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 <=$20K)
Indemnification
Same
=
Registration Rights
Same (but for definition of Qualified IPO)
-
Founders Vesting
Same base
-
Founders Acceleration
6 months acceleration in termination Accelerated vesting (double trigger) in change of control
depends
None (to be negotiated as part of employment contract)
Misc Termination
6 months salary if fired
Depends
None
© 2013 Viney Sawhney
Counsel already chosen by investors
10
