Session 4 Lecture Slides Case Study Trendsetter Inc

Trendsetter Inc. Private Equity Session 4 Source: Case Study – Term Sheet Negotiations for Trendsetter Inc.

© 2013 Viney Sawhney

Trendsetter Inc. Term Sheets
Integral part of the entrepreneurial process in

the USA and abroad


Each day hundreds of term sheets are proposed and

evaluated by entrepreneurs and those who finance them
Many entrepreneurs are not well versed in term sheets
It is dangerous for an entrepreneur to assume that it will suffice if only his or her lawyer understands the term sheet
Each entrepreneur should spend time studying term sheets before discussing his or her own term sheet under pressure in real time © 2013 Viney Sawhney

2

Trendsetter Inc. Comparison of Term Sheets
If you were advising the entrepreneurs at

Trendsetter, and you would not change any of the terms in either term sheet, which would you recommend?
What are some of the contextual elements of Trendsetter that you consider relevant for the analysis of the two financing offers?
Typical case; Trendsetter needs capital upfront to

develop software
Entrepreneurs have done quite well in creating interest among VCs; seven presentations and six firms showed interest
Time is of the essence (six weeks of cash left) © 2013 Viney Sawhney

3

Trendsetter Inc. Comparison of Term Sheets
How do the two term sheets compare?
Clearly there are a lot of issues to compare.

How can one sensibly structure the comparison into categories?









Valuation Liquidation preference and Anti-dilution Corporate Governance Vesting and Employment Comparison and Renegotiation International Comparison

© 2013 Viney Sawhney

4

Trendsetter Inc. “Flags” in Term Sheets
Green Flags
Simple language
Little downside protection for investors
Plain vanilla convertible stock
Yellow Flags
Milestones (can lead to short-term optimizing)
Complicated terms
Language that requires negotiations later
“mutually agreeable”
“to be determined”


Restrictive terms regarding appointment of 5th director
Option pool comes out of founders’ shares
Potential conflict: VC may want to award options to newly

hired employees while entrepreneur may resist © 2013 Viney Sawhney

5

Trendsetter Inc. “Flags” in Term Sheets … continued
Red Flags
Too many milestones
Lengthy exclusivity of term sheet
Complex due diligence procedures
Clauses / milestones that take control from founders
Mezzanine-style provisions in early found term sheets
Other key points
Personal chemistry and reputation can be more important than higher pre-money valuation
Work with lawyers who have extensive experience
Ask for their VC list and deal list


Specific VC partner matters more than the VC Firm
Which VC partner will be on your board? © 2013 Viney Sawhney

6

Trendsetter Inc. Differences in the Term Sheets Alpha

Better / Worse from the entrepreneur’s perspective =

Mega

Amount of Investment

$5,000,000

Pre-Dollar Valuation

$7,350,000 if meets hurdle $6,650,000 if does not meet hurdle 3,000,000

depends

$7,000,000

<

2,500,000

$4,200,000 if meets hurdle $3,800,000 if does not meet hurdle 501,253 shares

<

$4,500,000

Employee Pool (# of shares) Implied owner value

Escrow Issue Price

Dividend

Number of Investors

$1.05 if meets hurdle $0.95 if does not meet hurdle Noncumulative 7.6% if meets hurdle 8.4% if does not meet hurdle 2 VCs © 2013 Viney Sawhney

$5,000,000

Non $1.00

Cumulative 10%

depends

1 VC 7

Trendsetter Inc. Differences in the Term Sheets - continued Alpha

Better / Worse from the entrepreneur’s perspective depends

Liquidation Preference

3X

Conversion

Same

Automatic Conversion

Similar Lower Definition of a Qualified IPO ($5 / share; total offering >=$15M)

Mega

1.5X 1.25 in multiple 0.25 in dividend

=

>

Type of Security to be issued

Convertible preferred stock

Redemption Rights

None

>

Anti-dilution

Weighted average

>

Voting Rights

Super Majority voting as class in many specific instances

>

© 2013 Viney Sawhney

Higher Definition of a Qualified IPO ($20 / share; total offering >= $25M)

Convertible participating preferred stock Series A share price plus unpaid dividends Weighted average is sale between 50% -100% of price in Series A Full ratcheted if less than 50% Super Majority voting as class in instances not specified yet (closing docs) 8

Trendsetter Inc. Differences in the Term Sheets - continued Alpha

Better / Worse from the entrepreneur’s perspective

Representations & Warranties

Same

=

Nondisclosure

Same

=

Right for First Refusal

Given to investors

=

Given to investors (called pre-emptive)

Co-Sale Rights

Given to investors (p4)

<

No rights

Information Rights

For investors > $250K

>

For any investor

Board

5 Total 2 VCs 1 CEO 2 Co (1 choice, 1 board) Note: last board seat goes to VC if Co misses hurdle)

<

5 Total 2 VCs 1 CEO 2 Co (1 choice, 1 board)

Compensation committee

Controlled by VCs

<

None

© 2013 Viney Sawhney

Mega

9

Trendsetter Inc. Differences in the Term Sheets - continued Alpha

Better / Worse from the entrepreneur’s perspective -

Mega

Counsel and Expenses

Investor choice of counsel (but Trendsetter pays