Edocs, Managerial Problems Facing Kevin Laracey - Assignment Example

edocs, Inc. -- Brief Overview of the Case This case presents an excellent example of planning to expand business to leverage from the development intechnology at a time in 1998 when opportunities were ripe in communication to change the mode of business from hard copy to soft copy of the billing documents. An online billing system offered the possibility of reducing the cost of billing hugely, as in 1997 $2.4 million was spent on postage for bank statements and bills only through the U.S. Postal service. edocs is in search of a venture capital. Its search ends when a venture company makes an offer to invest $2 million in the business of edocs. The venture company CRV delivers Edocs CEO Kevin Laracey and team the term sheet, promising to arrange another venture capital investment through CRV. Management at Edocs is clueless over the complexity of the term sheet. Managerial Problems Facing Kevin Laracey Kevin Laracey wanted to expand business by including a number of critical stakeholders. Success in raising funds through venture capital was the most critical management issue in the face of severe market competition. Competition and marketing strategy were other leading issues to be managed with dexterity. Leading competitors included MSFDC, Check-Free, and vendors like IBM, Cephas Multimedia and BlueGill Technologies. Managerial Problems Facing Jonathan Guerster Jonathan Guerster, an associate of CRV closes a deal with edocs to invest $2 million and arrange another top-rated venture capital for a total finance of $4million. It was quite challenging to arrange another partner for the equal amount of $2 million after 45 days period. Q1. Evaluate the edocs business opportunities and the edocs team. edocs wanted to leverage the business opportunity of changing the traditional bill and statement production, delivery, and payment by enabling documents receiving through email and web-browsing. Internet offered the possibility of reducing costs on production, delivery, and payment of bills and at the same time changing those documenting into dynamic interactive marketing tools. The HTML format of the documents included hypertext links, animated image files and “clickable” image maps. Files could also be sent in attachments, thus, saving time on updating a finance register. Further technological collaboration with CyberCash offered a system-generated messaging button for payment of bills. Edocs team including Laracey, Canekeratne, and Moran were equally optimistic from the innovation in software product enabling edocs to reap huge benefits for both, the company and the customers. Team was very optimistic that companies using the edocs system could use the bills and statements to help in the cross-selling on the Web. Companies using this product could benefit from differentiation with competitors’ “print only” services. Further, investment in the legacy systems was secure as the edocs system connected seamlessly with the customer companies’ prevalent billing infrastructure. Team at edocs was sure that customer companies would also be benefitted by working cost-efficiently as postage, processing, printing, and finishing costs could be reduced greatly. Q2. How fair is the$10.5 million post-money valuation? The post-money evaluation of $10.5 million seems fair enough at first glance only. A thorough study reveals that CRV would be investing $2million only and in case the second venture is not realized during 45 days, capital of another $2 million would be invested by CRV. It brings the total investment to $4 million. The total figure from founders’ share and employee stock option comes to $6.5 million by totaling founder shares of $5 million and employee stock option of $1.5 million. The total of all contributions reaches $10.5 million, which is the post-money valuation. It is the warrants and option based management incentives that complicate post-money valuation. Fairness of $10.5 million post-money valuation can be evaluated by further analysis of the term sheet only. 3) Evaluate the current term sheet. The current term sheet, as shown in Exhibit 7, reveals that CRV is investing $4,000,000 in Series A Convertible Preferred Stock, with the share price of $1 per share. It expects accrued yearly dividend of $0.08 per share on redemption. Term of redemption is mutual agreement of both Series A Preferred Stock holders, in equal yearly installments from 5 to 7 years including pay back cost with accrued dividend. In case of any merger, restructuring or change of power of edocs, it is stated that cost of Preferred Stock shall be paid first. At the mark of $50 million valuation, the contract of participation of CRV would cease to exist. Preferred and common shares will be realized afterwards on as-converted basis. Regarding conversion, it is stated to be converted into one share of Common Stock at the option of the shareholder. It offers the other automatic alternate of a qualified IPO, limiting the value of each share to $5.00 and further aggregate of $15 million. Regarding Anti-dilution, it is formulated that conversion ratio be adjusted on a Weighted Average basis in the happening of the purchase