MEMORANDUM
PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT
To: Andrew Fitzpatrick, Lead Associate, Calderwood & Harkness LLP
From: Naomi Petersen, Working Associate, Calderwood & Harkness LLP
Date: July 10, 2022
Re: Employment and Benefits Due Diligence Summary — Verdana Software, Inc.
Matter No.: 1002-00004
Client No.: PIN-0042
Client: Pinnacle Venture Fund II LP
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I. Executive Summary
This memorandum summarizes the findings of the employment and benefits due diligence conducted by Calderwood & Harkness LLP ("C&H") in connection with Pinnacle Venture Fund II LP's ("Pinnacle") proposed $60,000,000 Series D Preferred Stock investment in Verdana Software, Inc. ("Verdana" or the "Company"). The purpose of this memorandum is to identify and assess employment-related liabilities, risks, and observations that are material to Pinnacle's evaluation of the proposed investment, and to recommend specific representations, warranties, closing conditions, and protective provisions for inclusion in the Series D Preferred Stock Purchase Agreement (the "SPA") and related transaction documents.
Diligence Period. C&H was granted access to the Company's virtual data room on May 16, 2022. Employment and benefits diligence materials were reviewed through approximately July 8, 2022. Throughout this period, C&H submitted multiple supplemental information requests to the Company's counsel, and follow-up responses were received on a rolling basis.
Scope of Documents Reviewed. The following categories of documents and materials were reviewed in connection with this memorandum:
• Executive employment agreements and amendments thereto
• Form and executed offer letters for non-executive employees
• Employee handbook (most recently updated January 2022)
• Benefit plan documents, including group health insurance plan summaries and enrollment materials
• 401(k) plan documents, summary plan descriptions, and the most recent Form 5500 filing
• The Verdana Software, Inc. 2016 Equity Incentive Plan (as amended), including board resolutions, stockholder consents, and a schedule of all outstanding equity awards
• Independent contractor agreements (reviewed on a sampling basis)
• Organizational charts and departmental headcount summaries
• Payroll summaries and compensation data
• Workers' compensation insurance policies and claims history
• Pending and threatened employment-related claims, demand letters, and related correspondence
• Confidential Information and Invention Assignment Agreements (CIIAAs), on a sample and coverage-representation basis
• Immigration and work authorization records, including H-1B visa summaries and I-9 compliance representations
All documents and information were provided by the Company and its outside counsel, Langford Price & Associates LLP ("Langford Price"), through partners Jonathan Hale and associate Rebecca Thornton, via the virtual data room and in response to C&H's supplemental diligence requests. Certain oral confirmations were also provided by Verdana's General Counsel, Sandra Mikkelsen, who is providing company-side support in the transaction alongside Langford Price.
Overall Assessment. Based on C&H's review of the materials described above, no material employment-related liabilities have been identified that would constitute a bar to closing the proposed Series D investment. The Company's employment practices, benefit programs, and workforce structure appear generally consistent with those of a technology company of similar size and stage. However, several observations and recommendations are noted in this memorandum that merit attention in the transaction documentation and in ongoing post-investment monitoring. In particular, the following areas warrant further discussion with the deal team:
1. ESOP Pool Expansion. The Company has proposed a 5,000,000-share expansion of its equity incentive plan prior to the Series D closing, which has material dilutive implications for Pinnacle's post-investment ownership percentage and is a significant point of contention in the valuation negotiation.
2. Executive Employment Agreements and Key Person Risk. The Company's co-founders, Raj Anand (CEO) and Lena Kovac (CTO), are critical to the Company's product development, customer relationships, and overall business trajectory. Their employment agreements contain severance and change-of-control provisions, and their combined equity holdings represent 35.0% of the pre-investment fully diluted capitalization.
3. Independent Contractor Classification. The Company engages approximately 15–20 independent contractors, primarily in software development and consulting capacities, and C&H recommends that Pinnacle confirm that the Company has conducted a classification analysis under applicable Oregon and federal standards.
4. Oregon Non-Competition Agreement Enforceability. Enforceability of the non-competition covenants in the executive employment agreements is subject to specific requirements under Oregon law (ORS 653.295), which impose certain procedural and substantive conditions on such agreements.
