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Return Logic Inc A Case Solution
The terms of the Series A provide several privileges to Series A preferred shareholders. The partners of Return Logics need funds, and for this reason, they have to go with the venture capitalists firm’s demands to get what they want. But some of the terms in the term sheet put the venture decisions into Insight Ventures hands to a huge amount and that is where changes should be negotiated, and other terms should be offered to ensure that not only partners have adequate control over the firm but also the venture capitalists are happy with the privileges they have in return for their invested money.
Following questions are answered in this case study solution
How can maintain 45% in the hands of Venture capital Insight without losing too much control to the investors?
How should the problem of Mr Chan and the technicians that Mr Chan recruited is solved. Give Solution by focusing on the term sheet?
The terms of the Series A in the term sheet should be accepted? In this case, what other terms can be proposed? (Answer should take in consideration the term sheet as a whole).
LLC is a good form for a Venture Capital? Why.
Case Analysis for Return Logic Inc A
1. How can maintain 45% in the hands of Venture capital Insight without losing too much control to the investors?
The partners first received funds from Angels after which they needed approximately $3,000,000 which was offered to them by Insight Ventures on the condition that it would represent 45% ownership in the Company. The concern of the partners regarding this deal was a loss of control over the decisions of the company to the investors.
In case the partners decide to receive funds from Insight Ventures and let them hold 45% of the company, terms of the deal should be negotiated with Insight Ventures to maintain sufficient control over the company. The terms, which need to be negotiated with the venture capitalists are as follows:
As per the terms spelled out by Insight Ventures the board of directors should have five members out of which four would be elected with the approval of the investors. The partners of the firm should approach the Venture Capital Firm to decrease the number of board members elected by Venture Capitalists to one or let at least two partners be members of the board of directors to let them have more control over the decisions of the firm. Apart from the CEO, another of the three partners should be one of the board members because they have full knowledge of the venture and have started this venture.
Another area of concern in the term sheet was the requirement of consent of 75% of Series A preferred shareholders for certain actions. The term sheet consisted of 10 actions, which required consent of 75% of preferred shareholders. The partners should negotiate with the venture capitalists to either reduce the percentage of shareholder consent or reduce the actions which would require their consent.
Initially, the Angels were promised at least 10% equity stake along with a seat as a board of director. Changes in the board were already being negotiated thus there is not much margin to negotiate for providing seats to the Angels. For compensating the angels, the partners should negotiate with Venture Capitalists to at least provide voting rights to the Angels so they can have a say in the decisions of the firm.
The partners were unsure as to whether it would be fruitful to approach the venture capitalists for negotiation or not since they have much more experience than the partners themselves. Despite this, the partners should approach them with these three demands and make them realize that they would still have sufficient control over the firm even after accepting these terms. If the partners successfully negotiate these three terms of the term sheet while keeping all other terms same, they would be able to have adequate control over the firm while they would also be able to receive the required funds for their venture.
2. How should the problem of Mr Chan and the technicians that Mr Chan recruited is solved. Give Solution by focusing on the term sheet?
When Chan had joined the team, Mottura and Ward had agreed upon equal equity stake for all three members i.e. 13.3% each of common stock. They had agreed to grant 10% of the common stock to angel investors while each of the partners agreed to keep 13.3% of it. The remaining 50% was decided to be divided as 35% for venture capitalists while 15% for employee stock option plan. The problem arose when Insight Ventures demanded 45% ownership in the company in exchange for the funding they were providing. Since the partners had planned for only 35% ownership to venture capitalists earlier whereas it had to be increased to 45% because the partners thought they would not get a better deal from anywhere else, so that left the three partners with only 5% to be devoted to employee stock option plan. Another problem was that the two partners; Mottura and Ward, thought later that they had taken a wrong step by promising Chan equal equity stake in the venture. They realized later that since the idea of the venture was incepted by them and had been putting their efforts into the venture more devotedly and for a longer period of time, so they deserved more equity stake than Chan. Going back on their promise now also meant that it might harm their friendship as well as a business relationship.
First thing to bring into light here is that the promise had not been formally documented (as per the information provided in the case study) thus it can be reversed. Another thing to keep in mind is that when you do business with a friend or a relation, it is important to keep your personal relationship aside for the betterment of the business itself. On the other hand, reversing the promise would not only be unfair to Chan but it might also become a cause for his demotivation and reduced commitment towards the venture. One important thing to note here is that Chan acted as a valuable member in the venture by sharing his experience and benefitting the venture. Although it is true that Mottura and Ward incepted the idea, but Chan played a significant role in bringing their idea to life. Thus, demotivating him at this stage would not be a good idea. 45% of the equity had already been claimed by Insight Ventures, and there wasn’t a huge margin left to be divided, thus to compensate for the less equity offered to Chan, he should be selected as the other member apart from the CEO who would become a board member which has been discussed as one topic, which needs to be negotiated. The equity stake provided to Chan should also not be less than 11%.
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