Drexel University Final Negotiation Exercise for Entrepreneurial Finance Paper After read the Harvard business case, then please fill out the Pre-Negotiati

Drexel University Final Negotiation Exercise for Entrepreneurial Finance Paper After read the Harvard business case, then please fill out the Pre-Negotiation form the excel and explain each of the choices you pick in a separate word document. As we have discussed several times this quarter, the Founder – VC relationship is a long-term partnership. As such, you need to balance the value of the deal terms being negotiated with the necessity of preserving a healthy long-term business relationship. This negotiation is an ideal setting to discern how future conflicts will be resolved. A scorched earth negotiating strategy will poison the relationship. You need to pay specific attention to ensuring the future of the relationship, but not at a disproportionate cost to the immediate stakes (e.g. the deal terms). This is called a “Balanced Concerns” type of negotiation.To reach an agreement you will need to concede on certain issues. While you should not share specific point information on a given issue, you can indicate which issues are most important to you and you can make it clear when the other side is taking a position that is a deal-breaker for you. For the exclusive use of Y. Luo, 2020.
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Aerospace Investment: Balancing Venture and Relationship
Capital
Confidential Instructions for the Founder
Scenario
You founded the company Earth Escape four years ago with the intent of revolutionizing
the public space travel industry. Earth Escape has made excellent progress as you have
personally led the development of a reusable launch vehicle (RLV) that drastically
reduces the cost and risk of suborbital space flight. Also serving as the company’s Chief
Executive Officer (CEO), you are now seeking $100 million of funding to build a small
fleet of six RLVs and develop the company infrastructure necessary to begin offering
tours of space to the general public.
You are particularly interested in receiving funding from a venture capital (VC) firm
named Aerovent Capital. You believe the firm would offer significant added value
through its focus on the aerospace industry and excellent dedication to working with its
portfolio companies. You have met with a general partner of the firm several times now
and are ready to discuss a term sheet. During this negotiation you will discuss the most
significant terms of the potential investment. If this negotiation is successful, the agreed
upon terms will provide the basis for a detailed term sheet to be signed later this week.
You are extremely interested in receiving venture capital from Aerovent and the wealth
of expertise that would come along with it. However, you realize that if you cannot
agree on terms that protect your interests in Earth Escape while developing the
foundation for a strong working relationship, you will abandon the deal and seek
funding elsewhere.
This simulation was written by Nicholas Sabin, who gratefully acknowledges its genesis in Professor Edward Bergman’s Negotiation
and Dispute Resolution course of the Wharton School’s Department of Legal Studies and Business Ethics. Copies are available from
the Teaching Negotiation Resource Center (TNRC), online at www.pon.org, by email: tnrc@law.harvard.edu, or by telephone at 800258-4406. This case may not be reproduced, revised or translated in whole or in part by any means without the written permission
of the TNRC Coordinator, Program on Negotiation at Harvard Law School, 501 Pound Hall, Cambridge, MA 02138. Please help to
preserve the usefulness of this case by keeping it confidential. Copyright © 2007, 2010, 2019 by the President and Fellows of
Harvard College. All rights reserved. (Rev. 06/19)
This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
Background on Earth Escape
Before founding Earth Escape, you worked at multiple aerospace corporations as a
management and engineering R&D (research and development) professional for over 25
years. You have always specialized in launch vehicle development, and you finally left
your corporate job four years ago to dedicate yourself to developing a reusable launch
vehicle that would make suborbital space travel economically realistic for the general
public.
Your company is now the sole owner of your proprietary design for a revolutionary type
of RLV. Though other companies are also seeking to advance the space tourism market
through suborbital flight, no other company has addressed the financial and safety
issues of suborbital flight as authoritatively as Earth Escape has.1 As a comparison, you
firmly believe that your design will immediately make the suborbital space tourism
industry significantly safer than the commercial airline industry was during its early
years of the late 1920s. Development and testing has gone smoothly as the RLV has
undergone 15 tours of space to date. You have even begun selling a limited number of
tickets on these flights to individuals eager enough to partake in these early tours and
able to afford the purposely exclusive ticket price.