Company Background. Verdana Software, Inc. is a Delaware C-corporation headquartered at 1175 NW Couch Street, Suite 800, Portland, Oregon 97209. The Company was founded in 2016 by Raj Anand and Lena Kovac. Verdana's primary product is an AI-powered supply chain optimization SaaS platform marketed under the brand name "Verdana SCX," which is sold to mid-market and enterprise manufacturers and logistics companies. The Company's primary employee operations are based in the Portland, Oregon metropolitan area, though a number of employees work remotely from various U.S. states.
II. Workforce Overview
A. Employee Headcount and Composition
As of March 31, 2022 — the date of the most recent financial data provided in diligence — Verdana employs approximately 310 employees. Based on C&H's review of the organizational charts, payroll data, and departmental headcount summaries provided in the data room, the Company's workforce is broken down by functional area approximately as follows:
The composition of the workforce is consistent with what would be expected for a growth-stage enterprise software company at Verdana's scale. Engineering and product development is the Company's largest functional area, reflecting the technical nature of the Verdana SCX platform and the Company's continued investment in AI and machine learning capabilities.
Geographic Distribution. The majority of Verdana's employees are based in the Portland, Oregon metropolitan area, where the Company maintains its headquarters and primary office. However, in common with many technology companies, a meaningful number of employees work remotely from locations across multiple U.S. states. The data room materials did not include a comprehensive state-by-state breakdown of remote employees, and C&H's supplemental request for this information remains outstanding as of the date of this memorandum. To the extent that Verdana has employees working remotely in states where it has not registered as an employer or is not withholding and remitting state income taxes, there may be state tax nexus and employment law compliance considerations. These items are more properly addressed in the tax due diligence stream but are noted here for coordination purposes.
No International Employees. Based on C&H's review of the organizational charts, payroll summaries, and representations provided by the Company's counsel, no international employees have been identified. All of the Company's employees appear to be U.S.-based. Accordingly, no foreign employment law, benefits, or social insurance compliance issues have been analyzed in this memorandum.
Founding Team. The Company was founded in 2016 by Raj Anand, who serves as Chief Executive Officer, and Lena Kovac, who serves as Chief Technology Officer. Thomas Brightwell was hired as Chief Financial Officer in 2021, bringing the executive leadership team to its current configuration. Additional members of the senior management team include Sandra Mikkelsen, General Counsel, who joined the Company in 2020.
B. Employment-at-Will Status
Oregon is an at-will employment state, meaning that either the employer or the employee may terminate the employment relationship at any time, with or without cause, and with or without notice, subject to applicable statutory protections and any contractual provisions to the contrary. C&H reviewed the Company's employee handbook (last updated January 2022) and confirms that it includes a clear and prominent at-will employment disclaimer applicable to all non-executive employees. The handbook states that the at-will nature of the employment relationship cannot be modified except by a written agreement signed by the CEO or an authorized officer of the Company.
The at-will disclaimer in the handbook appears to be drafted in a manner consistent with best practices and includes language clarifying that no supervisor, manager, or other employee has the authority to make oral or written promises of employment for any specific duration. C&H did not identify any provisions in the handbook that would undermine or be inconsistent with the at-will employment disclaimer.
No Collective Bargaining Agreements or Union Activity. The Company does not have any collective bargaining agreements, and its workforce is not represented by any labor union. Based on the representations of the Company's counsel and C&H's review of the data room materials, there is no evidence of any current or recent union organizing activity, unfair labor practice charges, or proceedings before the National Labor Relations Board. Given the Company's industry (enterprise software), workforce composition (primarily knowledge workers), and geographic concentration (Portland, Oregon), the risk of unionization is assessed to be low, although this assessment is inherently forward-looking and subject to change.
C. Independent Contractors
C&H identified approximately 15–20 independent contractors in the diligence materials, primarily engaged in software development, data science consulting, and specialized technical advisory capacities. The Company appears to rely on independent contractors to supplement its engineering and product development teams on a project-specific or part-time basis.
