PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 919 N. Market Street, Suite 1500 Wilmington, DE 19801
MEMORANDUM
Matter No.: 1009-00002
FROM: Robert Jansen, Lead Associate, and Amy Chesterton, Working Associate, Calderwood & Harkness LLP
TO: Miriam Calloway, Responsible Partner, Calderwood & Harkness LLP; Naveen Raghavan, Co-Founder & CEO, Skybridge Fintech Ltd.
DATE: June 10, 2022
RE: Preferred Stock Capitalization Analysis and Liquidation Waterfall — Series B Preferred Stock Financing of Skybridge Fintech Ltd.
I. EXECUTIVE SUMMARY
The purpose of this memorandum is to provide Skybridge Fintech Ltd. ("Skybridge" or the "Company") and issuer's counsel with a comprehensive analysis of the post-Series B preferred stock capitalization structure, liquidation waterfall mechanics, anti-dilution protections, and option pool expansion in connection with the proposed $45,000,000 Series B Preferred Stock financing (the "Series B Financing" or the "Financing") led by Granite Peak Ventures, LP ("GPV"). This memorandum is intended to serve as a working reference document for the transaction team, the Company's founders and management, and the responsible partner at this firm, and to identify key structural features, economic consequences, and potential areas of concern arising from the capitalization structure as it will exist following the closing of the Financing.
The Series B Financing contemplates aggregate gross proceeds of $45,000,000, to be invested at a price per share of $6.00, resulting in the issuance of 7,500,000 shares of the Company's Series B Preferred Stock to three institutional investors. The lead investor in the Financing is GPV, which is committing $30,000,000, representing approximately 66.67% of the round. Ridgeline Capital Partners, LLC ("RCP"), the Company's existing Series A lead investor, is investing an additional $10,000,000 in the Series B round, exercising its pro-rata participation right and receiving an additional allocation. Solstice Growth Fund I, LP ("SGF"), a new co-investor, is committing $5,000,000 to the round.
Based on the agreed-upon pricing, the pre-money valuation of the Company is $140,400,000, calculated on the basis of 23,400,000 pre-money fully diluted shares multiplied by the $6.00 per-share Series B price. The post-money valuation is $185,400,000, reflecting the sum of the pre-money valuation and the $45,000,000 in new capital. Following the closing of the Financing, the Company will have 30,900,000 shares outstanding on a fully diluted basis, inclusive of all outstanding equity, outstanding options, and shares reserved for issuance under the Company's equity incentive plan (including an increase to the option pool as described herein).
The aggregate senior liquidation preference across all outstanding series of Preferred Stock following the closing will be $56,500,000, comprising $45,000,000 attributable to the Series B Preferred Stock, $10,000,000 attributable to the Series A Preferred Stock, and $1,500,000 attributable to the Series Seed Preferred Stock. Each series of Preferred Stock carries a non-participating preferred structure, meaning that upon a liquidation event, each series of Preferred Stock will receive the greater of (a) its 1× liquidation preference per share or (b) the amount such holder would receive if such holder had converted its Preferred Stock into Common Stock immediately prior to such liquidation event and participated on a pro rata basis with the holders of Common Stock. This non-participating structure precludes the "double dip" associated with participating preferred arrangements and is generally more favorable to Common Stock holders (including the Company's founders) at mid-range exit valuations, as discussed in detail below.
The transaction documents are based on the model legal documents published by the National Venture Capital Association ("NVCA") (2020 edition), with customizations specific to this transaction. The principal documents include an Amended and Restated Certificate of Incorporation (the "A&R COI"), a Series B Preferred Stock Purchase Agreement, an Investors' Rights Agreement, a Right of First Refusal and Co-Sale Agreement, and a Voting Agreement. Signing and closing of the Financing are expected to occur simultaneously on or about July 18, 2022. The A&R COI will be filed with the Delaware Secretary of State upon the funding of the Financing.
This memorandum addresses the following topics in detail: (i) the Company's pre-Series B capitalization (Section II); (ii) the terms and investor allocations of the Series B Financing (Section III); (iii) the post-Series B capitalization on a fully diluted basis (Section IV); (iv) a comparative summary of the rights, preferences, and privileges of each series of Preferred Stock (Section V); (v) the option pool analysis, including the pre-closing increase (Section VI); (vi) a comprehensive liquidation waterfall analysis across multiple exit scenarios (Section VII); (vii) an analysis of the weighted-average broad-based anti-dilution protections applicable to each series (Section VIII); (viii) a discussion of the implications of the non-participating preferred structure (Section IX); (ix) post-closing board composition and governance considerations (Section X); and (x) key observations and recommendations for the Company's founders and management (Section XI). We also set forth the assumptions and limitations underlying this analysis (Section XII) and a list of exhibits and attachments (Section XIII).
II. PRE-SERIES B CAPITALIZATION
This Section sets forth the Company's capitalization as it exists immediately prior to the closing of the Series B Financing. The capitalization data presented below has been compiled from records provided by the Company's management, confirmed against transfer agent records maintained by Ledgermark Transfer Services, Inc., and cross-referenced to the Company's audited financial statements for the fiscal year ended December 31, 2021, as prepared by Whitfield & Hesse CPAs LLP. We have assumed the accuracy of such records without independent verification.
A. Common Stock
The Company's existing Certificate of Incorporation, as amended, authorizes the issuance of 30,000,000 shares of Common Stock, par value $0.0001 per share. As of the date of this memorandum, 12,400,000 shares of Common Stock are issued and outstanding. The holders of the outstanding Common Stock, and their respective holdings, are as follows:
Naveen Raghavan, Co-Founder & CEO: 4,200,000 shares. Mr. Raghavan co-founded the Company in 2018 and has served as Chief Executive Officer since inception. All of Mr. Raghavan's shares are fully vested and not subject to any repurchase right or forfeiture condition.
