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Term sheet Negotiations Case Solution

Solution Id Length Case Author Case Publisher
955 1110 Words (4 Pages) Noam Wasserman, Kyle Anderson, Furqan Nazeeri Harvard Business School : 812028
This solution includes: A Word File A Word File

The primary problem faced by the two inexperienced entrepreneurs is the evaluation of the two term sheets received from venture capitalists willing to invest in their project. The founders have no previous experience of raising money and the seed investment, which was sufficient to finance six weeks of operations, has been exhausted. This means that the decision has to be made quickly so as to continue business activities. Furthermore, the two companies interested in providing capital have high market repute so it is very important that the two entrepreneurs critically analyze and evaluate the nature and the outcomes of the two term sheets. Evaluation of these term sheets is important, as it will help unveil the expectations and intentions of the two venture capitalists i.e. the economics and control of the two term sheets. Thus, it is important that the founders evaluate the two term sheets before making any decision. However, as they are inexperience and there’s shortage of time which pose a threat to the accuracy of such an evaluation. Another important aspect involved is the lack of legal and professional advice to the two founders. The two founders not only realize the nature and importance of evaluating these term sheets, but they also intend to carry out the initial analysis on their own before taking guidance from a qualified person.

Following questions are answered in this case study solution

  1. Primary Problem

  2. Major Factors affecting the problem

    i. Inexperienced Founder

    ii. Less Time

    iii. Nature of term sheets

  3. Approach to address the problem

  4. Solution / Recommendation

  5. References

Case Analysis for Term sheet Negotiations

Major Factors affecting the problem

Major factors contributing towards the primary problem include

i. Inexperienced Founder

The founders have no experience of meeting and evaluating venture capitalists thus they have never been faced with such a situation before where they have to make a choice based on their analytical skills. This factor plays a crucial role towards this problem as both founders are unable to decode and comprehend the information contained in the two term sheets. The term sheets, which have been prepared by qualified professionals, have been carefully drafted so as to depict the intentions of the venture capitalists in the most pleasant manner. This is why it is difficult for inexperienced founders to understand the true meaning of the information in the term sheets.

ii. Less Time

The founders have to make this decision quickly because the company requires immediate funding. This is because the seed money was sufficient to continue operation for six weeks only. The founders had presented their business plan for two months before they received these term sheets. Thus, this shows that it is of utmost importance that the investment is injected into the business at the earliest.

iii. Nature of term sheets

None of the founders is qualified or experienced for such a situation, the problem aggravates when both the term sheets speak the same financial language. Despite of the fact that Alpha appears to have concerns about the company’s revenue stream, both venture capitalists provided similar top line valuations. The investment amount does not change and so do the counsel and expense, and registration rights. Thus, it is very difficult for someone incapable or inexperienced to read between the lines and determine the motives accurately.

Approach to address the problem

The primary problem can be solved efficiently by carrying out a detailed analysis of the two term sheets. The approach should be to analyze the business valuation of the company before and after the offer received from each venture capitalist. It is also of key importance that we unveil the economics and control depicted by each term sheet. While economics refer to the venture capitalists interest in the profits of the business, control refers to his intentions regarding the organizational structure and involvement in the management and decision-making processes of the business. This approach would focus on understanding the difference in the two offers under several possible scenarios. The initial analysis would try to create the larger picture for the two founders, which will include a detailed discussion of the vesting schedules and anti-dilution concerns of the founders and the investors.

The initial analysis should also include a governance section. The detailed analysis would focus on interpreting the minor details and developing an understanding of the language used so that the founders can easily understand it. The term sheet is like a financial document needs to be interpreted for inexperienced entrepreneurs so that they know what it really means.

In a nutshell, to address the problem, approach should focus on systematically unveiling and interpreting the two term sheets for the founders through a detailed analysis. This analysis would include the possible outcomes of the features included in the term sheets. The motive would be to present a critical analysis as well simplify the language of the document so that it is understood and founders are able to compare the merits and demerits of the two proposals.

Solution / Recommendation

According to basic evaluation Alpha seems to be the better deal for the company and the founders as it gives a better estimation of the company valuation. However, I would recommend the founders to accept Mega’s proposal. This is because the equity returns to the founders never go to 0% and there is no escrow clause in Mega’s proposal. This means that maximum ownership rests with the founders. Even in the $10 million downside scenario, the founders will make at least 10% if they accept Mega’s proposal. If Alpha’s proposal is accepted then the founders would be left with nothing if the company is valued below $15 million during the IPO phase.

The governance structure required by Alpha is unattractive and depicts that the venture capitalist is unsure about the performance of the company. This depicts lack of trust in the abilities of the founders thus there is a higher probability of interference and influence over the management.

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