C&H reviewed the Company's standard form independent contractor agreement and a sampling of executed contractor agreements from the data room. The standard form agreement includes the following key provisions:
• intellectual property assignment: All work product, inventions, and developments created by the contractor in the course of providing services to the Company are assigned to the Company.
• Confidentiality obligations: The contractor is subject to confidentiality restrictions that survive the termination of the engagement.
• Termination at will: Either party may terminate the engagement at any time, with or without cause, upon written notice.
• Independent contractor status acknowledgment: The agreement contains a representation by the contractor acknowledging their status as an independent contractor and not an employee of the Company.
• No benefits entitlement: The contractor acknowledges that they are not entitled to participate in any employee benefit plans or programs.
Classification Risk. The classification of workers as independent contractors rather than employees is a significant area of legal risk for technology companies. Oregon applies a version of the "ABC test" for purposes of determining worker classification under the Oregon Revised Statutes, which creates a presumption that a worker is an employee unless the hiring entity can demonstrate that: (A) the worker is free from the direction and control of the hiring entity; (B) the worker performs work that is outside the usual course of the hiring entity's business; and (C) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. The "B" prong of the ABC test can be particularly challenging for technology companies that engage independent contractors to perform software development or engineering work that is similar in nature to the work performed by the Company's full-time engineering employees.
In addition to the Oregon ABC test, the IRS applies a multi-factor common law test for federal employment tax purposes that examines the degree of behavioral control, financial control, and the type of relationship between the parties.
C&H did not identify any pending misclassification claims, audits, or proceedings against the Company as of the date of this review. However, C&H recommends that Pinnacle confirm that the Company has conducted, or will conduct, a classification analysis for its independent contractors, particularly those engaged in software development, to mitigate exposure to potential misclassification claims, back-tax liabilities, penalties, and retroactive benefit entitlements. This recommendation is reflected in Part VIII below.
III. Executive Employment Agreements
C&H reviewed the employment agreements and offer letters for the Company's four senior executives: Raj Anand (CEO & Co-Founder), Lena Kovac (CTO & Co-Founder), Thomas Brightwell (CFO), and Sandra Mikkelsen (General Counsel). A summary of the key terms of each agreement is set forth below.
A. Raj Anand — Chief Executive Officer & Co-Founder
Agreement History. Mr. Anand's employment is governed by an employment agreement originally executed in 2016 at the time of the Company's founding. The agreement was subsequently amended in 2019 in connection with the Company's Series B Preferred Stock financing and again in 2021 in connection with the Company's Series C Preferred Stock financing. C&H reviewed the original agreement and both amendments.
At-Will Employment. Notwithstanding the existence of a written employment agreement, Mr. Anand's employment is expressly at-will. The agreement provides certain terms, conditions, and benefits but does not create a fixed term of employment or impose a requirement of "cause" for termination by the Company (although "cause" is defined in the agreement for purposes of the severance and change-of-control provisions).
Compensation. Mr. Anand's base salary was reviewed by C&H in the data room. The specific amount is omitted from this memorandum for confidentiality purposes but is consistent with CEO compensation at similarly situated venture-backed technology companies. Mr. Anand is eligible for an annual performance bonus tied to board-approved targets, with the target bonus amount and performance metrics determined by the Board of Directors (or its compensation committee) on an annual basis.
Severance. Upon a termination without "cause" (as defined in the agreement) or a resignation for "good reason" (as defined), Mr. Anand is entitled to:
(i) Twelve (12) months of base salary continuation, payable in accordance with the Company's regular payroll schedule;
(ii) Twelve (12) months of continued health insurance coverage through Company-paid COBRA premium reimbursement; and
(iii) Any earned but unpaid annual bonus for the fiscal year preceding the year of termination.
The receipt of severance benefits is conditioned upon Mr. Anand's timely execution and non-revocation of a general release of claims in a form prescribed by the Company.