Claire Whitmore, Co-Founder & CTO: 3,800,000 shares. Ms. Whitmore co-founded the Company in 2018 and has served as Chief Technology Officer since inception. All of Ms. Whitmore's shares are fully vested and not subject to any repurchase right or forfeiture condition.
David Okonkwo, Chief Financial Officer: 600,000 shares. Mr. Okonkwo joined the Company in January 2021 and received a restricted stock award of 600,000 shares in connection with the commencement of his employment. Mr. Okonkwo's shares are subject to a four-year vesting schedule with a 25% cliff vest on the first anniversary of his start date (January 2022, which has been reached), with the remaining 75% vesting monthly over the subsequent thirty-six months. As of the date of this memorandum, approximately 225,000 shares have vested (150,000 cliff shares plus approximately 75,000 shares vesting monthly through June 2022). Unvested shares remain subject to the Company's right of repurchase at cost upon termination of Mr. Okonkwo's employment.
Remaining Common Stock holders: 3,800,000 shares are held by various employees and early advisors who received equity grants in connection with the Company's founding and early development. These shares are held by approximately fifteen individuals, the majority of whom received their shares through restricted stock awards or exercises of early stock options. Detailed holder-by-holder information is set forth in Exhibit A.
B. Series Seed Preferred Stock
The Company issued its Series Seed Preferred Stock in August 2018 in connection with the Company's initial seed financing. The terms of the Series Seed Preferred Stock are summarized as follows:
Shares outstanding: 3,000,000 shares of Series Seed Preferred Stock.
Original Issue Price ("OIP"): $0.50 per share.
Aggregate investment: $1,500,000.
Closing date: August 10, 2018.
Holder: The sole holder of the Series Seed Preferred Stock is Harborview Seed Investors LLC ("HSI"), an angel syndicate vehicle managed by Elliott Yun. HSI holds 100% of the outstanding Series Seed Preferred Stock. Mr. Yun formed HSI to aggregate commitments from a group of approximately twenty individual angel investors for the purpose of making a single, consolidated investment in the Company's seed round. HSI does not have a Board seat and does not hold any other class of the Company's equity securities.
Dividend rate: 6% per annum on the OIP, non-cumulative, payable when, as, and if declared by the Board of Directors. No dividends have been declared or paid on the Series Seed Preferred Stock since the date of issuance.
Conversion ratio: Each share of Series Seed Preferred Stock is convertible into one share of Common Stock at the option of the holder at any time (i.e., a 1:1 initial conversion ratio). The conversion ratio is subject to adjustment upon the occurrence of certain anti-dilution events, as described in Section VIII below.
Anti-dilution protection: Weighted-average broad-based, as described in Section VIII.
Liquidation preference: 1× non-participating. Upon a Deemed Liquidation Event, each holder of Series Seed Preferred Stock is entitled to receive, in preference to the holders of Common Stock, an amount equal to the OIP ($0.50 per share), or, if greater, the amount such holder would receive if the Series Seed Preferred Stock were converted to Common Stock immediately prior to such event.
C. Series A Preferred Stock
The Company issued its Series A Preferred Stock in March 2020 in connection with the Company's Series A financing round. The terms of the Series A Preferred Stock are summarized as follows:
Shares outstanding: 5,000,000 shares of Series A Preferred Stock.
OIP: $2.00 per share.
Aggregate investment: $10,000,000.
Closing date: March 6, 2020.
Holders: The Series A Preferred Stock is held by the following investors:
(i) Ridgeline Capital Partners, LLC ("RCP"): 3,750,000 shares, representing 75% of the outstanding Series A Preferred Stock. RCP committed $7,500,000 in the Series A financing. Thomas Brennan, Managing Director of RCP, has served as a member of the Company's Board of Directors since the closing of the Series A financing as the Series A Preferred Stock designee.
(ii) Other holders: 1,250,000 shares, representing 25% of the outstanding Series A Preferred Stock, held by approximately four other institutional and individual investors who participated in the Series A financing alongside RCP. These holders committed an aggregate of $2,500,000 in the round. A detailed breakdown of these holders is provided in Exhibit A.
Dividend rate: 6% per annum on the OIP, non-cumulative, payable when, as, and if declared by the Board of Directors. No dividends have been declared or paid on the Series A Preferred Stock since the date of issuance.
Conversion ratio: Each share of Series A Preferred Stock is convertible into one share of Common Stock at the option of the holder at any time (i.e., a 1:1 initial conversion ratio). The conversion ratio is subject to adjustment upon the occurrence of certain anti-dilution events, as described in Section VIII below.
Anti-dilution protection: Weighted-average broad-based, as described in Section VIII.
Liquidation preference: 1× non-participating. Upon a Deemed Liquidation Event, each holder of Series A Preferred Stock is entitled to receive, in preference to the holders of Common Stock and Series Seed Preferred Stock, an amount equal to the OIP ($2.00 per share), or, if greater, the amount such holder would receive if the Series A Preferred Stock were converted to Common Stock immediately prior to such event.
D. Equity Incentive Plan
The Company adopted its 2018 Equity Incentive Plan (the "Plan") in connection with the Company's formation. The Plan authorizes the issuance of equity awards, including incentive stock options, non-statutory stock options, restricted stock awards, and restricted stock units, to employees, directors, and consultants of the Company. As of the date of this memorandum, the Plan's reservation and outstanding awards are as follows:
Total shares reserved under the Plan (pre-Series B): 3,000,000 shares of Common Stock.
Options outstanding: 2,100,000 shares subject to outstanding stock option awards, at a weighted-average exercise price ("WAEP") of $1.15 per share. These options are held by approximately forty current and former employees and consultants of the Company. The exercise prices of individual option grants range from $0.50 per share (for grants made in 2018 and early 2019, when the Common Stock fair market value was at or near the Series Seed OIP) to $2.00 per share (for more recent grants made following the Series A financing, when the Board-determined fair market value of the Common Stock reflected the Series A pricing). A detailed option grant register is maintained by the Company's equity administration department and is reflected in Exhibit A.
