5 ms·

What exactly is a recapitalization? It says the round doesn't value them but doesn't the $5MM note have a cap of $80MM?

by jtchang 10y ago

arikr 10y ago
I think it means doesn't value because convertible notes set an upper cap on a valuation, but don't actually set the valuation. e.g. the next round could be at $40mm, and if it's priced, then this $5mm note would be at $40mm (minus any discount on the note). or if the next round is at $100mm, then this note would be at $80mm.
clairity 10y ago
a recap is when the company issues new shares to change the capital structure of the company (i.e., the ownership percentages). the early investors aren't getting any new shares, so their stake in the company gets "crammed down". it might be to make room for a new shareholder to get a larger stake of the company for a given dollar amount than might otherwise be implied by the current capital structure (a down round).
- lawnchair_larry 10y ago
  Why is it legally easy for them to do this, but in other high profile examples it was difficult for companies to dilute a now-unwanted partner? For example, Gates and Ballmer pushing out Allen, or Zuckerberg pushing out Saverin.
  - joshjkim 10y ago
    it's not quite apples/apples, and the law tries to protect minority shareholders from unfair actions by majority holders, but if the major stakeholders can say "it's in the best interest of the company" with a straight face and not just so the major stakeholders can enrich themselves at the expense of others, it's usually passable. in general, you'd ask lawyers a lot of questions about this, and you definitely take into account the risk of a shareholder lawsuit. so, it's a lot easier to do this kind of thing when there's a downround and the alternative to these terms is the company shutting down - basically, the new folks diluting old folks can say this is ultimately in the best interest of the company because the alternative is a shutdown. in the context of MS or FB, both companies were on the up and increasing in value, so harder for the big stakeholders to say pushing out another SH was just about "serving the best interest of the company" with a straight face.
  - mvpu 10y ago
    Legally very easy because it's a down road (read up on "VC cram down"). They'd raised $120million prior, and now they're doing a $5-$15million convertible at a $80million valuation (significantly down round). All existing investors will either "play" (invest more at this valuation) or "pay" (suffer significant dilution). When valuation takes a down turn, all rules are off - the board has the fiduciary duty to do whatever it thinks is right for the company, even if it means getting rid of all previous shareholders who are not pitching in to help. VC backed companies are like drugs - feels great as long as you're high but could die in a second.
  - rhino369 10y ago
    It's been a long time since I took business associations, but you aren't allowed to discriminate against any of the shareholders. You can dilute everyone, but you can't dilute just some people. IIRC Zuckerberg and Thiel created a new entity and gave Saverin a difference class of shares/equity then diluted that class. They must have known they'd never get away with it, it was likely just a move to be able to fire him quickly and just cut a check at a later date.
joshjkim 10y ago
a recap is a pretty general term used to describe any time capital structure is meaningfully changed, but in this case (and oftentimes in the realm of VC-backed co's) it usually refers to a situation where in connection with a new round of fundraising, existing stakeholders have their (preferred stock) rights meaningfully altered, and usually for the worse. this usually occurs in the context of a downround, where the new investor has a lot of leverage and the existing investors are effectively asked to give up some meaningful portion of their rights in order to sweeten the deal for the new investors, either by literally giving those rights up (usually by converting to common stock), or else by granting the new investors some very superior terms that diminish the existing investors rights (like a discount on IPO shares for new investors that existing investors do not get, or a higher-than-usual liquidation preference that supersede existing investors'. in contrast, the "cleanest" fundraising terms would be something like: new investors get the same rights as older investors, just with the price-per-share-based rights adjusted for the higher valuation the new investors bought at. (for reference, here's a good example of a widely read VC post where the term is used with that general framework: http://abovethecrowd.com/2016/04/21/on-the-road-to-recap/ http://abovethecrowd.com/2016/04/21/on-the-road-to-recap/) in some cases, a recap is also formulated to incentivize existing investors to put in more money by setting up a deal where existing investors who don't put in more money will end up with their shares converting to common stock (thereby losing their liquidation preferences and anti-dilution provisions), but those who put in their share (usually pro rata) will maintain comparable preferences to the new investors (or whoever is leading the round). (this is sometimes called pay to play, and it's one of the more common recaps i saw when i was an attorney) In this case, could be a novel spin on the same dynamics using a convertible note valuation cap: they are raising a down round (their last reported valuation was $300m, so a major down round here), and "Old investors were asked to pony up more money or see their stakes lose their value, according to one person familiar with the matter." it does not go exactly into the mechanism for how the value would be reduced, it might just be through straight up dilution (see note below), but in any case it seems like the ultimate objective is the same: using a new structure to reward new (or returning) investors who are willing to save the company in these (arguably self-imposed!) hard times, and push/punish existing investors who may have lost faith in the company. one thing I'd note: honestly, they seem to be implying a significant recap, but there's nothing specific in the article that points directly to any particularly unusual mechanisms. In fact, it's possible that this is just be a down round using a relatively straightforward convertible note with a cap, and even in that case the following statements that seem to imply a recap could still be true: "The value of shares that may be doled out to backers later will change depending on the company's subsequent valuation." (that can be true in a regular convertible note deal) and "Old investors were asked to pony up more money or see their stakes lose their value, according to one person familiar with the matter." (weirdly worded, but this could be true for any new infusion of capital). also, for relatively small investments ($5m) on mid/late stage companies, convertible notes are used just because they are fast/easy to negotiate and execute on, so i would not be surprised if this is just something like that - still, a major downround in any case!