Change of Control Provisions. Mr. Anand's employment agreement provides for double-trigger acceleration of unvested equity awards upon a qualifying termination event within twelve (12) months following a "change of control" (as defined in the agreement). Specifically, if Mr. Anand's employment is terminated without cause or Mr. Anand resigns for good reason within the twelve-month period following a change of control, 100% of his then-unvested equity awards (including stock options and restricted stock, if any) will immediately vest and become exercisable. Importantly, this provision is structured as a double-trigger mechanism — a change of control alone does not trigger acceleration; there must also be a qualifying termination event within the specified window.
Restrictive Covenants. Mr. Anand is subject to the following post-termination restrictive covenants:
• Non-Competition: For a period of twelve (12) months following the termination of employment (for any reason), Mr. Anand is prohibited from directly or indirectly engaging in, or providing services to, any business that develops, markets, or sells AI-driven supply chain optimization software in competition with the Company.
• Non-Solicitation of Employees: For a period of eighteen (18) months following the termination of employment, Mr. Anand is prohibited from directly or indirectly soliciting, recruiting, or hiring (or attempting to solicit, recruit, or hire) any employee of the Company.
• Non-Solicitation of Customers: For a period of eighteen (18) months following the termination of employment, Mr. Anand is prohibited from directly or indirectly soliciting or diverting (or attempting to solicit or divert) any customer or prospective customer of the Company with whom Mr. Anand had material contact during the last twelve (12) months of his employment.
Oregon Non-Competition Enforceability Analysis. Oregon has enacted significant statutory restrictions on the enforceability of non-competition agreements. Under ORS 653.295, as amended, a non-competition agreement is voidable and unenforceable unless, among other requirements: (a) the employer informs the employee in a written employment offer received at least two weeks before the first day of the employee's employment that a non-competition agreement is required as a condition of employment, or the non-competition agreement is entered into upon a subsequent bona fide advancement of the employee; (b) the employee is engaged in administrative, executive, or professional work and earns above a specified annual salary threshold (which has been adjusted over time and, under the most recent amendments effective January 1, 2022, requires that the employee's annual gross salary and commissions exceed $100,533); and (c) the non-competition period does not exceed certain durational limits (currently 12 months under amendments effective January 1, 2022, reduced from a prior 18-month limit).
Mr. Anand's original 2016 employment agreement predates certain of the more restrictive amendments to ORS 653.295. However, the non-competition provision was re-executed in connection with the 2021 amendment to his employment agreement, which was entered into upon the Series C financing and arguably constitutes a bona fide advancement. C&H's preliminary assessment is that the non-competition covenant is likely enforceable, given that: (i) the covenant was re-executed in connection with the 2021 amendment; (ii) Mr. Anand's compensation exceeds the statutory salary threshold; and (iii) the 12-month duration is within the currently permissible limit. However, there is inherent uncertainty in the enforceability of non-competition agreements under Oregon law, and a court could decline to enforce the covenant if it determined that the procedural requirements were not strictly satisfied or that the covenant is broader than reasonably necessary to protect the Company's legitimate business interests.
Equity Holdings. Mr. Anand holds 14,000,000 shares of Common Stock of the Company, representing 50% of the 28,000,000 total founder shares. Mr. Anand's shares are fully vested, having completed the original four-year vesting schedule. These shares were not issued under the Company's 2016 Equity Incentive Plan but rather were issued as founder shares at the time of the Company's incorporation.
B. Lena Kovac — Chief Technology Officer & Co-Founder
Agreement History. Ms. Kovac's employment is governed by an employment agreement that was originally executed in 2016 at the time of the Company's founding and was subsequently amended upon the Series B (2019) and Series C (2021) financings, in parallel with Mr. Anand's agreement.
At-Will Employment. Ms. Kovac's employment is expressly at-will, consistent with the structure of Mr. Anand's agreement.
Compensation. Ms. Kovac's base salary was reviewed by C&H in the data room and is consistent with CTO compensation at similarly situated companies. Ms. Kovac is eligible for an annual performance bonus tied to board-approved targets.
Severance. The severance provisions in Ms. Kovac's employment agreement are substantively parallel to those in Mr. Anand's agreement. Upon a termination without cause or a resignation for good reason, Ms. Kovac is entitled to:
(i) Twelve (12) months of base salary continuation;
(ii) Twelve (12) months of Company-paid COBRA continuation coverage; and
(iii) Any earned but unpaid annual bonus for the preceding fiscal year.
