Edocs Inc free essay sample

A no shop clause is common primarily in MA and private equity transactions and prevents the seller or investee/entrepreneur from looking for another bidder/investor- the reason for the inclusion of a no shop clause is that a buyer or investor plans to spend considerable time and resources conducting due diligence and does not want to run the risk of losing the deal or getting out-bid, hence the prevention from â€Å"shopping around. † CRV realizes that this is a hot market (VC commitments 21% CAGR for last 5 years) and that edocs represents a unique, high growth/return potential investment and wants to secure the deal for itself. CRV knows that edocs could take their term sheet and try to get other VCs to outbid/offer better terms to edocs and CRV wants to avoid a bidding war which would drive up the valuation (cost) and reduce CRV’s stake. This is also an important transaction for CRV, particularly for Jonathan Guerster, as this is his first VC transaction for CRV, so he wants to be sure he will not lose the deal. The CRV term sheet signifies instant certification and validation of the edocs business plan and investment opportunity- a no shop clause was necessary for CRV in order to hook in edocs without the fear of needing to enter a bidding war with another VC. However, from edocs perspective, there are both pros and cons to the no shop clause: The benefits for edocs include: ? Higher valuation, CRV term sheet acts as certification for the edocs opportunity and hence VCs will be willing to pay more to seal the deal on a high potential/lucrative deal; a higher valuation will mean that the founders will keep more of the company; which is also good for interest alignment/motivation; ? Renegotiation of key terms in favor of edocs the CRV term sheet would represent the best, most investor friendly option, thus any subsequent offer will need to adjust the terms to be more entrepreneur/edocs friendly or else they won’t get the deal- / minimum offer to edocs- opening up the bid, especially in a hot market such as 1998 could shift the bargaining power to edocs Cons for edocs: May not get additional bidders: edocs has spent months trying to find investors and they run a significant risk if they decide to shop around and in the end do not end up with any financing- time to market/first mover advantage is critical; Negative signaling- the fact the edocs would dump the first, highly credible/experienced investor interested in their business could be a sign to other VCs of the quality and commitment of the sponsors- such an act of defiance could make other VCs questions whether putting up a competing bid would be worth their time- they would not want to get far in the negotiations only to have edocs sell out the first offer they are given; Inability to raise full amount: While $2M may be easy to raise, it may be more difficult to find one investor willing to put in $4M; edocs may even have to try to negotiate with 2 or more parties and that may make the entire negotiation much more difficult and would put edocs in an even worse bargaining position; CRV has an excellent network from which to source the $2M and is able to put up the full $4M if need be. If edocs thinks they can renegotiate some of the stickier/more sensitive elements of the term sheet with CRV then it would be beneficial to allow the no shop clause- this would enable them to access much needed funding quickly when timing to market is crucial. The deal on the table would still leave majority control with the founders. On the other hand, if edocs does not think it can renegotiate key terms then it should not accept the no shop clause. I would advise edocs to accept the no shop clause but narrow the time window (i. e. 20-30 days max) so that CRV will need to act fast in its due diligence and come quickly to a conclusion so that if negotiations do deteriorate then edocs can, without having lost too much time, go back to the market and try to find another financier- in this way they can accept the term while putting pressure back on CRV to make good on/improve the deal on the table. 2. What was the most contentious negotiating point (see Exhibit 7)? Why? Guerster (CRV) on one hand proposes a financing round of $4M against the issuance of Series A Convertible Preferred Stock (CPS). CRV would make an investment of $2M and in line with their general financing model, CRV will also search for one other top-tier venture firm to put in the remaining $2M. However, if no venture firm appears to be willing to put down the $2M, CRV will close the gap. As remuneration for the additional direct financing, CRV does require 500,000 of warrants (exercisable at $0. 