The RLV offers its passengers a truly unique tour of space by taking off from a standard
runway, exiting the earth’s atmosphere and entering outer space for approximately
twenty minutes at a peak altitude over 100 miles above the earth’s surface, and
returning to the same runway with a round trip time of only two hours. The exclusive
perks of the flight include the weightlessness of outer space, a life-changing view of the
earth from afar, and acknowledgment as a true astronaut.
When you were founding the company four years ago you arranged for enough startup
capital from a few wealthy individuals interested in space exploration to fund the
development of your RLV. They generously invested approximately $23 million in
exchange for common stock in your brainchild. Your company currently employs 35
individuals, but you have plans to create a much larger organization. You are seeking
$100 million in venture capital to advance Earth Escape to the next stage of its
development, i.e. offering suborbital space tours to the public with a small fleet of six
RLVs. Further in the future, you believe that Earth Escape could be the leader of a billion
dollar space tourism industry offering flights to thousands of new “astronauts” every
year.
1
Note that the risks and challenges of orbital space flight are significantly greater than those of suborbital
space flight. You estimate that orbital flight is currently at least 10-20 times as costly as suborbital flight
due to the additional speed and energy requirements of launching a vehicle into the earth’s orbit.
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2
This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
Alternatives to a Negotiated Agreement
In the last two weeks you have also begun discussions with two other venture capital
firms. They seem interested in Earth Escape, but you have not sat down to negotiate the
terms of an investment with them yet, as you are about to do with Aerovent Capital.
You think they may have the means to offer competing term sheets, but you honestly
do not believe they can match the value Aerovent Capital can add through its reputation
and expertise. Though you may gain leverage by generally mentioning the interest of
other VC firms, you have been warned by other entrepreneurs not to divulge the
specific names of the venture firms you are seeking competing term sheets from. A
disastrous result can occur if the “competing” VC firms contact each other and negotiate
a single term sheet that destroys your leverage and leaves you with a single take-it-orleave-it-offer.2
Considering the potential term sheets you may receive from the other venture capital
firms that have shown interest, you have quantified your Best Alternative To a
Negotiated Agreement (BATNA). You may accept a minimum of 45 substantive points. If
you can not reach an agreement with Aerovent that meets your acceptable minimum,
you would prefer to pursue opportunities with other venture capital firms.
Earth Escape’s Process Interests
You would be extremely disappointed if your negotiation with Aerovent leaves you with
the impression that the partners view your company just as an opportunity to make
another quick financial return. You are interested in an investor who you can trust not
to sacrifice the long-term health of the company for short-term profits. You are aware
that a VC does not require overt control of a company to greatly impact its future. You
hope to avoid any future power struggles over Earth Escape by finding a venture capital
firm that you can trust even in situations when you strongly disagree over governance
issues.
This negotiation is the ideal setting to discern how future conflicts will be resolved. You
realize that your expectations should not be one-sided though. You will have to invest in
the future of this relationship just as actively as the venture capitalist. Your process
goals are to establish an open flow of communication based on mutual respect and to
understand the primary interests underlying Aerovent’s positions. By standing by
commitments made and negotiating fairly, you hope to convince the venture capitalist
that you are interested in as equitable a process as possible and that the opportunity to
work with Earth Escape should not be neglected. You hope that you can achieve such
process goals while agreeing to a term sheet that champions your interests in Earth
Escape.
2
See Cardis, Joel, et al. Venture Capital: The Definitive Guide for Entrepreneurs, Investors, and
Practitioners. New York: John Wiley & Sons, 2001. p. 195-196.