Severance is subject to the execution and non-revocation of a general release.
Change of Control Provisions. Ms. Kovac's agreement contains the same double-trigger acceleration structure as Mr. Anand's agreement: 100% acceleration of unvested equity upon a qualifying termination (without cause or for good reason) within twelve (12) months following a change of control.
Restrictive Covenants. Ms. Kovac is subject to the same restrictive covenant package as Mr. Anand: a 12-month post-termination non-competition covenant limited to AI-driven supply chain optimization software, and 18-month non-solicitation covenants covering employees and customers. The Oregon enforceability considerations discussed above in Section III.A apply with equal force to Ms. Kovac's non-competition covenant. Ms. Kovac's 2021 amendment similarly constitutes a re-execution of the non-competition provision, and her compensation is understood to exceed the applicable statutory salary threshold.
Equity Holdings. Ms. Kovac holds 14,000,000 shares of Common Stock, representing the remaining 50% of the 28,000,000 total founder shares. Ms. Kovac's shares are fully vested and were issued as founder shares, not under the 2016 Equity Incentive Plan.
C. Thomas Brightwell — Chief Financial Officer
Agreement History. Mr. Brightwell's employment is governed by an employment agreement executed in 2021 upon his hiring as Chief Financial Officer. The agreement has not been subsequently amended.
At-Will Employment. Mr. Brightwell's employment is expressly at-will.
Compensation. Mr. Brightwell's base salary was reviewed in the data room and is consistent with CFO compensation at comparable venture-backed technology companies. Mr. Brightwell is eligible for an annual performance bonus. In addition, Mr. Brightwell received a cash signing bonus upon the commencement of his employment, the amount of which was reviewed in the data room. The signing bonus is subject to a repayment obligation if Mr. Brightwell voluntarily terminates his employment within twelve (12) months of his start date, a provision that has now lapsed given Mr. Brightwell's tenure.
Severance. Upon a termination without cause or a resignation for good reason, Mr. Brightwell is entitled to:
(i) Nine (9) months of base salary continuation;
(ii) Nine (9) months of Company-paid COBRA continuation coverage; and
(iii) Any earned but unpaid annual bonus for the preceding fiscal year.
Severance is subject to the execution and non-revocation of a general release. The severance entitlements for Mr. Brightwell are modestly shorter in duration than those provided to the co-founders (9 months versus 12 months), which is consistent with his more recent tenure and his role as a non-founder executive.
Change of Control Provisions. Mr. Brightwell's agreement provides for double-trigger acceleration of unvested equity upon a qualifying termination within nine (9) months following a change of control (as compared to the 12-month window applicable to the co-founders). The structure is otherwise identical: 100% acceleration of unvested awards upon termination without cause or resignation for good reason within the specified post-change-of-control period.
Restrictive Covenants. Mr. Brightwell is subject to: (i) a 12-month post-termination non-competition covenant, and (ii) a 12-month post-termination non-solicitation covenant covering employees and customers. The non-solicitation period is shorter than that applicable to the co-founders (12 months versus 18 months). The Oregon enforceability considerations discussed in Section III.A above apply to Mr. Brightwell's non-competition covenant as well, although the enforceability analysis is somewhat more straightforward given that Mr. Brightwell's agreement was executed in 2021 and the non-competition provision was included at the outset of his employment.
Equity. Mr. Brightwell received a stock option grant under the Company's 2016 Equity Incentive Plan. The options vest over a four-year period with a one-year cliff (i.e., 25% of the shares subject to the option vest on the first anniversary of Mr. Brightwell's start date, with the remaining shares vesting in equal monthly installments over the following 36 months). The specific number of shares and exercise price were reviewed in the data room and are consistent with the Company's standard equity grant practices for senior executives.
D. Sandra Mikkelsen — General Counsel
Offer Letter. Ms. Mikkelsen's employment is governed by a standard offer letter rather than a comprehensive employment agreement. The offer letter was executed upon her hiring in 2020. Ms. Mikkelsen's employment is expressly at-will.
