Have you heard the term “ROFR” (pronounced “Roafer”)?  This term is well known by professional investors.
 
ROFR means Right of First Refusal.  We will do a deep dive on ROFRs in this post.

​This post is a continuation of the post “Preferred Stock Financings: Registration Rights Overview.”
 
In the prior post, we discussed the registration process, which enables the company and/or existing stockholders to sell shares to the public on a stock exchange, such as the New York Stock Exchange (“NYSE”) or NASDAQ.  We discussed S-1 registration statements and S-3 registration statements, which are the primary ways for the company to sell stock to the public.
 
In this post, we explore “demand” registration rights and “piggyback” registration rights, which are rights held by the preferred stockholders in order to be able to register their shares so they can be sold in the public markets.

​There are two key events that occur for an investor in a private company:  The purchase of the stock and the exit (an “exit” is the sale or exchange of the stock for cash or publicly traded stock).  The primary exits are when a company is sold and the investor receives cash for its stock, and when the investor sells their shares into the public market as part of a registered offering, such as an IPO.
 
“Registration rights” are the rights that preferred stock investors obtain to allow them to sell their stock in a registered offering. 

​There’s a lot to discuss here, so buckle up and let’s get going.

I am pleased to be moderating a panel at the Carmo Middle Market Private Equity Web Conference on February 9-10, 2021.  I will be moderating the panel "Consumer & Business Services: A Conversation on Value.  The link to the conference is here: ​https://www.carmocompanies.com/middle-market-private-equity-web-meeting

When you buy stock of a publicly-traded company, there's lots of information available about the company's business and finances.  This is because publicly-traded companies are required by law to publish their financials and other company information.  

The world is very different when investing in private companies.  Absent an agreement, private companies have very few requirements to provide investors with information on the company’s business and finances.  That’s where information rights come in.
 
This post explores information rights typically obtained by preferred stockholders in private companies.

​Here’s a scenario inspired by real events that I have experienced:  a startup telecom company was all the rage and the company’s Series A preferred stock financing was heavily oversubscribed.  As a result, the deal was “take it or leave it” for investors and the Series A preferred stockholders invested without obtaining many of the normal provisions protecting their investment.  The company raised significantly more money than they needed at that stage.  With all this cash burning a hole in the company’s pocket, the company decided to buy some land and build itself a new headquarters building.  The company also gave management huge raises and bonuses and lavishly spent on marketing (sponsoring a race car and hiring a celebrity spokesperson), office décor, company retreats and parties.  Not surprisingly, the company blew through all of its cash very rapidly, with little progress to show for it.  The company then tried to raise another round of financing but couldn’t agree with investors on valuation (the investors wanted a very low valuation) and the company went out of business.
 
Moral of the story: If the investors in the financing described above had obtained protective provisions, this financial debacle may not have occurred.
 
This blog post is about protective provisions.

​Boards of directors for early-stage companies are very important and serve a number of critical functions.  The board hires the company’s CEO and other senior management (and sometimes fires them), and decides other major events for the company, such as whether and when to raise additional capital, enter into important contracts, sell the company, go public or to wind the company down.  In addition, the board often has committees, including an audit committee (to review the financials of the company) and a compensation committee (to establish officer compensation) that meet separately from the board.
 
Members of the board of directors are elected by the stockholders, and represent the stockholders’ interests.  In preferred stock financings, the lead investor will usually obtain the right to appoint a director to the board.  If the lead investor doesn’t obtain a board appointment right, then the investor may obtain the right to be a “board observer.”  Board observer rights are sometimes granted in addition to board appointment rights.
 
This blog discusses an investor’s rights to appoint a member of the board and/or a board observer.

​Redemption rights are rights held by preferred stockholders to require a company to repurchase its stock from the preferred stockholders.  Redemption rights are sometimes referred to “put rights,” meaning the preferred stock investors have the right to “put” its shares to the company.  A “put” in finance is the right to sell a security (usually stock) to another party at a certain price.
 
Redemption rights are rare in early-stage venture capital financings, but can sometimes be found in later stage financings, down rounds or in restructurings.
 
Let’s get started.

​In a convertible preferred stock financing, one of the most heavily negotiated terms is the liquidation preference. 
 
A liquidation preference is a priority payment right given to preferred stockholders when a company has a “liquidation” event – which means a sale of the company or the bankruptcy/winding down of the company.  In the event of a liquidation, the liquidation preference determines how the liquidation proceeds are prioritized and paid to the preferred stockholders and the common stockholders.  These payments are called a “liquidation waterfall.”
 
Liquidation preferences can be pretty complex, so let’s break this down into components.

A “dividend” is the payment of "excess cash" by a company to its shareholders (it’s a bit more complicated than that, but we’ll get to that later).  If the company pays dividends, the stockholders will receive the dividends based on their ownership in the company.
 
For privately-held companies, especially early-stage companies, dividends are generally not paid as these companies generally don’t have excess cash, and even if they did, they would use any excess cash to grow the company’s business.  But even though dividends are generally not paid by privately-held companies, it is important to understand how dividends work because preferred stock investors may negotiate dividend provisions that could result in substantial sums of money being paid to the preferred stockholders in certain situations.

​ 
When private companies hold financing rounds with venture capital and other professional investors, these investors acquire convertible preferred stock from the company.  The “convertible” or “conversion” feature of the preferred stock is fundamental to many of the rights, privileges and preferences granted to the preferred stock investors.
 
So what is the convertible feature of convertible preferred stock?  Read on.

​Anti-dilution provisions protect existing stockholders from value dilution and/or ownership dilution. They are powerful investor protections and they come in different flavors.  
 