10 per share, duration of 3 years) for common shares in addition to the Series A CPS. Although the edocs idea sounds very profitable, CRV is also taking a huge risk with this venture investment. If no other investor is convinced of the potential of the edocs business model, CRV will suffer financial damage. First of all, CRV would need to come up with an additional $2M and the news about this failed collaboration will also damage the edocs investment. Therefore, CRV will argue that it needs some measure of compensation for such damages. In addition, CRV could argue that the idea behind the syndication is to give the investment company (edocs) access to a diverse network and to provide a stronger financial syndicate. So in fact, CRV has the best interest of the portfolio company in mind. Edocs, on the other hand, will argue that CRV, based on the firm valuation, has proposed an investment amount and that CRV should also be responsible for raising the funds. There is no justifiable business reason for penalizing the founders if CRV is not successful in finding a syndicate partner. The founders would not want to bear the risk and the costs of CRV not finding a co-investor. It is not likely that edocs will accept this warrant arrangement, especially since the VC market is booming. The founders even have an offer for their company readily waiting for them back home. Guerster on the other hand will be conservative in his negotiations on behalf of CRV. First of all, Guerster is taking a huge reputational risk with this investment. Secondly, Guerster is a new recruit at CRV and will not want to take big risks for his first deal. He needs to close the deal in a way that CRV’s interests are best secured. 3. What are the most important terms for edocs (Kevin Laracey)? Below is an overview of the most important terms for edocs: Valuation CRV was offering a $10. 5 M valuation for edocs. Considering the increase in the venture investments, Laracey had to make sure that edocs was taking advantage of the competition between VCs while maintaining edocs’ first mover advantage. CRV had after all identified two of edocs’ competitors Just-in Time Solutions (JITS) and Bluegill as a potential investment target so Laracey did not have too much time to negotiate. CEO Position The proposed documents mention that CRV intends to hire a new CEO to run edocs. However, Kevin Laracey clearly wants to stay in charge of edocs operations. Laracey, together with Canekeratne, has developed the innovative idea behind the edocs software product and business model. Both guys have invested their personal savings in developing product in the early stage. Furthermore, Laracey has initiated some strategically important developments for edocs. As an example, Laracey arranged a partnership agreement with CheckFree which was a leading provider of electronic payment and bill presentment services. Following this agreement, Laracey signed a Technology Partnership agreement with CyberCash, the leading provider of technology that enabled secure payments over the internet (credit card/checking account). This strategic partnership enabled the recipients of online bills (edocs generated messages) to make the payments online with just a click on a button. Laracey early on recognized that this would be an important service for future clients of edocs. Taking into account the technical knowledge, industry experience, the commitment and the dedication to develop edocs into a large and successful company, it is understandable that Laracey was not willing to step aside at this stage. After all the hard work in bringing an idea into life, Laracey wants to bring the company to the next level, at least until his limited managerial experience are no longer sufficient to run edocs. Board of Directors (BOD) As regards the composition of the BOD, two issues are of importance for the founders of edocs. The current draft term sheet first of all appoints only one of the founders as a board member. CRV would have two representatives on the board of directors and two outside directors would be appointed after approval by both parties. Before appointing a new CEO by CRV, the BOD would therefore consist of five board members with only Laracey as the representative of the founders. Considering their equity position and their involvement in the company, edocs founders would require a more strong representation on the board. We can imagine that edocs would like to appoint one of the founders as the chairman of the BOD. Secondly, the above described composition of the BOD excludes Canekeratne from a position in the BOD. It is very important for Laracey that his partner from the very first beginning of edocs has a seat on the BOD. First of all, Canekeratne has co-invested in the development of the edocs software and he has served as a key technical advisor to the edocs team. In addition, Canekeatne and his family have helped to facilitate the off shore development of edocs’ software by giving access to software development personnel in Sri Lanka (family had a company in Sri Lanka). Vesting schedule CRV has proposed a vesting schedule of 48 months for the founders’ options (total of 1. 5M). The proposed vesting scheme stipulates a 12-month cliff and linear vesting thereafter. The founders’ shares would vest for 25% on closing and with a linear vesting of 36 months for the remainder shares. Considering the quality and the experience of the founding team, CRV does not want to run the risk that the founders will leave with their equity position after the investment. Laracey feels that vesting of the founder shares is as a signal of mistrust. The founders have already incorporated edocs, Inc. and already own an equity stake in the company. The edocs founders do not want to be tied down by CRV. The founders are already committed to the product and to the company and they are not planning to leave the company. The founders do not need a vesting scheme to stay motivated and committed to the company. Warrants This first financing round against the issuance of Series A Convertible Preferred Stock is for a total amount of $4M. CRV would make an investment of $2M and in line with their general financing model, CRV will also search for one other top-tier venture firm to put in the remaining $2M. If no venture firm is willing to co-invest, CRV will close the gap of $2M. For this additional direct financing, CRV request for 500,000 of warrants (exercisable at $0. 