Ontology engineering

uilding a business© 2010 Nature America, Inc. All rights reserved.redemption of the securities purchased by theinvestor and registration rights.The type of security (Box 3) that the investorwill purchase is directly related to its exit strategy.For example, investors may use a promissorynote to try to protect their investment inthe event that the company is sold or dissolvedby having a ‘liquidation preference’ (liquidationincludes being sold). Essentially, the liquidationpreference says that if the companyis sold or dissolved for whatever reason, theinvestor’s investment (or a multiple thereof)is paid back in full before any funds are paidto other stockholders.This should be of special concern to youbecause it represents an amount of money thatwill be paid out before you, as founder, get onedime of the proceeds. You should try to negotiatethe most narrow liquidation preferencepossible to maximize the amount of money thatwill go to you and other stockholders. Tensionsmay arise only upon liquidation because theliquidation preference can often reveal divergingviews between an investor, who might havelittle incentive to seek additional revenue for thefounders at exit, and the founders, who wouldlike to finally share in a payday after years ofunderappreciated efforts.In the case of a strictly failed biotechcompany (not taken public or acquired, forexample), the investors will typically take anyavailable cash to recover their lost investmentwhen assets are sold off to the highest bidder.The most valuable assets are often the patentrights and in-licensed rights, and they can beaccompanied by trade secret information,such as clinical data from patient trials oreven a Food and Drug Administration drugapproval, as well as real estate, furniture andthe like. Here you could often receive little ornothing due to the liquidation preference, butit may be possible to negotiate around the liquidationpreference and obtain a share of anycash proceeds raised by asset liquidation.Preferred stock that is ‘redeemable’ meansthat the stock must be repurchased by the companyupon the happening of a specified event,such as the passage of time, an insufficient levelof cash, a failed drug trial, poor clinical studyresults, criminal accusations over patient consentor merely at the option of the investor. Thecompany will normally have to purchase thestock back at the investor’s purchase price plusany accrued but unpaid dividends. Redemptionis a feature of preferred stock that is generallydemanded by investors in the current market.Registration rights provide an investor withthe power to register the shares of stock he orBox 3 Defining stockAll types of stock are not equal. The main types of stock that you will encounter fall intothree categories:Common stock. This is the normal type of stock that all companies issue, and the rightsof common stockholders are set forth in the corporation laws of the company’s state offormation. Common stock is usually owned by the founders.Preferred stock. This is usually demanded by most professional investors. Preferred stockis created by amending the company’s certificate of incorporation to include the typeand amount of preferred stock issuable and the rights and privileges of the preferredstockholders. Preferred stock normally has preference over common stock when issuingdividends and distributing assets upon the liquidation or sale of the company. The termsof the preferred stock are typically heavily negotiated and should be discussed in detail inthe term sheet to ensure the parties agree on this fundamental point.Promissory note. This can take the place of stock and is usually convertible to common orpreferred stock upon the occurrence of a certain event (for example, meeting one or morecommercial milestones like successful phase 1, 2 or 3 trials), the passage of time or atthe option of the investor. The terms of the promissory note are also heavily negotiated andshould be addressed in the term sheet. The investor may prefer a promissory note becausein the event of liquidation, noteholders typically recover their investment before anystockholders, even preferred stockholders. Convertible promissory note deals are commonin very early stage investing or in so-called ‘bridge’ financings (short-term loans made inanticipation of subsequent equity financings).she owns during the company’s initial publicoffering (IPO) or after the company hascompleted its IPO. Registered stock is freelytransferable. Even so, it should be noted thatalthough agreements regarding registrationrights are enforceable, the underwriter mayrestrict or eliminate such rights at the timeof an IPO depending on both the respectiveregistration rights of other investors and themarket conditions.ConclusionsRegardless of whether your transaction involvesan investment, an asset purchase, a joint developmentproject or a more complex structure, itis crucial for the parties to enter a term sheet—itwill substantially increase the chances of successfullyclosing a deal. Also, having a written agreementthat outlines the terms of the transactionwill minimize the potential for confusion, costlynegotiation and disagreement between the partiesduring the drafting and negotiation of theinvestment documents.Depending on your need for capital andthe relative attractiveness of your companyto investors, the terms of a financing transactionmay or may not be negotiable. If you donot immediately need funds and the investorfinds your firm attractive, you will have moreleverage negotiating financing terms than ifyou face an immediate cash crisis. Either way,you should pay particular attention to a fewkey terms of the investment. Specifically, tryto negotiate advantageous positions regardingthe percentage of equity the investor will purchasein the transaction, the amount of controlthe investor will have over the company’sdaily operations and major decisions and theamount of money the investor will receiveupon the sale or liquidation of the company.These terms will directly affect the control youand the other founders have over the companypost-investment, as well as your share of theinvestment returns.Money can be hard to find right now,but according to a survey conducted by theUS National Venture Capital Association(Washington, DC) in December 2008,(National Venture Capital Association, 2009Venture Capital Predictions Survey Results,Dec. 17, 2008), the biotech and life sciencesectors are viewed as the second most promisingareas for increasing venture investment.If that’s correct, close scrutiny of term sheetsin biotech ventures is going to become evenmore important than before.To discuss the contents of this article, join the Bioentrepreneur forum on Nature Network:http://network.nature.com/groups/bioentrepreneur/forum/topics122 volume 28 number 2 FEBRUARY 2010 nature biotechnology