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This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
To gauge your ability to achieve your process goals, the VC will complete a process
evaluation based on his or her experience during the negotiation. The evaluation will be
filled out after an agreement has been reached, but before any confidential information
is shared. Specifically, you will be scored on the following five process attributes:
• Trust: How much does the VC trust you?
• Respect: Did the VC feel respected during the negotiation?
• Equitability: How fair does the VC believe the process was?
• Regard for Other’s Interests: How much did you attempt to understand the VC’s
interests?
• Interest in Future Collaboration: How interested is the VC in working with you in
the future?
You will receive a score from 0 to 10 for each of the attributes for a potential total of 50
Process Points. The Process Points you receive will be added to your Grand Total Score.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
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This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
CONFIDENTIAL
Negotiable Terms for the Founder
The following confidential information regards eight negotiable terms you will discuss
with the venture capitalist.3 The terms may be negotiated in any order. A confidential
score sheet is also included, which breaks down the specific point values for each term.
Use this score sheet to record the agreed terms of your negotiation and to calculate
your total score. For the purpose of this simulation, you must abide by the scoring
restrictions.
The point values for each term are based on the totality of your interests, e.g. financial
concerns, risk profile, personal preferences, etc. Note that if the specified minimum
terms are not agreed upon as outlined in the instructions (unacceptable terms are
reiterated as “No Deal” on the score sheet) or the substantive BATNA is not reached,
you will not proceed with the entire investment. Do not show any of your confidential
instructions to the venture capitalist.
Term #1: VC Equity Percentage
Aerovent Capital will receive equity in Earth Escape for the $100 million investment. You
would like to give as small an equity percentage to the VC as possible. In your previous
meeting with the VC you both agreed that a $100 million investment is the appropriate
amount to help Earth Escape reach the next stage of its development. To determine an
approximate percentage of the equity the VC deserves you have considered your
valuation of Earth Escape. The equity percentage and valuation are related such that the
higher the valuation you attach to the company, the smaller the equity percentage the
VC deserves for the fixed $100 million investment.4
You have used a number of techniques to objectively value Earth Escape. From a variety
of detailed revenue projections and comparisons to other aerospace companies, you
have concluded that Earth Escape deserves a post-investment valuation between $250
and $300 million. In which case, Aerovent Capital would receive between 33% and 40%
of the company for its $100 million investment.5 Your analysis has shown situations in
which the company could be valued even more aggressively. Overall, you think an
equity percentage between 33% and 40% more than fairly compensates Aerovent
because the firm could easily earn a multiple of ten return on its investment in five years
if the company develops as planned. Furthermore, the company has already grown
through its most vulnerable stage by developing a launch vehicle that has proven to
surpass all industry standards. Now, it is just a matter of implementing the business
plan.
3
Additional terms of the investment will not be considered during this negotiation. For the purpose of this
negotiation it can be assumed that any terms not scored will be in accord with Aerovent Capital’s standard
term sheet.
4
Valuation in this sense refers to “post-money valuation” and relies on the venture capital industry
standard of assuming all stock issued is common stock for simple valuation purposes.
5
Assume percentages of the company are on a fully-diluted basis post-financing.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
5
This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
Though you may be willing to negotiate a higher VC percentage than 40% in exchange
for other terms in your favor, you do not want to give up shareholder control of your
company. Earth Escape’s bylaws detail that for governance issues requiring a
shareholder vote, a simple shareholder majority is required for approval.6 You have built
Earth Escape from the ground up and you strongly oppose giving control to a VC at this
point in the company’s development. Therefore, you are extremely hesitant to accept
any term sheet that gives the VC 50% or more of the company’s equity. The lower the
VC equity percentage you can negotiate without damaging the future relationship the
better.7
Term #2: Type of Stock
You also must agree on the nature of the security Aerovent Capital will receive for its
investment. You are considering three forms of stock for Aerovent’s equity share:
common, convertible preferred, and redeemable preferred.