Options available for future grant: 900,000 shares remain available for issuance under the Plan as of the date of this memorandum. As discussed in Section VI below, the Company and the Series B investors have agreed to increase the Plan reservation by 1,635,000 shares at the closing of the Financing, which will bring the total shares available for future grant to 2,535,000 shares.
E. Pre-Money Fully Diluted Share Count
The following table summarizes the Company's capitalization on a fully diluted basis immediately prior to the closing of the Series B Financing, and forms the basis for the pre-money valuation calculation:
It is important to note that the option pool increase of 1,635,000 shares that will be effectuated at closing is carved from the pre-money fully diluted share count — that is, the increase is treated as having occurred prior to the Series B investment for purposes of calculating the pre-money valuation and the price per share. This is a standard venture capital convention and has the effect of allocating the dilutive impact of the option pool increase to the pre-money stockholders (both Common and Preferred, on an as-converted basis) rather than to the Series B investors. However, for accounting purposes, the Plan amendment and share reservation increase will not be formally adopted and effective until the closing date. The mechanics and implications of the option pool increase are discussed in greater detail in Section VI below.
Based on the foregoing, the pre-money valuation of the Company is calculated as follows:
23,400,000 pre-money fully diluted shares × $6.00 per share = $140,400,000 pre-money valuation
III. SERIES B FINANCING — TERMS AND INVESTOR ALLOCATIONS
This Section sets forth the key economic terms of the Series B Financing and the allocation of shares among the participating investors.
A. Series B Economic Terms
The following table summarizes the principal economic terms of the Series B Preferred Stock, as set forth in the draft term sheet dated April 22, 2022 and the draft Stock Purchase Agreement circulated on May 27, 2022:
The Series B Preferred Stock will rank senior to the Series A Preferred Stock and the Series Seed Preferred Stock with respect to dividend priority and liquidation preference, and all series of Preferred Stock will rank senior to the Common Stock. The seniority structure is standard for a multi-series preferred stock capitalization and reflects the chronological order of investment.
B. Investor Allocations
The Series B Preferred Stock will be allocated among the participating investors as follows:
The post-closing fully diluted percentage for each investor is calculated by dividing that investor's Series B shares by the total post-closing fully diluted share count of 30,900,000. For RCP, the percentage shown above (5.39%) reflects only its Series B holdings; RCP's aggregate post-closing fully diluted ownership, inclusive of its existing Series A position, is discussed in Section IV.C below.
The following information is provided regarding each of the participating investors:
Granite Peak Ventures, LP ("GPV"): GPV is the lead investor in the Series B Financing and is committing $30,000,000, representing approximately two-thirds of the round. GPV is a growth-stage venture capital fund based in San Francisco, California. The deal lead for GPV is Priya Deshmukh, Partner. Ms. Deshmukh will join the Skybridge Board of Directors upon closing as the Series B Preferred Stock designee, pursuant to the terms of the Voting Agreement. GPV has conducted extensive due diligence on the Company over the past three months and has negotiated the principal economic terms reflected in the term sheet.
Ridgeline Capital Partners, LLC ("RCP"): RCP is the Company's existing Series A lead investor, holding 3,750,000 shares of Series A Preferred Stock (75% of the Series A). RCP is exercising its contractual pro-rata participation right under the existing Investors' Rights Agreement, which entitles it to maintain its percentage ownership in the Company by purchasing its proportional share of new securities offered in the Series B Financing. In addition to its pro-rata allocation, RCP has negotiated an additional allocation, bringing its total Series B commitment to $10,000,000 (1,666,667 shares). Thomas Brennan, Managing Director of RCP and current Board member, will continue to serve as a Board Director following the closing.
Solstice Growth Fund I, LP ("SGF"): SGF is a new co-investor in the Company and is committing $5,000,000 to the Series B Financing (833,333 shares). SGF is an early-growth-stage venture fund based in New York, New York. The deal lead for SGF is Angela Moreau, Principal. SGF will not have a designated Board seat but will be a party to the Investors' Rights Agreement, the Right of First Refusal and Co-Sale Agreement, and the Voting Agreement, and will hold the standard information rights, pro-rata participation rights, and protective provision voting rights afforded to "Major Investors" under such agreements.
Harborview Seed Investors LLC ("HSI"): HSI, the holder of 100% of the outstanding Series Seed Preferred Stock, is not participating in the Series B Financing. HSI has been offered the opportunity to exercise its pro-rata participation right but has elected not to invest additional capital in this round. HSI will retain its existing Series Seed position of 3,000,000 shares and will continue to be a party to the transaction agreements as an existing investor.
C. Placement Agent
Compass Bridge Advisory Group LLC ("Compass Bridge") acted as the Company's exclusive placement agent in connection with the Series B Financing. Pursuant to the terms of an engagement letter dated February 1, 2022, Compass Bridge is entitled to a placement agent fee equal to 2.0% of the aggregate gross proceeds raised in the Financing. Based on the $45,000,000 in aggregate gross proceeds, the placement agent fee is calculated as follows:
$45,000,000 × 2.0% = $900,000
The placement agent fee is payable at closing from the gross proceeds of the Financing. Accordingly, the net proceeds to the Company after payment of the placement agent fee will be $44,100,000. The placement agent fee does not affect the number of shares to be issued or the per-share price; the Company bears the fee as a cost of the capital raise. The Company will separately bear its own legal fees and expenses in connection with the Financing (estimated at approximately $175,000) as well as reimburse GPV's legal counsel fees up to a cap of $50,000, as is customary for a financing of this size.
IV. POST-SERIES B CAPITALIZATION (FULLY DILUTED)
This Section sets forth the Company's capitalization on a fully diluted basis as it will exist immediately following the closing of the Series B Financing and the filing of the A&R COI with the Delaware Secretary of State.
A. Complete Post-Closing Cap Table
The available-for-grant figure of 2,535,000 shares reflects the sum of the 900,000 shares that were previously available for grant under the Plan plus the 1,635,000-share increase to the Plan that will be effectuated at closing. The 2,100,000 shares subject to outstanding option awards remain unchanged by the Financing and will continue to be exercisable at their respective exercise prices and in accordance with their existing vesting schedules.
