Trendsetter Inc. Case Study

Sam Wasserman

Trendsetter Inc. Case Study

Fin 457        

1.         When it comes to the two term sheets offered by the Venture Capitalist firms, there are many differences and similarities. Starting with the valuation each VC firm gives to Trendsetter Inc., both Alpha and Mega plan on investing $5 million in the company, Alpha has a higher pre-money valuation, valuing the company at $7,350,000, while Mega values it at $7,000,000. Because of that, Trendsetter also receives a higher implied owner value ($12,350,000 with Alpha compared to $12,000,000 with Mega). Another difference between the two offers is the number of investors. By taking Alpha’s investment, Trendsetter would receive money from two VC funds and one “Other Investor”, whereas with Mega it would only be taking money from one investor. This has pros and cons for the founders. Only having one investor could make it easier to work with them and make sure they are satisfied with their investment. On the other hand, having more than one investor would limit each investor’s influence on the firm.

        The two term sheets also greatly different when it comes to the escrow clause and the employee option pool. Alpha has an escrow clause where 501,253 Series A convertible shares will be held in escrow and not issued unless the company fails to reach a revenue of $500,000 for the year 2000. This shows a lack of trust from Alpha towards the company, as this gives them the opportunity to decrease their ownership in the company if Trendsetter performs poorly in their first year. For the employee option pool, Alpha assigns 3 million shares to the pool, and Mega only designates 2.5 million shares to the pool (with 929,889 of those options being subject to previously granted options). Alpha’s terms provide a better option for Trendsetter and will be able to attract talent and employees through this higher reserve of available shares.

Dividends are another aspect of the term sheets where the VC funds go in very different directions.. Under Alpha’s terms, Series A Preferred would be entitled to noncumulative dividends in an amount of $0.08 (in preference to dividend on Common Stock). With Mega, the Series A Preferred would receive dividends accruing at 10% after the first year, but only up to 25% of the purchase price. These dividends would only be payable if declared by the board or at liquidation. In addition, under Mega’s terms, Common Stock shareholders would only be able to receive dividends if 60% of the outstanding Preferred shareholders agreed to it. In this case, Mega’s terms are unfavorable to Trendsetter as they set pretty high requirements on the firm and limit future possibilities of dividends for the founders and other Common Stock shareholders.

2.        Without the ability to negotiate any of the terms in the two offer sheets, Trendsetter would most likely accept the offer from Mega. The main reason for doing so is because it is a more conservative offer built to ensure the founders’ equity position in the long run. The first justification is tied to the control of the Board of Directors. The two offers deal with the board similarly except for the escrow clause Alpha included. In this case, if the escrowed shares are released, the VC will have the option to replace one board member without Wendy and Jason’s input.