Why Would Edocs Ask for a Second Term Sheet? Why Not? Which Terms Should Be Changed in the Second Term Sheet?

5. Why would edocs ask for a second term sheet? Why not? Which terms should be changed in the second term sheet?

Gompers & Sahlman (2002) state that term sheets include letters of intent, are drafted by lawyers, set a precedent, and are not only about money. The business associate of CRV, Jonathan Guerster, requires protection by the inclusion of anti-provisions in the term sheet. Debt and equity are two different type of securities that investors can include in their term sheet in order to protect their investment (Chaplinksy & Triantis, 2009). Therefore, it is important to include control and valuation in the term sheet.

Edocs needs an investment of $4.000.000, while CRV is willing to invest $2.000.000. The preliminary investment term sheet, which can be found in appendix I, shows that the remaining $2.000.000 needs to be invested by an additional mutually agreeable venture capital firm. However, when CRV will not find the commitment of another venture within 45 days, CRV will invest the remaining $2.000.000 as well. In this scenario, we refer to scenario B. If CRV invests $4.000.000 in total, they require a return for a grant of 500.000 warrants for common shares which are exercisable at $.10/share, for the duration of three years. The term sheet shows that the share price is $1.00/share. Scenario B would have a big disadvantage for Edocs, because the founders will lose revenues and equity. In terms of revenues, when CRV will retain 500.000 shares for $.10 for a duration of three years, Edocs will lose $1.350.000 in revenues for the first three years ($0.9 x 500.000 x 3). In terms of equity, the founders would receive 5 million shares, 1.5 million shares would be set aside for employee stock options, and CRV and its additional partner would receive the remaining 4 million shares. In scenario B, CRV will get 500.000 common shares in return which means that the founders will lose 500.000 shares. This implicates that both, the Edocs’ founders and CRV, will have 450.000 shares. Based on the ratio between the valuation of the firm and the investment of CRV, the entrepreneurs should not be willing to give more equity than 38% (4.000.000/10.500.000). This is due to the fact that the founders should not give more equity than the invested part in the organization. When calculating the ratio for the amount of shares compared to the invested capital of CRV in Edocs, the ratio is 42%. Moreover, Edocs will lose control of the firm since they will have the same amount of shares as the investors. Currently, the board of Edocs consists of five board members: Keil (chairman), Laracey (president), Canekeratne (director), Moran (executive vice president), and Crone (director). The term sheet shows that the board of directors increases to six with a new CEO taking additional board seat. Until the new board member is hired, the board will consist of: Laracey who will be the founders’ representative and CEO, there will be one outsider recommended by the founders and acceptable to investors, and one additional outside director, and two representatives of the series A preferred. This means that the only board member that will stay is Laracey, all other board members need to leave the board or apply again. Therefore, the other founders of Edocs will have less control in the firm since Laracey is their representative in a board with five other board members.