It should be noted that the "unallocated authorized Common Stock" line reflects shares that are authorized under the A&R COI but are neither issued, outstanding, reserved for conversion of Preferred Stock, nor reserved under the Plan. These shares are available for future issuance by the Board (subject to applicable corporate approvals and protective provision restrictions). For purposes of fully diluted calculations and ownership percentages, unallocated authorized shares are excluded from the denominator.
B. Authorized Share Capital (Post-A&R COI)
The A&R COI to be filed at closing will authorize the following share capital:
Common Stock: 30,000,000 shares authorized, par value $0.0001 per share. This is unchanged from the current authorized share count. Of these 30,000,000 authorized shares, 12,400,000 are issued and outstanding, and additional shares are reserved for issuance upon conversion of Preferred Stock and under the Plan as set forth above.
Preferred Stock: 15,500,000 shares authorized, par value $0.0001 per share, designated as follows:
• Series Seed Preferred Stock: 3,000,000 shares designated
• Series A Preferred Stock: 5,000,000 shares designated
• Series B Preferred Stock: 7,500,000 shares designated
All designated shares of each series of Preferred Stock will be issued and outstanding following the closing. There will be no undesignated shares of Preferred Stock authorized under the A&R COI; any future series of Preferred Stock would require an amendment to the A&R COI, subject to the applicable protective provision approval requirements.
C. Post-Closing Ownership by Holder (Selected)
The following table sets forth the post-closing ownership position of selected significant holders, including shares held across multiple classes of equity:
Several observations are noteworthy with respect to the post-closing ownership structure:
First, the two co-founders, Mr. Raghavan and Ms. Whitmore, will collectively hold 8,000,000 shares of Common Stock, representing approximately 25.89% of the Company's fully diluted capitalization. This level of founder ownership is within the range typically observed for venture-backed companies at the Series B stage and provides meaningful economic alignment between the founders and the investor group.
Second, RCP, through its combined Series A and Series B holdings, will be the single largest stockholder of the Company on a fully diluted basis, holding 5,416,667 shares (17.53%). GPV will be the second largest institutional stockholder, holding 5,000,000 shares (16.18%). The proximity of these two holders' ownership positions may have implications for future governance dynamics and investor negotiations in subsequent financing rounds.
Third, the combined institutional investor ownership (HSI, RCP, GPV, and SGF) will represent approximately 52.12% of the Company's fully diluted capitalization (excluding the other Series A holders), which exceeds the combined ownership of the founders and employees. This is a common dynamic at the Series B stage and underscores the importance of the protective provision and governance structures discussed in Sections V and X below.
V. PREFERRED STOCK RIGHTS, PREFERENCES, AND PRIVILEGES — SUMMARY COMPARISON
This Section provides a comparative analysis of the rights, preferences, and privileges attached to each series of the Company's Preferred Stock, as set forth in the A&R COI.
A. Comparative Table
The table above reflects the principal economic and governance terms associated with each series. Each of these features is discussed in further detail in the subsections below and elsewhere in this memorandum.
B. Non-Cumulative Dividend Analysis
All three series of Preferred Stock carry non-cumulative dividend rights. This means that the applicable dividend rate establishes the maximum rate at which dividends may be paid when declared by the Board, but dividends do not accrue or accumulate from period to period and are not owed to the holders unless and until the Board affirmatively declares a dividend. No dividends have been declared or paid on any series of the Company's Preferred Stock since the Company's formation, and the Company does not anticipate declaring dividends for the foreseeable future, consistent with the typical practice for venture-backed growth-stage companies.
The per-share and aggregate dividend calculations for each series are as follows:
Series Seed Preferred Stock:
Dividend rate: 6% per annum on the OIP of $0.50 Per-share annual dividend (if declared): 6% × $0.50 = $0.03 per share Aggregate annual dividend (if declared): $0.03 × 3,000,000 shares = $90,000 per year
Series A Preferred Stock:
Dividend rate: 6% per annum on the OIP of $2.00 Per-share annual dividend (if declared): 6% × $2.00 = $0.12 per share Aggregate annual dividend (if declared): $0.12 × 5,000,000 shares = $600,000 per year
Series B Preferred Stock:
Dividend rate: 8% per annum on the OIP of $6.00 Per-share annual dividend (if declared): 8% × $6.00 = $0.48 per share Aggregate annual dividend (if declared): $0.48 × 7,500,000 shares = $3,600,000 per year
The total aggregate annual dividend, if declared across all series, would be $4,290,000 ($90,000 + $600,000 + $3,600,000). Because the dividends are non-cumulative, this amount does not represent an accruing liability and has no balance sheet impact absent a Board declaration.
Dividend priority. The A&R COI establishes a payment-priority waterfall for dividends. Dividends on the Series B Preferred Stock must be paid in full before any dividends may be paid on the Series A Preferred Stock or the Series Seed Preferred Stock. Dividends on the Series A Preferred Stock must be paid in full before any dividends may be paid on the Series Seed Preferred Stock. Dividends on the Series Seed Preferred Stock must be paid in full before any dividends may be paid on the Common Stock. This priority structure is standard and ensures that the most senior series of Preferred Stock is satisfied first in the event of any dividend declaration.
As a practical matter, the non-cumulative nature of the dividends and the Company's current growth-stage posture mean that the dividend provisions are largely academic. Their primary function is to establish priority of payment in the event the Board elects to declare dividends and to provide a protective provision trigger for the Series B holders (as discussed immediately below).
C. Protective Provisions (Series B)
The A&R COI and the Series B Stock Purchase Agreement contain a series of protective provision covenants that require the affirmative vote or written consent of the holders of a majority of the outstanding shares of Series B Preferred Stock, voting as a single class, before the Company may take certain specified actions. These protective provisions are a standard feature of venture capital financing arrangements and serve to protect the economic and governance interests of the lead investor.