What exactly is a recapitalization? It says the round doesn't value them but doesn't the $5MM note have a cap of $80MM?

by jtchang 10y ago

What exactly is a recapitalization? It says the round doesn't value them but doesn't the $5MM note have a cap of $80MM?

arikr 10y ago

I think it means doesn't value because convertible notes set an upper cap on a valuation, but don't actually set the valuation. e.g. the next round could be at $40mm, and if it's priced, then this $5mm note would be at $40mm (minus any discount on the note). or if the next round is at $100mm, then this note would be at $80mm.

clairity 10y ago

a recap is when the company issues new shares to change the capital structure of the company (i.e., the ownership percentages). the early investors aren't getting any new shares, so their stake in the company gets "crammed down". it might be to make room for a new shareholder to get a larger stake of the company for a given dollar amount than might otherwise be implied by the current capital structure (a down round).

lawnchair_larry 10y ago
Why is it legally easy for them to do this, but in other high profile examples it was difficult for companies to dilute a now-unwanted partner? For example, Gates and Ballmer pushing out Allen, or Zuckerberg pushing out Saverin.
- joshjkim 10y ago
  it's not quite apples/apples, and the law tries to protect minority shareholders from unfair actions by majority holders, but if the major stakeholders can say "it's in the best interest of the company" with a straight face and not just so the major stakeholders can enrich themselves at the expense of others, it's usually passable. in general, you'd ask lawyers a lot of questions about this, and you definitely take into account the risk of a shareholder lawsuit. so, it's a lot easier to do this kind of thing when there's a downround and the alternative to these terms is the company shutting down - basically, the new folks diluting old folks can say this is ultimately in the best interest of the company because the alternative is a shutdown. in the context of MS or FB, both companies were on the up and increasing in value, so harder for the big stakeholders to say pushing out another SH was just about "serving the best interest of the company" with a straight face.
- mvpu 10y ago
  Legally very easy because it's a down road (read up on "VC cram down"). They'd raised $120million prior, and now they're doing a $5-$15million convertible at a $80million valuation (significantly down round). All existing investors will either "play" (invest more at this valuation) or "pay" (suffer significant dilution). When valuation takes a down turn, all rules are off - the board has the fiduciary duty to do whatever it thinks is right for the company, even if it means getting rid of all previous shareholders who are not pitching in to help. VC backed companies are like drugs - feels great as long as you're high but could die in a second.
- rhino369 10y ago
  It's been a long time since I took business associations, but you aren't allowed to discriminate against any of the shareholders. You can dilute everyone, but you can't dilute just some people. IIRC Zuckerberg and Thiel created a new entity and gave Saverin a difference class of shares/equity then diluted that class. They must have known they'd never get away with it, it was likely just a move to be able to fire him quickly and just cut a check at a later date.

joshjkim 10y ago

a recap is a pretty general term used to describe any time capital structure is meaningfully changed, but in this case (and oftentimes in the realm of VC-backed co's) it usually refers to a situation where in connection with a new round of fundraising, existing stakeholders have their (preferred stock) rights meaningfully altered, and usually for the worse. this usually occurs in the context of a downround, where the new investor has a lot of leverage and the existing investors are effectively asked to give up some meaningful portion of their rights in order to sweeten the deal for the new investors, either by literally giving those rights up (usually by converting to common stock), or else by granting the new investors some very superior terms that diminish the existing investors rights (like a discount on IPO shares for new investors that existing investors do not get, or a higher-than-usual liquidation preference that supersede existing investors'. in contrast, the "cleanest" fundraising terms would be something like: new investors get the same rights as older investors, just with the price-per-share-based rights adjusted for the higher valuation the new investors bought at. (for reference, here's a good example of a widely read VC post where the term is used with that general framework: http://abovethecrowd.com/2016/04/21/on-the-road-to-recap/ http://abovethecrowd.com/2016/04/21/on-the-road-to-recap/) in some cases, a recap is also formulated to incentivize existing investors to put in more money by setting up a deal where existing investors who don't put in more money will end up with their shares converting to common stock (thereby losing their liquidation preferences and anti-dilution provisions), but those who put in their share (usually pro rata) will maintain comparable preferences to the new investors (or whoever is leading the round). (this is sometimes called pay to play, and it's one of the more common recaps i saw when i was an attorney) In this case, could be a novel spin on the same dynamics using a convertible note valuation cap: they are raising a down round (their last reported valuation was $300m, so a major down round here), and "Old investors were asked to pony up more money or see their stakes lose their value, according to one person familiar with the matter." it does not go exactly into the mechanism for how the value would be reduced, it might just be through straight up dilution (see note below), but in any case it seems like the ultimate objective is the same: using a new structure to reward new (or returning) investors who are willing to save the company in these (arguably self-imposed!) hard times, and push/punish existing investors who may have lost faith in the company. one thing I'd note: honestly, they seem to be implying a significant recap, but there's nothing specific in the article that points directly to any particularly unusual mechanisms. In fact, it's possible that this is just be a down round using a relatively straightforward convertible note with a cap, and even in that case the following statements that seem to imply a recap could still be true: "The value of shares that may be doled out to backers later will change depending on the company's subsequent valuation." (that can be true in a regular convertible note deal) and "Old investors were asked to pony up more money or see their stakes lose their value, according to one person familiar with the matter." (weirdly worded, but this could be true for any new infusion of capital). also, for relatively small investments ($5m) on mid/late stage companies, convertible notes are used just because they are fast/easy to negotiate and execute on, so i would not be surprised if this is just something like that - still, a major downround in any case!