, will be diluted equally, but he below his 50%, which will deny him a controlling stake.
Expert:  JG replied 5 years ago.

Typically dilution will be addressed in the classification of stock series. Anti-dilution clauses always appear in a term sheet - initial investers usually insist on it.

 

Anti-dilution protection would give the original investor rights to purchase an amount of stock of the new class to enable his interest to stay consistent. Alternatively a diluted average approach would convert the share value but not allow for the purchase of additional shares.

 

For instance if you issued 100 shares of Class A stock for 10,000 each the initial valuation would be 1,000,000. And if investor X owns 60 shares, investor X owns a majority of the company.

 

If you then issued another 100 shares of Class B (assume they carry the same ownership interest) stock for 5,000 each, the valuation for the company becomes 1,500,000.

 

Under an anti-dilution provision Investor X (a Class A holder) would have the right to 60 shares of Class B stock and his 60 shares of Class A stock would convert to 120 giving him a total of 180 (60+120) shares valued at $5,000 and keeping his ownership interest consistent. 180/300 = 60%.

 

Under a diluted approach there would now be 200 converted shares of Class A stock and 100 shares of Class B stock. All stock would move to the lower 5,000 valution and Investor X would own 120 shares (because his interest is now worth twice as many shares). However Investor X has no right to purchase Class B shares so hw sould own 120 shares of Class A stock. 120/300 is .40 so Investor X now only owns 40% of the company.

 

One way to achieve this result is to include a clause in the term shee that says:

 

"In the event that the Company issues additional securities in the future at a purchase price less than the Series A offer price, the additional securities class shall be adjusted in accordance with the following formula: Class A value will be reduced to the price at which the new share class are issued at and any additional shares that result from the lower price conversion will be distributed accordingly. Class A holders will have no guranteed right to purchase any quantity of new securities classes offered. This will apply to all future classes issued."

 

This is a complicated matter and I am not providing legal advice just information. A key take away from this discussion is surely to use a banker for the calculations and a lawyer to business lawyer licensed in your jursidiction to negotiate this clause for you.

 

If my answer was satisfactory to you please accept the answer so I can receive credit for my response and please leave feedback if you found the information helpful. BONUSES are appreciated.

Thank you.

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