The holders of the Series B Preferred Stock, voting as a single class, must approve the following actions:
1. Any amendment, alteration, or repeal of any provision of the Certificate of Incorporation or the Bylaws of the Company that adversely affects the rights, preferences, privileges, or powers of the Series B Preferred Stock.
2. The creation, authorization, or issuance (or obligation to issue) of any equity security of the Company that is senior to or on parity with the Series B Preferred Stock with respect to dividends, liquidation preference, redemption, or voting rights, or any security convertible into or exchangeable for any such equity security.
3. Any Deemed Liquidation Event, including any merger or consolidation of the Company with or into another entity, or any sale, lease, exclusive license, or other disposition of all or substantially all of the assets of the Company.
4. Any redemption, repurchase, or other acquisition of shares of the Company's capital stock (other than repurchases of unvested shares at cost upon termination of service pursuant to the terms of the applicable equity award agreement).
5. Annual capital expenditures exceeding $5,000,000 in the aggregate.
6. The incurrence of indebtedness (including capital lease obligations and guarantees) exceeding $3,000,000 in the aggregate.
7. Any increase in the number of shares reserved for issuance under the 2018 Equity Incentive Plan (or any successor plan) beyond 15% of the post-closing fully diluted shares of the Company (i.e., beyond 4,635,000 shares based on the current fully diluted share count of 30,900,000).
8. The declaration or payment of any dividend or other distribution on any shares of Common Stock.
These protective provisions grant the Series B holders (and principally GPV, as the holder of 66.67% of the Series B) effective veto power over the enumerated corporate actions, regardless of the Board of Directors' composition or the outcome of a general stockholder vote. The practical significance of these provisions is discussed further in Sections X and XI below.
It should be noted that the Series A Preferred Stock also carries certain protective provisions under the existing Certificate of Incorporation, including the right to approve amendments that adversely affect the Series A, the authorization of senior or pari passu securities, and Deemed Liquidation Events. The A&R COI will preserve these Series A protective provisions to the extent they do not conflict with the Series B provisions.
VI. OPTION POOL ANALYSIS
A. Pre-Series B Option Pool
Prior to the closing of the Series B Financing, the Company's 2018 Equity Incentive Plan provides for the following:
Total shares reserved under the Plan: 3,000,000 shares of Common Stock.
Options outstanding: 2,100,000 shares subject to outstanding stock option awards. These options have a weighted-average exercise price of $1.15 per share and are held by approximately forty current and former employees and consultants. The options were granted at exercise prices reflecting the Board-determined fair market value of the Common Stock at the time of grant, which ranged from $0.50 per share for the earliest grants (made shortly after the Series Seed closing in 2018) to $2.00 per share for grants made following the Series A closing in 2020. All options were granted as either incentive stock options (to employees) or non-statutory stock options (to consultants) and are subject to standard four-year vesting schedules with one-year cliff provisions, unless otherwise specified in individual award agreements.
Options available for future grant: 900,000 shares remain available for future issuance under the Plan as of the date of this memorandum. This represents the difference between the 3,000,000 shares initially reserved under the Plan and the 2,100,000 shares subject to outstanding awards. No shares have been returned to the Plan through forfeitures, cancellations, or expirations as of the date of this memorandum (any such returned shares would increase the available-for-grant pool).
B. Option Pool Increase at Closing
As a condition of the Series B Financing, the Company and the Series B investors have agreed that the Plan will be amended at or prior to closing to increase the number of shares reserved for issuance by 1,635,000 shares. The key parameters of the pool increase are as follows:
Additional shares to be reserved: 1,635,000 shares of Common Stock.
Post-closing total Plan reservation: 3,000,000 (existing) + 1,635,000 (increase) = 4,635,000 shares, which equals 15% of the post-closing fully diluted share count of 30,900,000.
Post-closing shares available for future grant: 900,000 (existing available) + 1,635,000 (new increase) = 2,535,000 shares. This represents the total number of shares that can be awarded to new and existing employees, directors, and consultants following the closing, without any further increase to the Plan.
Approval requirements: The Plan increase requires the approval of the Company's Board of Directors and, under Delaware law, may also require stockholder approval if the Plan (as amended) is to comply with the requirements of Section 422 of the Internal Revenue Code for incentive stock options and to satisfy any applicable stock exchange listing standards (although the Company is not currently publicly listed). The Board approval will be obtained as part of the closing actions, and the existing stockholders who are parties to the Voting Agreement have agreed to execute written consents approving the Plan amendment.
The post-closing Plan reservation of 4,635,000 shares (15% of fully diluted shares) is intended to provide the Company with sufficient headroom to make competitive equity grants to new hires and to provide retention grants to existing employees as the Company scales its operations. The Company's management has indicated that it anticipates making approximately $8,000,000 to $10,000,000 in equity grants (measured at the Series B fair market value) over the next eighteen to twenty-four months, primarily in connection with the hiring of a Vice President of Sales, a Vice President of Engineering, and other senior-level positions. Based on a fair market value of $6.00 per share, this would imply approximately 1,333,000 to 1,667,000 shares in new grants, which is within the 2,535,000 shares available for future grant.
C. Dilutive Impact
The option pool increase has a meaningful dilutive impact on the pre-money stockholders, particularly the Common Stock holders. This impact arises from the standard venture capital convention of carving the pool increase from the pre-money fully diluted share count — that is, the 1,635,000 new shares are included in the 23,400,000 pre-money fully diluted figure used to calculate the pre-money valuation and the price per share.
The mechanics of this convention are as follows. Without the option pool increase, the pre-money fully diluted share count would be 21,765,000 shares (i.e., 23,400,000 – 1,635,000). At a $6.00 per share price, the pre-money valuation would be $130,590,000 (21,765,000 × $6.00), and the post-money valuation would be $175,590,000 ($130,590,000 + $45,000,000). By including the pool increase in the pre-money count, the effective pre-money valuation is reduced by $9,810,000 (1,635,000 × $6.00), and this reduction is borne by the existing pre-money stockholders.
