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

© 2013 Viney Sawhney 7

Alpha Better / Worse from the

entrepreneur’s

perspective

Mega

Amount of Investment $5,000,000 = $5,000,000

Pre-Dollar Valuation $7,350,000 if meets hurdle

$6,650,000 if does not meet

hurdle

depends $7,000,000

Employee Pool (# of

shares)

3,000,000 < 2,500,000

Implied owner value $4,200,000 if meets hurdle

$3,800,000 if does not meet

hurdle

< $4,500,000

Escrow 501,253 shares Non

Issue Price $1.05 if meets hurdle

$0.95 if does not meet

hurdle

$1.00

Dividend Noncumulative

7.6% if meets hurdle

8.4% if does not meet

hurdle

Cumulative

10%

Number of Investors 2 VCs depends 1 VC

Trendsetter Inc.

Differences in the Term Sheets - continued

© 2013 Viney Sawhney 8

Alpha Better / Worse from the

entrepreneur’s

perspective

Mega

Liquidation Preference 3X depends 1.5X

1.25 in multiple

0.25 in dividend

Conversion Same =

Automatic Conversion Similar

Lower Definition of a

Qualified IPO ($5 / share;

total offering >=$15M)

>

Higher Definition of a Qualified

IPO ($20 / share; total offering

>= $25M)

Type of Security to be

issued

Convertible preferred

stock

Convertible participating

preferred stock

Redemption Rights None > Series A share price plus

unpaid dividends

Anti-dilution Weighted average > Weighted average is sale

between 50% -100% of price

in Series A

Full ratcheted if less than 50%

Voting Rights Super Majority voting as

class in many specific

instances

> Super Majority voting as class

in instances not specified yet

(closing docs)

Trendsetter Inc.

Differences in the Term Sheets - continued

© 2013 Viney Sawhney 9

Alpha Better / Worse from the

entrepreneur’s

perspective

Mega

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

Trendsetter Inc.

Differences in the Term Sheets - continued

© 2013 Viney Sawhney 10

Alpha Better / Worse from the

entrepreneur’s

perspective

Mega

Counsel and Expenses Investor choice of counsel

(but Trendsetter pays

<=$20K)

- Counsel already chosen by

investors

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