A start-up venture usually aims to be partially or fully sold or to go public in order to monetise the hard work of the founders and the employees over the years.
Increasingly start-ups dream of and plan to go public in an IPO (initial public offering of shares in a stock market). A recent example is the Facebook IPO. From a business perspective, the start-up will have to achieve a certain amount of business success and, generally, have revenues to make it marketable to investors in public markets.
In order to position a start-up to go public, strategy and proper legal planning is required early on. Two of the most important legal rights that must be addressed for a start-up going public are conversion rights and registration rights.
Holders of preferred shares (shares that have superior rights to ordinary, common shares) in venture capital deals normally have the right to convert their preferred shares into common shares at any time.
The ratio at which preferred shares are converted into common shares is typically determined by dividing the initial purchase price of the preferred shares by a number called the conversion price, which is adjusted upon certain events. Initially, the conversion price is equal to the purchase price of the preferred shares, so the preferred shares convert into common shares on a one-to-one basis.
Also, the preferred shares usually are automatically converted into common shares upon certain events. Many times, these events are an initial public offering that meets certain criteria. Generally, the start-up company would like the preferred shares to convert as soon as possible to eliminate its special rights and to clean up the balance sheet for the initial public offering.
The criteria for triggering automatic conversion on an initial public offering generally include the following:
1. The offering must be firmly underwritten (i.e., the underwriters must have committed to placing the entire offering, rather than adopting the best efforts approach common in penny shares offerings).
2. the offering must raise a certain amount of money for the company.
3. (Often) the offering price must be at a certain minimum (e.g., four times the conversion price of the preferred shares).
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