In economic terms, while the dilution from the pool increase is nominally borne equally by all pre-money stockholders (both Common and Preferred, on an as-converted basis), the Preferred holders' economic exposure is mitigated by their liquidation preferences. The liquidation preference of each series is fixed at its aggregate investment amount and is not affected by the pool increase. Therefore, in downside exit scenarios (where Preferred holders take their liquidation preference rather than converting), the pool increase dilutes only the Common Stock holders' residual claim. In upside exit scenarios (where all Preferred converts), the dilution is shared proportionally by all stockholders.
The practical effect is that the option pool increase primarily benefits future employees (who will receive option grants from the expanded pool) and the Series B investors (who obtain a lower effective price per share by including the pool increase in the pre-money denominator), at the expense of the existing Common Stock holders (including the founders).
VII. LIQUIDATION WATERFALL ANALYSIS
A. Waterfall Mechanics — Overview
The Company's A&R COI, as it will be in effect following the closing of the Series B Financing, establishes a non-participating preferred liquidation preference structure that governs the distribution of proceeds upon a "Deemed Liquidation Event." A Deemed Liquidation Event is defined to include (a) a merger or consolidation of the Company with or into another entity (other than a transaction in which the Company's stockholders retain a majority of the voting power of the surviving entity), (b) a sale, lease, exclusive license, or other disposition of all or substantially all of the assets of the Company, and (c) any other event that the Board of Directors determines constitutes a change of control of the Company. The occurrence of a Deemed Liquidation Event triggers the distribution waterfall described below.
Upon a Deemed Liquidation Event, the proceeds available for distribution to the Company's stockholders (the "Distributable Amount") are allocated in the following sequence of priority:
Step 1 — Series B Liquidation Preference. Each holder of Series B Preferred Stock is entitled to receive, prior to and in preference to any distribution to the holders of Series A Preferred Stock, Series Seed Preferred Stock, or Common Stock, an amount per share equal to the greater of (a) the Series B OIP ($6.00 per share), for an aggregate of $45,000,000, or (b) the amount such holder would receive if such holder's Series B shares had been converted to Common Stock immediately prior to the Deemed Liquidation Event and such holder participated pro rata with the holders of Common Stock and all other Preferred Stock on an as-converted basis. If the Distributable Amount is insufficient to pay the full Series B liquidation preference, the available proceeds are distributed among the holders of Series B Preferred Stock on a pro rata basis in proportion to the respective full preferential amounts to which they would otherwise be entitled.
Step 2 — Series A Liquidation Preference. After the Series B preference has been paid in full, each holder of Series A Preferred Stock is entitled to receive, prior to and in preference to any distribution to the holders of Series Seed Preferred Stock or Common Stock, an amount per share equal to the greater of (a) the Series A OIP ($2.00 per share), for an aggregate of $10,000,000, or (b) the amount such holder would receive on an as-converted basis. If the remaining Distributable Amount is insufficient to pay the full Series A liquidation preference, the available proceeds are distributed among the holders of Series A Preferred Stock on a pro rata basis.
Step 3 — Series Seed Liquidation Preference. After the Series B and Series A preferences have been paid in full, each holder of Series Seed Preferred Stock is entitled to receive, prior to and in preference to any distribution to the holders of Common Stock, an amount per share equal to the greater of (a) the Series Seed OIP ($0.50 per share), for an aggregate of $1,500,000, or (b) the amount such holder would receive on an as-converted basis. If the remaining Distributable Amount is insufficient to pay the full Series Seed liquidation preference, the available proceeds are distributed among the holders of Series Seed Preferred Stock on a pro rata basis.
Step 4 — Remaining Proceeds to Common Stock. After the liquidation preferences of all series of Preferred Stock have been paid in full, any remaining proceeds are distributed pro rata to the holders of Common Stock. Preferred Stock holders that have elected to receive their liquidation preference (rather than converting to Common) do not participate in this residual distribution.
The critical feature of the non-participating preferred structure is that each series must choose between taking its liquidation preference or converting to Common Stock and sharing pro rata with all other Common Stock holders (and any other Preferred Stock holders that have elected to convert). There is no "double dip" — a Preferred holder cannot receive its liquidation preference and also participate in the residual distribution. This election is made on a series-wide basis (not on a holder-by-holder basis), and each series will rationally elect the option that maximizes its aggregate return.
The aggregate senior liquidation preference across all series of Preferred Stock is:
Series B: $45,000,000 Series A: $10,000,000 Series Seed: $1,500,000 Total: $56,500,000
This aggregate liquidation preference of $56,500,000 represents the minimum exit value at which all Preferred Stock holders would receive their full 1× return, with the residual (if any) flowing to Common Stock holders. At exit values below $56,500,000, one or more series of Preferred Stock (beginning with the most junior series) will receive less than its full liquidation preference, and Common Stock holders will receive nothing.
B. Conversion Breakpoint Analysis
The "conversion breakpoint" for each series of Preferred Stock is the exit valuation at which that series' pro rata share of the total proceeds (on an as-converted basis) equals its liquidation preference. At exit values above its conversion breakpoint, a series of Preferred Stock will rationally elect to convert to Common Stock and participate pro rata, because its as-converted share exceeds its preference amount. At exit values below its conversion breakpoint, the series will rationally retain its preference.
The basic formula for calculating the conversion breakpoint is:
Breakpoint for Series X = (OIP × shares outstanding of Series X) ÷ (shares of Series X ÷ Total FD shares)
This can be simplified to:
Breakpoint for Series X = Aggregate Liquidation Preference of Series X ÷ (Series X as-converted ownership percentage)
Applying this formula to each series:
Series Seed Preferred Stock:
Aggregate preference: $1,500,000 As-converted ownership: 3,000,000 / 30,900,000 = 9.71% Breakpoint: $1,500,000 / 9.71% ≈ $15,450,000
At exit values above approximately $15.45 million, the Series Seed's pro rata as-converted share would exceed its $1,500,000 preference. However, this simplified calculation does not account for the seniority of the Series B and Series A preferences. In practice, the Series Seed breakpoint is relevant only after the senior preferences have been satisfied. In the waterfall context, the Series Seed holders will take their preference at any exit value where the remaining proceeds (after Series B and Series A have been paid) multiplied by the Series Seed's as-converted percentage of the remaining pool are less than $1,500,000. The effective breakpoint, when analyzed within the full waterfall, is discussed in the illustrative scenarios below.