price less than $1.00. The exceptions not initiating anti-dilution adjustments include stock allotted to employees, consultants, directors or other single stakeholders. Further “pay to play” conditions are envisaged on anti-dilution. CRV further stipulates its right to make Pro rata adjustments for stock splits, combinations, and dividends. On voting rights, it includes the provision of votes on an as-converted basis, but also carries the provision of class vote. The term sheet binds the founders and major employees over Non-Competition and Non-Disclosure and invention agreements with the Company, i.e. edocs. A number of negative covenants have been included to secure the stakes of CRV, such as permission of at the minimum 60% of the outstanding Preferred Stock for dividends on Common; Preferred or Common repurchase; granting loans to employees; offering guarantees; Merger consolidation, sale of near total assets; Mortgage, pledge, or creation of a security interest; Possession of any security by the edocs; causing debt senior to the Series A Preferred Stock; Shift in the main business of edocs; investments in other businesses; capital spend of $250,000 at a time or in aggregate of $500,000 throughout a year. Right of First is kept with the CRV, having a pro rata right as per its share in equity. It keeps the right to refuse ownership of Preferred Stock or it keeps the right to refuse its inclusion in later equity financing of the edocs. The term sheet applies condition on the shareholder of the common equivalent to offer shares first to the shareholders of Series A Preferred if any sale of shares is planned. Participation basis of Series A Preferred shareholders in the sale of common shares would be pro rata, which won’t be applicable to the IPO sale or later. Another important segment of term sheet stipulates Founders’ Stock, with an Option pool of 1,500,000 with 48 months authority, 12-month cliff, and straight vesting later. Founder’s shares are to be resided 25% on closing, with the rest of the authority straightening over a 36-month period, and the not-authorized part under repurchased provisions. edocs has right to repurchase unvested shares in the possibility of job termination. All power residing will advance by 12 months on an acquisition causing in a shift in management. 4) As Kevin or Jonathon, propose an alternative term sheet on which both parties hopefully could agree. Explain the terms you have changed. As Kevin, I would suggest non-cumulative dividends to be paid on the Series A Preferred equal to $1per share of Series A Preferred, as in case announced by the Board. In the CRV term sheet, cost of Preferred Stock was to be paid first. The agreement with CRV was to be terminated at the valuation of $50 million. In stead of participation going away on matching to $50 million, I would propose the alternative of full participating Preferred Stock. A liquidation preference proceeds should include payment of Original Purchase Price along with accrued dividends, and declared and unpaid dividends on all shares of Series A Preferred. After that, the Series A Preferred should participate with the Common Stock pro rata on an as-converted basis. This would be a balanced approach, facilitating consideration for the Common Stocks. Regarding voting rights, in the interests of common stock, their number should be increased or decreased with the permission of both, Preferred and Common leading Stock, voting collectively as an individual type, and without a split class vote by the Common Stock. This way, edocs would be in a better position to do justice with the stakes of Common Stock. Term that is recommended to be changed on voting rights had the provision of votes on an as-converted basis, with the added provision of class vote. Regarding employee options to be vested in case of job termination, I recommend them to vest on the same lines as that of the founders; 25% to be vested after one year while the rest of the shares to be vested each month till the next 36 months time. An undistributed option pool of employee share can be created who are no more with the company just before the Series A Preferred Stock investment. The CRV term sheet had provided edocs the right to repurchase unvested employee shares with the time period of only 12 months. It will release the thread on time rigidness, which is not going to impact negatively in any way the stakes of CRV. My recommendation in the interest of edocs over Right of First, Refusal, and Take-Me-Along include offering the first right to edocs and second to CRV regarding First Refusal in relation to the shares of capital stock of edocs to be transferred by edocs management. In the CRV term sheet, the Right of First is vested with the CRV, on the pro rata basis, depending on its share in equity. It had stipulated the right to refusal of ownership of Preferred Stock or the right to refuse its inclusion in later equity financing of the edocs. CRV term sheet cannot be stated to be considerate to the interests of the edocs founders and employees. My recommendations will balance the interests of edocs. Work Cited Case Study Gompers, Paul A . edocs, Inc. (A). Harvard Business School. 5 September 2001. Read More