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
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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)
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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

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
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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?
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Trendsetter Inc.
Differences in the Term Sheets
Alpha Amount of Investment Pre-Dollar Valuation $5,000,000 $7,350,000 if meets hurdle $6,650,000 if does not meet hurdle 3,000,000 $4,200,000 if meets hurdle $3,800,000 if does not meet hurdle 501,253 shares $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

Better / Worse from the entrepreneurs perspective = depends

Mega

$5,000,000 $7,000,000

Employee Pool (# of shares) Implied owner value

< <

2,500,000 $4,500,000

Escrow Issue Price

Non $1.00

Dividend

Cumulative 10%

Number of Investors

depends

1 VC
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Trendsetter Inc.
Differences in the Term Sheets - continued
Alpha Liquidation Preference 3X Better / Worse from the entrepreneurs perspective depends Mega 1.5X 1.25 in multiple 0.25 in dividend Higher Definition of a Qualified IPO ($20 / share; total offering >= $25M)

Conversion Automatic Conversion

Same Similar Lower Definition of a Qualified IPO ($5 / share; total offering >=$15M) Convertible preferred stock None Weighted average

>

Type of Security to be issued Redemption Rights Anti-dilution

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

Voting Rights

Super Majority voting as class in many specific instances

2013 Viney Sawhney

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Trendsetter Inc.
Differences in the Term Sheets - continued
Alpha Better / Worse from the entrepreneurs perspective = = = < > < Given to investors (called pre-emptive) No rights For any investor 5 Total 2 VCs 1 CEO 2 Co (1 choice, 1 board) Mega Representations & Warranties Nondisclosure Right for First Refusal Co-Sale Rights Information Rights Board Same Same Given to investors Given to investors (p4) For investors > $250K 5 Total 2 VCs 1 CEO 2 Co (1 choice, 1 board) Note: last board seat goes to VC if Co misses hurdle) Controlled by VCs

Compensation committee

<

None

2013 Viney Sawhney

Trendsetter Inc.
Differences in the Term Sheets - continued
Alpha Counsel and Expenses Investor choice of counsel (but Trendsetter pays <=$20K) Same Same (but for definition of Qualified IPO) Same base 6 months acceleration in termination Accelerated vesting (double trigger) in change of control 6 months salary if fired Better / Worse from the entrepreneurs perspective Mega Counsel already chosen by investors

Indemnification Registration Rights

= -

Founders Vesting Founders Acceleration

depends None (to be negotiated as part of employment contract)

Misc Termination

Depends

None

2013 Viney Sawhney

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