Trendsetter Report
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Both Alpha Ventures and Mega Fund offer to invest the same amount of $5,000,000. The company is very closely valued in terms of pre-money valuation – the difference of $350,000 comes from a $0.05 difference in share price. Alpha Ventures includes an escrow clause while Mega Fund does not, which reflects Alphas lack of confidence in the firm. Alpha Ventures proposes to issue convertible preferred stock while Mega Fund proposes to issue convertible participating preferred (a double dip). However a side-by-side comparison of the capital provided, valuation, dividends, and control provisions show Mega Fund to be a better match for Trendsetter, Inc.
Valuation. Alpha Ventures escrow clause severely affects the pre-money valuation of the firm. At $1.05/share Trendsetter, Inc. is valued at $7.35M. However, if the revenue goals are not met as stated by the term sheet pre-money valuation drops to $6.65M. This also affects ownership. Without use of the escrow clause, the owners of Trendsetter are entitled to 59.5% of the company. However, again, if revenue goals arent met, Alpha Ventures receives and additional 501,523 shares and ownership drops to 54.86%.
Vesting. Both VC Firms offer 25% ownership immediately with linear vesting over 36 months. However, given the differing provisions stated for shares outstanding, the founders get .25*4.5M = 1.125M shares at $1.00/share ($1.125M). However, for the Alpha deal, they only receive .25*4M = 1.00M shares at $1.05/share ($1.05M). However if they do not meet their revenue goals, they only receive $.95M
Liquidation Preference. Alpha Ventures liquidation preference proposes the initial pay issuance price while Mega Fund offers preferred shareholders 1.25*$5M ($6.25M) before anyone is allowed anything. Under the liquidation preference for Alpha, investors are allowed to make a choice regarding equity returns during liquidation. Liquidation events include merger, an acquisition or “any event where there is transfer of control.” If they choose to collect on liquidation preference, investors can receive up to three times the investment, resulting in a payoff of $15M. An equity return would depend on the terminal value.
Control. Governance is quite similar between the two proposals, both with a requirement for a 5 person board. However, the escrow clause allows more control for board members should escrow shares be released. Founders also do not have a say over the compensation committee.
The escrow-release clause, as well as the Alphas 180 lock-up period make the term sheet quite unattractive. Alphas term sheet is based on mitigating risk, which reflects poor confidence in the level of the company.
Some provisions on Alphas term sheet can be altered to offer to shift the scales towards the founders. The most important would be removing the escrow clause, which would also possibly allow more control on the founders side