Series A Preferred Stock:
Aggregate preference: $10,000,000 As-converted ownership: 5,000,000 / 30,900,000 = 16.18% Breakpoint: $10,000,000 / 16.18% ≈ $61,800,000
At exit values above approximately $61.8 million, the Series A's pro rata as-converted share would exceed its $10,000,000 preference. As with the Series Seed, this is a simplified calculation that does not account for the impact of other series' conversion decisions on the denominator.
Series B Preferred Stock:
Aggregate preference: $45,000,000 As-converted ownership: 7,500,000 / 30,900,000 = 24.27% Breakpoint: $45,000,000 / 24.27% ≈ $185,400,000
The Series B conversion breakpoint of approximately $185.4 million is equal to the post-money valuation of the Company. This is the expected result for a 1× non-participating preferred stock in a new financing round: the new series is indifferent between taking its preference and converting at exactly the post-money valuation. At exit values above $185.4 million, the Series B will convert; at exit values below that threshold, the Series B will take its preference.
Important note regarding iterative analysis: In practice, breakpoint calculations are iterative rather than static, because the conversion decision of one series changes the denominator (total participating shares) for the remaining series. For example, if the Series Seed elects to convert at a given exit value, the total shares participating in the residual distribution increase, which affects the per-share value for all converting holders. The illustrative waterfall tables in Section VII.C below model this iterative dynamic.
C. Illustrative Liquidation Waterfall Tables
The following subsections present detailed liquidation waterfall analyses at five illustrative exit values: $50 million, $100 million, $200 million, $400 million, and $800 million. These scenarios are designed to illustrate the distribution of proceeds under a range of outcomes, from a distressed exit below the aggregate liquidation preference through a highly successful exit at a premium to the post-money valuation.
Scenario 1: $50,000,000 Exit Value. This scenario illustrates a distressed exit at a value below the aggregate liquidation preference of $56,500,000. In this scenario, the Distributable Amount is insufficient to satisfy all preferred liquidation preferences, and the junior series (and Common Stock) are partially or fully impaired.
Step 1: Series B preference of $45,000,000 is payable. The Distributable Amount of $50,000,000 is sufficient to pay the Series B preference in full. The Series B holders' alternative — conversion to Common Stock — would yield 24.27% × $50,000,000 = $12,135,922, which is substantially less than the $45,000,000 preference. Accordingly, Series B elects to take its preference. Remaining proceeds: $50,000,000 − $45,000,000 = $5,000,000.
Step 2: Series A preference of $10,000,000 is payable from remaining proceeds. Only $5,000,000 remains, which is insufficient to satisfy the full Series A preference. The Series A holders receive the entire remaining $5,000,000, representing a 50% recovery on their $10,000,000 aggregate investment. This equates to $1.00 per share (vs. the $2.00 OIP). The Series A holders' conversion alternative is not viable because the as-converted value would be even lower. Remaining proceeds: $0.
Step 3: Series Seed preference of $1,500,000 is payable from remaining proceeds. No proceeds remain. The Series Seed holders receive $0, representing a total loss on their $1,500,000 aggregate investment.
Step 4: Common Stock distribution. No proceeds remain. Common Stock holders receive $0.
Commentary: At a $50 million exit value, which falls below the aggregate liquidation preference of $56.5 million, the preferred liquidation waterfall operates as a strict priority mechanism. The Series B holders receive their full preference of $45 million (recovering 100% of their investment), the Series A holders receive only $5 million (a 50% recovery), and the Series Seed holders and Common Stock holders are entirely wiped out. This scenario starkly illustrates the downside risk borne by Common Stock holders (including the founders) in the event of a below-expectation exit. The founders' combined 8,000,000 shares of Common Stock have zero value in this scenario, despite the Company's post-money valuation of $185.4 million at the time of the Series B investment.
Scenario 2: $100,000,000 Exit Value. This scenario illustrates an exit at a value that exceeds the aggregate liquidation preference but falls below all preferred conversion breakpoints. In this scenario, all preferred series take their preferences and Common Stock receives the residual.
Step 1: Series B preference of $45,000,000 is payable. The as-converted alternative for Series B would yield 24.27% × $100,000,000 = $24,271,845, which is less than the $45,000,000 preference. Series B elects to take its preference. Remaining proceeds: $100,000,000 − $45,000,000 = $55,000,000.
Step 2: Series A preference of $10,000,000 is payable. The remaining $55,000,000 is sufficient. The Series A holders' conversion alternative would need to be evaluated, but at this exit value, the per-share value on an as-converted basis for Series A (considering the impact on the total participating shares) remains below the $2.00 OIP for the shares retained as preferred. Series A elects to take its $10,000,000 preference. Remaining proceeds: $55,000,000 − $10,000,000 = $45,000,000.
Step 3: Series Seed preference of $1,500,000 is payable. The remaining $45,000,000 is more than sufficient. However, the Series Seed must evaluate whether its as-converted share of the total exit value would exceed $1,500,000. At $100 million, if Series Seed converted, it would participate with Common Stock in the residual pool. Because both Series B and Series A are taking their preferences (and not converting), the residual pool is distributed only among Common Stock holders and any converting Preferred holders. If Series Seed alone converted, its 3,000,000 shares would join the 12,400,000 Common shares, creating a pool of 15,400,000 shares sharing $43,500,000 in residual proceeds (i.e., $100M − $45M − $10M − $0 = $45M, less the $1.5M Series Seed preference that would not be paid). In this scenario, Series Seed's share would be 3,000,000 / 15,400,000 × $45,000,000 = $8,766,234 — which exceeds the $1,500,000 preference. However, the A&R COI provides that the conversion election is evaluated against the preference amount, and the correct analysis under the non-participating structure is that Series Seed compares its 1× preference ($1,500,000) to its as-converted share of the entire exit value (9.71% × $100M = $9,708,738), considering all shares on a fully diluted basis. Since $9,708,738 exceeds $1,500,000, the Series Seed would elect to convert. But this iterative analysis requires recalculating the waterfall with the Series Seed converting.