In a prior post, we discussed Rights of First Offer (also known as Pre-Emptive Rights) which offer protection against ownership dilution.
 
This post will explore anti-dilution protections that protect against value dilution.

​A “right of first offer,” also known as a “pre-emptive right,” provides an investor in a company with the right to participate in future financing rounds so that the investor can maintain its ownership percentage in the company.  Rights of first offers are referred to in shorthand as ROFOs.
 
There are many elements to ROFOs.  Let’s break them down.

This is second part of the post on dilution.  The first post discussed ownership dilution, also known as equity dilution.  The first post can be found here:  http://www.allenlatta.com/allens-blog/dilution-part-one-understanding-ownership-dilution
 
As discussed in part one, I view dilution as having two components: ownership (equity) dilution and value dilution.  These concepts are related.  Let’s now explore value dilution.

I am pleased to be participating in a webinar for family offices presented by the Context Family Network on September 25, 2020.  I will be interviewing the Chief Investment Officer for a family office that actively invests directly in private technology companies.  The Context Family Network website can be found here: contextfn.com/.

​The word “dilution” is used often private equity, particularly in venture capital financings.  One can hear venture capitalists and founders say they don’t want to be diluted.  But what are they talking about when they say this?  That’s the topic of this post.
 
I view dilution as having two components: ownership dilution and value dilution.  These concepts are related.  In this post, we’ll take a look at ownership dilution.  We’ll look at value dilution in a later post.

What can you learn from reviewing over a thousand private equity fund presentations (also known as “pitch decks”)?  Among other things, you learn what works in a fund presentation and what doesn’t.  This post contains my thoughts on what an emerging manager should include in a fund presentation. 

I am pleased to be speaking on the Private Markets Insider webinar "Esoteric Opportunities in Private Equity & Special Situations" to be held on Wednesday, September 2, 2020 at 11:00 am ET.  Here's a link to the webinar information page: ​https://www.eventbrite.com/e/private-markets-insider-webinar-tickets-112114838500.

A fund secondary transaction occurs when an existing investor in a private equity fund sells its interest to a third party in a private transaction.

While this may sound pretty straight-forward, fund secondaries are fairly complex.  One complexity relates to the fact that an investment in a private equity fund is "illiquid."  It is called illiquid because it isn’t very easy for an investor in a private equity fund to sell its fund interest.
 
There are several reasons why interests in private equity funds are illiquid.  First, unlike publicly-traded stocks which can be bought and sold very easily on public markets like the New York Stock Exchange and NASDAQ, there is no public market where one can buy or sell interests in private equity funds.  Second, for stocks to be able to be sold on public markets like the New York Stock Exchange and NASDAQ, by law they must first be registered with the US Securities and Exchange Commission (“SEC”).  Interests in private equity funds are not registered with the SEC, and so there are legal (statutory) restrictions on the sale or transfer of these fund interests.  Third, investors in private equity funds sign contracts (known as “limited partnership agreements” or “LPAs”) which contain restrictions on the sale or transfer of the fund interests.

​In my prior post, “LP Corner: Understanding the “Equity” of Private Equity” we explored the “Equity” in Private Equity.  In this post we explore the “Private” in Private Equity.  These posts are complements to my initial post “LP Corner: What is Private Equity?”.  The hope is that these posts will provide the reader with a good overview of what “Private Equity” means.
 
So what does the “Private” in Private Equity mean?  In essence, it means that the companies that PE funds (buyout, venture capital and growth equity funds) invest in and/or acquire are privately-held companies.  To understand this, first we'll explore what public companies are, and then we'll take a deeper dive into what private companies are, and we'll finish with a discussion of the types of companies that buyout funds acquire..

​Private equity, generally speaking, is an equity (stock) investment in a privately-held company.  My blog post “LP Corner: What is Private Equity?” provides an overview of how the term “private equity” is used.  This post is going to explore the “equity” component of “Private Equity.”  This post is a complement to my posts "LP Corner: What is Private Equity" and "LP Corner: The "Private" in Private Equity".
 
Let’s start with a basic definition of equity: Equity is the most basic form of ownership in a company.  Since virtually all private equity-backed companies in the United States are corporations, we are going to focus on equity in a corporation.

To all readers: I hope you and your families are healthy and safe.  My thoughts are with all who are impacted by this deadly virus.
 
I’ve been around for a while, and have experienced several market dislocations in my career.  I had just started my career as a corporate finance attorney when the “Black Monday” stock market crash of October 19, 1987 occurred.  I was a telecommunications investment banker when the dot-com crash occurred in March 2000.  I was a private equity fund-of-funds manager when the Global Financial Crisis (“GFC”) hit in 2008.  Because of these experiences, I have some thoughts for limited partners (“LPs”) during this crisis.

​A concept that is important for understanding company financings is that of “pre-money” and “post-money” valuation.  Pre-money valuation is the value of a company immediately prior to a financing round.  Post-Money Valuation is the value of the company immediately after the financing round.  The difference is usually the amount of money raised in the round.
 
Let’s explore this deeper.

I'm pleased to be a moderator and discussion facilitator at the upcoming PartnerConnect Texas conference to be held December 9-11 at the Fairmont Dallas.  I will be moderating the panel "LP Corner: How LPs are preparing and managing their private markets portfolios for a potential downturn," and facilitating a breakout discussion on "The Impending Bear Market and its Effects on PE and VC."

​Here's a link to the PartnerConnect Texas conference website: https://www.peievents.com/en/event/partnerconnect-texas-2019/