10 per share, duration of 3 years) for common shares. The founders want to protect and maintain their equity stake in the company. This warrant scheme will chip away from their equity position and give CRV cheap warrants. The founders will not want to bear the risk of CRV not finding a co-investor. Anti-dilution and Right of first refusal Anti-dilution provision allows investors to maintain their equity position in the company in light of subsequent equity issances. In case of a weigthed average basis, there is a re-pricing of the investors’ shares in the event that the subsequent stock issuance is at a lower price. In such an event, the conversion price is reset based on an average of all the prices at which the company has sold stock. edocs, a company in its start-up phase, will consider this instrument as an impediment to future financings. In addition to the general anti-dilution provision, CRV proposes a â€Å"pay to play† provision. Based on this provision, stockholders are required to participate in subsequent stock offering in order to benefit from the antidilution protection. Edocs could request removal of this harsh provision since it could scare away future minority investors. Similar to a call option, the investor wants to secure that in the event that one of the founders decides to sell their shares, an offer is made to the investors. This does mean that the founders will have limited freedom to choose future investors in the edocs company. This limited flexibility is worriesome for the founders. However, our recommendation would be to use this provision as small change in their negotiations with CRV. 4. What are the most important terms for Charles River Ventures (Jonathan Guerster)? CRV, i. e. Jonathon Guerster is aware that the market conditions are dictating the need for CRV to act quickly. This is the reason why CRV offered the term sheet right at their initial presentation. Valuation Considering the stage of the product development, the very ambitious business plan and some of the amounts raised by the comparable firms, post money of $10. 5M seems fair from the CRV side. Also, CRV has committed to finance $2M and to shop for another $2M investor for 45 days. Guerster has canvassed bill presentment solution companies and knows that edocs is a possible star, but since he’s a newcomer in CRV and his reputation is at stake, he’s trying to acquire some cheap equity through warrants, rather than, as he’s trying to present to Laracey, a buffer for unsuccessful co-investor search. Laracey as future CEO CRV wants to keep the right to hire a new CEO according to the proposed board representation structure. Laracey has indeed ambition to stay in charge, he has organized and developed with Canekeratne the online billing and payment solution and strategically directed the company by signing several win-win partnership agreements. But at that point, Laracey didn’t have much senior managerial experience, was 33 years old and had no experience in dealing with VCs. If CRV is not satisfied with the work done by Laracey, they want to have an option to place someone more adequate for this position. Antidilution CRV is not demanding a ratchet provision, but instead more company-friendly weighted average provision, but in the same time insisting on a pay-to-play provision. CRV wants to protect itself since edocs will need syndication in subsequent financing rounds, and CRV preference is to act as lead investor, but since in the draft term sheet is not defined how the pay-to-play† provision is going to be restructured, it could range from losing some of the preferential features (participation rights, voting rights, all or a portion of the liquidation preference etc) to complete loss of all preferential rights. Right of First Refusal/Right of Co-Sale It is important for CRV to have a right to participate in any subsequent equity financing either through option of first offer (RoFR) or right to co-sale its shares along with shareholders of Common or equivalent- this prevents dilution, and potential to acquire more of the company, if things go well, and the freedom to sell, if things go poorly. 5. Why would edocs ask for a second term sheet from CRV? If no, why not? If yes, which terms should bechanged in the second term sheet? Taking into account that edocs has just finished its product development stage and given the state of the VC market, it is legitimate for edocs to ask for second term sheet. Adjusted provisions should include: ? Higher valuation. Favorable market conditions, admitted by Guerster himself, are pushing valuations upwards. Strategically, CRV left some wiggle room if it gets into the bidding war for edocs, so Laracey and the rest of the team could hammer out better valuation by shopping the deal to other VCs. Otherwise, the issuance of warrants, stock options, buy-back provisions or other earn in options could sweeten the deal for edocs founders. ? Expulsion of warrants as a method of compensation. The responsibility for not finding a co-investor should lie solely on CRV, and not on edocs and that’s why it’s unacceptable for edocs to give up of 5% shareholding for $50,000. ? Give Laracey a proper chance. Edocs should fight for it’s CEO, since he has showed already outstanding results, and CRV should give him a chance to manage a company.