Trendsetter Term Sheet Negotiations

Mergers and Acquisitions SCH-MGMT 597M

Background

Trendsetter has two offers of VC funding. Presentations took two months. Time is of the essence: only 6 weeks of cash left to burn! How do the two term sheets compare? Which is the better proposal? Why?

Key Issues

Valuation Liquidation preference & antidilution Corporate governance Vesting & employment

Valuation

How much will VCs invest? Alphas pre-money valuation? Effect of revenue milestone on Alphas valuation? Likelihood of achieving revenue milestone? What is founders value?

Liquidation preference & antidilution

How are liquidation preferences treated in each term sheet? What types of securities are being considered? What are potential liquidation scenarios under each term sheet? How do antidilution provisions differ?

Corporate governance

How are voting rights defined in each term sheet? Board composition? Information rights to investors? Role of the compensation committee? Number of investors (Alpha=one and Mega=two)

Vesting & employment

Alpha offers six months vesting with termination without cause Alphas accelerated vesting is undefined Megas terms of employment to be determined in subsequent negotiations prior to closing of the financing round

Renegotiate terms

Valuation (Alpha & Mega) Liquidation & antidilution (Mega) IPO requirements (Mega) Termination without cause (Alpha) Content of employment agreements & vesting schedules (Mega)

Renegotiate terms

Performance hurdle (Alpha) Board composition (Alpha) Specific instances of voting (Mega) Second VC (Alpha) Redemption rights (Mega) Co-sale rights (Alpha)

Less critical issues

Information rights Dividends

Key Learnings

Green flags Yellow flags Red flags Soft issues

Green flags

Simple, easy-to-understand term sheets Little downside protection for investors Plain vanilla convertible preferred stock

Yellow flags

Milestones may lead to short-term actions that jeopardize long-term potential for success Complicated terms and conditions Open-ended terms that require negotiation later in the closing documents Restrictive terms regarding fifth director Option pool comes out of founders shares

Red flags

Too many milestones Lengthy exclusivity of term sheet Complex due diligence procedures Triggers that take control from founders Mezzanine-type provisions in early round term sheets

Soft issues

Personal chemistry and reputation more important than higher pre-money valuation Select legal counsel experienced in the industry and in doing deals (verify) Specific VC partner (who will be on you board) matters more than the VC firm Trust your intuition rather than blind reliance on the numbers

The End

Thoughts? Comments? Reactions?

Questions?