Upon further iterative analysis: if all series evaluated independently, the Series Seed's as-converted share of a $100M exit (9.71% of $100M) is approximately $9.7M, which exceeds its $1.5M preference. Thus, the Series Seed converts. This does not affect the Series B and Series A elections because the Series B as-converted share ($24.3M) remains below its $45M preference, and the Series A as-converted share ($16.2M) remains below its preference when the Series A is taking its $10M preference.
However, when Series Seed converts, the residual distribution pool changes. If Series Seed converts, the distribution becomes: Series B takes $45M preference, Series A takes $10M preference, and the remaining $45M is distributed among Common (12,400,000) and converted Series Seed (3,000,000) = 15,400,000 shares. Per share for residual pool: $45,000,000 / 15,400,000 = $2.92/share. Series Seed would receive 3,000,000 × $2.92 = $8,766,234 (vs. $1,500,000 preference). Common would receive 12,400,000 × $2.92 = $36,233,766.
But to keep the analysis tractable and consistent with the standard waterfall convention — where each series independently elects between preference and conversion based on the global as-converted share — we present the simplified analysis below assuming all series take their preferences. This is because in practice, the waterfall is typically modeled with each series making its election in order of seniority, and the standard presentation shows each series either taking its preference or converting. At $100M, the more nuanced iterative analysis suggests the Series Seed may convert, but for consistency with the standard waterfall presentation format, we present both the base case (all take preference) and note the conversion opportunity.
Base case presentation (all preferred takes preference):
Commentary: At a $100 million exit value, all preferred series receive their full 1× liquidation preference, and the Common Stock holders receive the residual of $43,500,000, or approximately $3.51 per share. It should be noted that the 2,100,000 outstanding options (at a WAEP of $1.15) are in-the-money at this exit value (since $3.51 exceeds $1.15), and option holders would be expected to exercise their options to participate in the distribution. Unexercised options and shares reserved but not yet issued under the Plan do not participate in the distribution. For purposes of this simplified presentation, we have excluded option exercise dynamics; the attached Excel model (Exhibit B) includes a more detailed treatment.
As noted above, the Series Seed would likely elect to convert at this exit value, since its as-converted share significantly exceeds its preference. If the Series Seed converts, Common holders would receive $2.92/share rather than $3.51/share (because the Series Seed's 3,000,000 converted shares would share in the residual pool), but the aggregate residual would increase from $43,500,000 to $45,000,000 (because the Series Seed does not withdraw its $1,500,000 preference). This nuance illustrates the iterative nature of the waterfall analysis and the importance of modeling each series' conversion election carefully.
Scenario 3: $200,000,000 Exit Value. This scenario illustrates an exit above the Series B conversion breakpoint of approximately $185.4 million, at which all preferred series convert to Common Stock and participate on a pro rata as-converted basis.
Analysis: At a $200 million exit value, we evaluate each series' conversion decision:
• Series B: As-converted share = 24.27% × $200,000,000 = $48,543,689. This exceeds the Series B preference of $45,000,000. Series B elects to convert.
• Series A: As-converted share = 16.18% × $200,000,000 = $32,362,460. This exceeds the Series A preference of $10,000,000. Series A elects to convert.
• Series Seed: As-converted share = 9.71% × $200,000,000 = $19,417,476. This exceeds the Series Seed preference of $1,500,000. Series Seed elects to convert.
Because all preferred series convert, the entire Distributable Amount of $200,000,000 is distributed pro rata among all shares on a fully diluted, as-converted basis. The per-share value is:
$200,000,000 / 30,900,000 fully diluted shares = $6.47 per share (rounded)
The distribution by holder category is as follows:
Note regarding option holders: The 2,100,000 outstanding options must be exercised (at the WAEP of $1.15 per share) in order for the option holders to participate in the distribution. The gross per-share value to option holders is $6.47, but the net value per option (after payment of the exercise price) is $6.47 − $1.15 = $5.32 per share. The aggregate exercise price that would be collected by the Company upon exercise of all outstanding options is $2,415,000 (2,100,000 × $1.15). For simplicity, the table above models the gross proceeds as distributed across 30,000,000 issued shares (12,400,000 Common + 3,000,000 Series Seed + 5,000,000 Series A + 7,500,000 Series B) plus 2,100,000 exercised option shares, on a simplified basis without applying the treasury stock method. The shares reserved but not yet issued under the Plan (2,535,000 shares) do not participate in the distribution.
Commentary: At a $200 million exit value, all preferred series convert to Common Stock because the per-share value ($6.47) exceeds every series' OIP. This exit value is above the Series B conversion breakpoint of approximately $185.4 million, confirming that the Series B is the last series to cross its indifference point. Notably, the per-share value of $6.47 at a $200 million exit represents only a modest premium over the Series B OIP of $6.00, illustrating that the Series B investors require an exit at or above the post-money valuation merely to break even relative to their investment price on a per-share basis (though they achieve a 7.9% premium at this level through the conversion mechanics).
Scenario 4: $400,000,000 Exit Value. This scenario illustrates a successful exit at approximately 2.2× the post-money valuation, well above all conversion breakpoints.
Analysis: At a $400 million exit value, all preferred series convert because the per-share value significantly exceeds every series' liquidation preference on a per-share basis. The per-share value is:
$400,000,000 / 30,900,000 fully diluted shares = $12.94 per share (rounded)