11 KiB
The Deal on the Table
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The Deal on the Table
_After talking to virtually every venture capitalist in the business, in May of 1984 it appeared that we were finally going to close a deal. Frank Chambers, who had been introduced to us by Jack Stuppin, indicated that he was willing to make an investment in our company. Despite our cynicism, born of endless tiresome and fruitless meetings which consumed our time when it was desperately needed to develop the company, we were eager to obtain funding we could apply to increase our marketing efforts and seize the market before better-funded competitors entered the fray.
Mike Ford described the situation as ``being in a verdant field with gold bars lying all around. The question is how many can we throw in our pickup truck before a big vacuum cleaner comes down from the sky and sucks them all up.'' In essence then, being greedy and aggressive suckers ourselves, we wanted the cash to nail down the largest possible market share while we still could.
After numerous and lengthy discussions, Frank Chambers communicated the terms of the deal. What follows is a transcription of Dan Drake's notes taken while hearing the terms over the phone, with annotations explaining what the terms mean. _
Terms I: Frank Chambers
- $500-700K. Size of the investment in dollars. This would represent about 1/10 of the company.
- $2 preferred, convertible to 1 share common. The investment would be preferred stock, so that if the company failed the investor would get his money from the remains before any of the common shareholders. The stock could be converted to common stock at any time. This is conventional in venture capital deals.
- If not liquid in 4 1/2 years, we offer to repurchase at 2x price (plus accrued dividends). If the company did not go public or get acquired, thus providing an opportunity for the investor to ``cash out'', we would buy back the investment at twice its original value.
- 8% dividend from 2/1/85; with majority of preferred holders or the board able to substitute change in conversion ratio. We would pay this dividend from the company's earnings. If we didn't have the earnings to pay the dividend, the foregone income would be used to increase the venture capitalist's ownership share of the company. Most venture capital deals work this way, but it's unusual to have the dividend start so soon after the deal.
- One demand registration, unlimited piggyback. The investor could, at will, demand that we make a public offering in order to enable him to cash out his stock. The company would bear all of the costs of the public offering. In this, or any other offering the company made, the investor would be able to sell his shares ``piggyback'', up to the total amount of the shares owned.
- Options.
- 110,000 at $.75.
- Remainder at least $2 + 5% per 6 months.
- Dilution protection, unspecified, above 500,000 options.
- Vesting at least 4 years.
- Forfeited options are canceled, not returned to pool.
- Board of directors. 7 people: preferred elects one, one by agreement of preferred and common shareholders. Jack Stuppin to be on the board. Advisory committee to the board up to 3 people chosen by the investor.
- Representative of preferred investor approves: ``All compensation matters'', and all capital expenditures over $25,000.
- John Walker: key man insurance $500K; employment contract, 2 years, non-competition.
- Frank Chambers approves investors.
- Preferred has first refusal on private equity offerings.
_We didn't like it. While many of the terms were conventional and were what we expected, several totally unexpected constraints on our ability to develop the company in the way that had brought us to the present point were contained in the deal. In particular, our ability to grant stock options to new employees was severely constrained by limits on the number available, by forcing the option exercise price to above the price paid by the investor (who received much better terms on his preferred than the employee would on his common stock), by retiring from the pool any options granted to an employee who subsequently left the company, and by imposing a four-year vesting period on all options, which the founders of the company felt transformed the options from their original purpose of allowing employees to share in the company's success to a kind of twentieth century indentured servitude which compelled employees to stay with the company or face forfeiture of their financial gains.
We also thought that the general tone of the deal was far from consonant with the percentage of the company being purchased and the demonstrated performance of the company to date and the track record of its managers. But we still wanted the cash. So...we came back with the following suggested terms. _
Terms II: Us
- $500-700K.
- $2 preferred.
- Repurchase at 1.5x if not liquid in 4 1/2 years; call on preferred at $4 + 20% per year. The call provision would allow us to forcibly buy out the investor for twice the investment plus an increment of 20 percent per year. This was meant to be symmetrical with the repurchase provision benefiting the investor.
- 8% dividend from 2/1/85; reduction in conversion price on missed dividend. This is equivalent to the original requested terms, just more lucidly put.
- One demand registration if proceeds exceed $X, X >= $5 million?
