Outfoxed, Case Study Example

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Case Study

Prior to the first cash investment in Outfoxed, how should the capitalization table have been structured:

If Jake and Jason do not continue with the business?

If Jake and Jason do not continue with the business, the capilization structure should be such that they would be compensated for the analysis, design, and development they had invested into the enterprise. At the IPO, they would retain enough shares to cover the costs incurred during start-up at least. If they are looking to sell-out to Yahoo! In the short run, for example, it would be acceptable business practice to included a profit margin above a simple break-even of the resources invested.

If they commit full time to the business?

If Jake and Jason continue with the business full time, they would negotiate a reasonable number of shares as part of executive contracts. The rest would be in wages and performance bonuses. Within this paradigm, they would still need to assess the cost of start-up and include it as a break-even point, but would estimate salaries based on similar such positions in similar such companies of similar such age.

Be sure to be specific about people and the percentage holding and related number of shares.

See spreadsheet data.

The estimates of initial development costs range between $200,000 to $500,000, and overall startup costs are estimated at $1.5 million. A fair mark-up might be something like 20% to 50% or more. So, resale value of Outfoxed would end up being somewhere between $240,000 to $750,000 minimum if Jake and Jason bailed at the end of development, but based on the market and the initial performance of Outfoxed, it could be far greater. If they saw the venture through the initial start-up process, it would be closer to $1.8 million to $2.3 million.

Explain why you selected these particular cap tables structures.

The reason capitalization structures are manifold. The bottom line, however, is for Jake and Jason to make good on their investment. In the first scenario, the long-term profits of their labor would be lost if they just sold outright, but by retaining an appropriate number of shares, they not only keep part of that benefit but they also cut someone else in at an acceptable price who picks up the costs of operations. In the second scenario, it is the opposite. They keep less of the IPO and subsequent long range benefits but receive more money in the form of salaries and bonuses. It is really a balancing act. So much so in fact that upon further analysis it could be broken down into an equation, where the zero would represenst the intitial development cost and perhaps a logarithmic function to represent the hike in cost as start-up ramped up and a leveling as operations approached its symptotic limit.

Present the cap tables using Excel. (10 points)

See spreadsheet data.

  • What should the pre-money valuation of Outfoxed be at the time of the first investment of cash beyond prize money in the summer of 2006?

$61,800

Why?

It is the amount of cash invested to that point in the form of awards plus a modest profit margin – not a bad start.

  • On the assumption that you personally as an angel or your VC firm will try to invest in Outfoxed, prepare a term sheet for presentation to Outfoxed’s management for the funding of Outfoxed. Utilize the format of the taped presentation on term sheets for guidance on general structure.

Term Sheet

This Term Sheet has been prepared for venture capital investments made at an early stage by “Venture Capital Fund”. The terms have been simplified to match the stage of investment and are offered for consideration and acceptance.

Offer of Investment

The Fund will purchase, together with any syndicated investors, (collectively the “Investors”), common shares (the “Shares”) at a price of $258 per Share. The total round for all Investors will be $750,000 of which the Fund will invest $299,280 to acquire a total of 1160 Shares. So long as the Investors hold their Shares and until a liquidity event, they shall have the right to exchange them for the same kind and class of securities issued by Outfoxed (the “New Securities”) in any follow on financings should such New Securities have rights superior to the Shares. The Investment will be made pursuant to an Investment Agreement made between the Investors, the Company and certain of its principals (the “Principals”). The capital structure on closing will be as described in the attached Share Register.

Board of Directors

The Fund believes that early stage investments need strong mentoring and governance provided by a high quality, engaged Board. On the completion of the investment, the Board will be comprised as follows:

  • a total of five members, being the CEO, one nominee of the Fund and three nominees independent of management that the Company and the Fundagree on; and
  • each director must have made a meaningful investment in the Company.

Share and Option Vesting

The Fund believes that it is important that the Principals’ interests align with the Investors. In this regard the parties agree that all stock options and all nominally priced previously issued shares will vest on the following basis:

  • 50% of the shares will vest daily and linearly over a three year period; and
  • the other 50% will not vest unless and until there is a sale of the Company.

All share and option vesting will accelerate on a sale of the Company. An Escrow Agreement will be entered into to provide for the vesting.

Liquidity Event

To ensure that a return can be provided to all of the Company’s shareholders when an opportunity presents itself to sell the Company, the Fund will require a “drag-along” right be added to the Company’s constating documents to allow the holders of 51% of the issued shares of the Company to cause the sale of all of the shares of the Company.

Reporting to Shareholders

The company will send a CEO Update monthly to all shareholders. Financial statements are also available upon request.

Investor Rights

Investors have the right of first refusal to participate in future financings.

Any changes to the capital structure, new shares, options or debt requires the approval of the majority of the investors in this round.

General

The Company will pay the legal costs of the Fund not to exceed $6,500, plus taxes and disbursements thereon. The Company will keep confidential this Term Sheet and all discussions with the Fund for a period of two years.

Binding Nature

This Term Sheet will terminate on *[date], unless terminated earlier by the Fund. The Company will not seek alternate financing unless and until this Term Sheet has terminated or been terminated by the Fund. The confidentiality provisions will survive termination of this Term Sheet. Acknowledged and agreed to by the Company and by the Fund this * day of *, 200* by: [Signatures]

Give rationales for the specifics of each section of your term sheet. 

The offer is based on the preceding calculations with room for additional investors. We included a section on how the board is to be elected to ensure a fair say in corporate governance but we plan to retain both Jake and Jason. We also made sure there would be at least 50% of the shares retained by the company. A majority of preferred stock vote could initiate a sale. Regular reporting is required of corporate governance so shareholders can monitor the performance of the enterprise over time. Investors are not required to inject anymore money if they choose not to, and we will inject no more than our fair share of legal expenses. Signatures are required to seal the deal.

  • Prepare a capitalization table for Outfoxed that reflects the acceptance of your term sheet. Present the resultant cap table in Excel. (15 points)

See spreadsheet data.

  • What “business model” would you recommend for Outfoxed:
  1. The services to be offered?

Outfoxed user-rating schema is the cornerstone of the entire endeavor.

  1. The revenue model?

We prefer the advertising model.

  • The market(s) to be addressed?

Any and all Web users are our target market – so anything we can do within responsible economic limits to attract a strong user base.

Why?

We opted for the advertising schema over the SuperUser scenario intitially, because during start up, we really do not want to deal with the intricacies or expenses associated with SuperUsers. Nevertheless, the SuperUser secenario is quite viable once Outfoxed acquires sufficient market footing to execute without unnecessarily high risk. Think of it in terms of starting an egg farm. You do not go selling your eggs before you have raised enough hens to ensure a sufficient supply to sell.

For the latter section of this question, would you recommend pursuing multiple “business models” simultaneously or one at a time?

Multiple.

 Why?

Despite what route they take, the mix of capitalization should be somewhat diverse, drawing from each opportunity at least in part. The real question ends up being: What is the most optimal mix of capitalization opportunities based on the above secenarios.

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