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Great info, thanks for sharing. What's the "merger premium" you usually see on such term sheets? Also, can you explain a bit more about the tax implications?

• grellas 17y ago
  Usually it is 2x. Tax gets complicated in these areas but the general principle is that, any time founders or others need to vest shares, the IRS regards the value of those shares as service income, i.e., taxable income. That is why trivial valuations are used up front even though founders may in fact believe the value of their stock to be significant even right out the gate. Once founders permit any form of "measurable event" to occur - that is, any event (usually involving a funding but also can involve paying people in stock measured by the value of services performed) that gives the IRS a way of putting an objective value on the stock at a time when its value would otherwise be nebulous - then that measure begins to define potential taxable income to those who receive the stock after that event occurs. So, if a founder gets 1M shares at $.001, and has to vest shares over 4 years, any taxable service income attributable to that effort is negligible ($1K) (assuming an 83(b) election is timely filed - http://www.grellas.com/faq_business_startup_004.html http://www.grellas.com/faq_business_startup_004.html). But, if the company takes in bridge funding in such a way that the common stock has to be repriced, say, up to $0.20/sh, any later recipient of 1M shares of such stock would be dealing with potential service income of $200K. This issue can also arise if founders do a $.001/sh capitalization, and then do a funding that bumps up too close in time to their own capitalization. In some scenarios, the IRS can treat these as one event and attribute significantly more income to the founders than might appear from their own $.001/sh pricing. As I said, the issues get complicated but that gives you an idea of the general principles. A convertible bridge note avoids these tax issues by letting founders get funding without having to price the stock in any way - in essence, the terms of the note say it is a loan, repayable at x date, and forced to convert into preferred stock on the same terms (except for price discount) as those used in any qualified funding occurring within y period. In effect, re-pricing of the shares is deferred until the qualifying round. This lets the company defer the "measurable event" to the date of the qualifying preferred-stock round and lets them keep pricing nebulous (and hence "cheap") until then.
  • prakash 17y ago
    Thank you very much!