- Options: dilution protection by issuing proportional shares at the same price as exercised options. Vesting set by board when option issued. No cancellation of forfeits--return to pool.
- Board of directors. 7 people: preferred elects one, common elects 6.
- Ceiling on executive salaries and bonuses until some numbers (sales and profit) achieved; override by preferred representative. Preferred representative approves capital expenditures over $100,000.
- John Walker: key man insurance; contract, no non-competition. Being an ornery S.O.B., I said that signing a non-competition agreement with a company in which I was the largest shareholder was beneath my dignity and that I wouldn't do it. Moral: don't pick an asshole to be president of your company.
- Frank Chambers approves investors, but present stockholders can buy in subject to $ ceiling and regulatory problems. We didn't want the venture capitalist to be able to veto further investments by people who got in before he did.
- In general, the constraints have drop-dead provisions. This meant that every constraint on our freedom to run the company would expire when we reached some well-defined performance milestones.
_He didn't like it. So, we got together and attempted to come up with another offer which would be acceptable. Here it is. _
Terms III: 5/10/84
- $500-700K.
- $2 preferred, convertible.
- Repurchase terms OK (?) We acceded to the original terms.
- Forced conversion if we get to $10 million (?) annual sales and $1 million annual profit or make a public stock offering over $5 million.
- One demand registration, piggyback, after 1/1/87 for >$5 million.
- Options: 100,000 shares at $.75, 200,000 shares at $1.60, 200,000 shares at $2.00, 200,000 shares at $3.00, 200,000 shares at $4.00. Majority of each class of stock to approve any new plan. Vesting at best 50-25-25 after the first 100,000 shares. This meant that after the first 100,000 shares of options (which were committed to fulfilling options we'd already granted to people), those who received options would receive 50% of their shares the first year, 25% the second year, and 25% the third year. Forfeited options return to pool.
- Board: ask Chambers*, Ellison, Stuppin. (? Unsettled). What are the terms on paper?
- If not on board, an advisor.
- $75,000 ceiling on officer and director salaries. Override by 6 or 7 directors.
- $25,000 on capital expenditures. Override how?
- John Walker: key man insurance; employment contract to ``devote substantially all his time''.
- Frank Chambers approves investors. Common holders can buy in (n.b. might have to keep it intrastate to avoid sophisticated investor problems). Since people who joined the company in the beginning and worked themselves to exhaustion to build it to the point that venture capitalists were interested in investing were not ipso facto
qualified'' to risk their savings by investing in their own company since they were not already wealthy. This is an example of what was referred to in the 1980's as theopportunity society''. - First refusal on private equity offerings.
_After these terms were presented, it was clear that we would never come to an agreement on the issue of awarding stock options to employees to give them a real stake in the company's success. In addition, the overall flavour of the deal seemed to us totally inappropriate for a company which was, at the time of these negotiations, generating sales equal to the size of the deal every month and generating after-tax profits close to the size of the deal every quarter.
We couldn't believe that this was the best deal obtainable for venture funding of the company, and we were inclined to ask around to see if this was reasonable. But, our Distinguished Financial Advisor informed us that this would constitute
shopping the deal'' whena deal was on the table'' which was right out by the genteel standards of the venture community, and that he could not countenance such unrefined behaviour (notwithstanding the fact that in the real world this kind of collusion is called ``conspiracy in restraint of trade'' and people go to jail for it).So, after a brief weekend meeting in which we discovered we all agreed on the obvious conclusion, we decided to graciously decline this generous offer of funding and carry on with our own resources. Upon hearing this decision, Jack Stuppin said that if we didn't take this deal, he did not wish to be a shareholder and wanted us to buy him out. Not wishing to deplete our treasury, we declined. In not accepting our terms, which differed from his original proposal primarily in issues of philosophy, not money, Frank Chambers chose to forgo an investment of $500,000 which, if held until the stock price hit its 1987 high, would have appreciated to more than $37 million. _
_Peter Barnett drew this geological strata illustration in 1984 to demonstrate the multiple dot and dash line types introduced in AutoCAD 2.0. The drawing doesn't represent any real geological formation--it was made up out of thin air, not hard rock. It has been used as a sample drawing from AutoCAD 2.0 to date. _
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Editor: John Walker