You would prefer to issue Aerovent common stock. Up to this point, all investors in
Earth Escape have received common stock and you would like to maintain equality
among the investors. Common stock would give Aerovent no liquidation or conversion
preferences. However, you would be willing to concede common stock because you
expect that Aerovent will be highly resistant to investing without preference, and you
are more concerned with other terms.
Your second choice is to issue Aerovent shares of convertible preferred stock. In the
event of a liquidation, convertible preferred shares would give Aerovent the right to
recoup the full value of its investments from the liquidation proceeds before you or any
of the other holders of common stock receive anything. Furthermore, Aerovent would
have the option of converting its preferred shares into common stock, which the firm
would likely do if the value of its equity share exceeds its initial investment.8 You would
rather issue common stock, but convertible preferred is acceptable to you because you
are highly confident that the value of Earth Escape is going to increase such that
Aerovent would convert its shares to common stock anyway.
The stock you would least like to issue is redeemable preferred.9 Shares of redeemable
preferred would overcompensate the VC by allowing the firm to double dip into Earth
Escape’s proceeds. Aerovent would be allowed to fully redeem its initial investment in a
liquidation event and also take its full equity percentage of any remaining proceeds. You
6
Regardless of the type of stock agreed upon in Term #2, Aerovent shall have shareholder votes
representative of the Term #1 VC Equity Percentage and shall vote as a class with all holders of preferred
and common stock. Note that you will negotiate Aerovent’s representation on the board of directors as a
separate term.
7
You may use the company’s valuation to negotiate this term, but settle on the specific equity percentage
for the venture capital firm.
8
Assume a one to one conversion ratio.
9
Redeemable Preferred stock would be issued along with common stock equal to the agreed upon VC
equity percentage.
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This document is authorized for use only by Yawen Luo in FIN335 Spring – Founder taught by Raymond Liguori, Drexel University from May 2020 to Jul 2020.
For the exclusive use of Y. Luo, 2020.
Aerospace Investment: Confidential Instructions for the Founder
find it unreasonable that in the event Earth Escape does well for all its investors,
Aerovent would be allowed to essentially get its money back and keep its investment.
Term #3: Dividends
You have already established with Aerovent Capital that paying cash dividends while
trying to grow an early stage company is unreasonable. However, the option of granting
dividends payable in equity (commonly referred to as payment in kind) that accrue until
a liquidation event still remains. You think that Aerovent should be satisfied with its
basic equity percentage and concentrate more on increasing the value of Earth Escape
for all its investors.
Furthermore, overcompensating the VC with equity may misalign incentives with the
other stock holders. If Aerovent receives too much of Earth Escape’s equity, it will
actually be a detriment to Aerovent because the employees and other stock holders of
Earth Escape will be overly diluted and their incentives diminished. If you choose to
grant dividends, negotiate them as a percentage per annum of the original VC owned
equity and aim to keep them as minimal as possible.10
Term #4: Antidilution Rights
You will also discuss antidilution rights for Aerovent.11 An antidilution provision can be
included to protect the VC’s equity interest in the case of additional rounds of financing.
The provision you will be discussing is the VC’s right of first refusal. If Earth Escape
requires additional capital in the future, the right of first refusal would give Aerovent the
right to buy the additional shares of equity before they are offered to another party.
Some CEOs in your position might prefer to limit a VC’s future investing rights as much
as possible, but you would actually prefer Aerovent to have the right of first refusal. It
seems reasonable to you that the VC have the right to reinvest before the option is
given to additional investors. You also stand to benefit from Aerovent maintaining a
strong equity position with Earth Escape. You realize that if Aerovent’s equity is overly
diluted, the firm is less likely to consider your company a priority for Aerovent’s nonfinancial resources. Additionally, you hope to build trust with the VC by agreeing to a
right of first refusal. You must negotiate this term as either “VC Right of First Refusal” or
“No Antidilution Rights.”
Term #5: VC App…
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