Severance. The offer letter does not contain any specific severance provisions. In the event of a termination, Ms. Mikkelsen would be entitled only to any accrued and unpaid compensation and any benefits continuation required by applicable law (e.g., COBRA).
Equity. Ms. Mikkelsen received a stock option grant under the 2016 Equity Incentive Plan, subject to the Company's standard four-year vesting schedule with a one-year cliff.
Note Regarding Transaction Role. Ms. Mikkelsen is providing company-side legal support in connection with the proposed Series D investment, alongside the Company's outside counsel at Langford Price. C&H has interacted with Ms. Mikkelsen throughout the diligence process in her capacity as the Company's General Counsel. There are no conflict-of-interest issues identified with respect to her dual role as an employee and an advisor in the transaction.
E. Observations on Executive Agreements
Standard Protections. All executive employment agreements reviewed contain standard confidentiality and intellectual property assignment provisions. The confidentiality obligations survive the termination of employment, and the IP assignment provisions are substantively consistent with the Company's standard CIIAA (discussed further in Part VI.B below).
Key Person Risk. C&H wishes to highlight the key person risk associated with the Company's co-founders, Raj Anand and Lena Kovac. Mr. Anand is the public face of the Company and has been instrumental in building customer relationships, establishing the Company's market position, and leading the Company's fundraising efforts. Ms. Kovac is the architect of the Verdana SCX platform and leads the Company's engineering and product development organization, which comprises approximately 42% of the total workforce. The departure of either co-founder could materially and adversely impact the Company's business, product development roadmap, and customer retention.
This key person risk is compounded by the fact that the co-founders collectively hold 28,000,000 shares of Common Stock, representing approximately 35.0% of the Company's pre-investment fully diluted capitalization of 80,000,000 shares. As previously noted in the deal team's discussions regarding the proposed drag-along provision and other protective provisions, the founders' significant equity stake gives them substantial influence over corporate governance and stockholder voting matters.
Recommendation. C&H recommends that the SPA include a closing condition providing that, as of the closing date, (i) the employment agreements of Raj Anand, Lena Kovac, and Thomas Brightwell remain in full force and effect, (ii) no notice of termination has been given by or to any such executive, and (iii) no event has occurred that, with the passage of time or the giving of notice (or both), would constitute "good reason" under any such executive's employment agreement. This closing condition would provide Pinnacle with protection against the risk of key executive departures between signing and closing of the proposed investment.
IV. Equity Incentive Plan (ESOP)
A. Current Plan Structure
Verdana maintains the Verdana Software, Inc. 2016 Equity Incentive Plan (the "Plan"), which was adopted by the Board of Directors and approved by the Company's stockholders in 2016. The Plan has been amended from time to time, including in connection with prior financing rounds.
The key terms and current status of the Plan are summarized as follows:
The Plan is structured as a standard equity incentive plan for a Delaware corporation and contains provisions that are customary for a venture-backed technology company, including: (i) the authority to grant incentive stock options ("ISOs") to employees and non-qualified stock options ("NQOs") to consultants and non-employee directors; (ii) the authority to grant restricted stock awards ("RSAs") and restricted stock units ("RSUs"); (iii) standard acceleration provisions in connection with a change of control; (iv) provisions governing the treatment of awards upon a participant's termination of service; and (v) a 90-day post-termination exercise period for vested options (with a longer exercise period in the case of termination due to death or disability).
As of the most recent data available in the data room, approximately 1,500,000 shares remain available for future grant under the Plan. This relatively limited remaining pool has been identified by the Company as a constraint on its ability to attract and retain employees and is the basis for the proposed ESOP expansion discussed in Section IV.B below.
B. Proposed ESOP Expansion
Verdana has proposed expanding the ESOP by 5,000,000 additional shares, which would increase the total number of shares reserved under the Plan from 12,000,000 to 17,000,000 shares. The Company has indicated that this expansion is necessary to fund anticipated hiring and retention grants in connection with the growth expected to result from the Series D capital infusion.
Dilutive Impact and Valuation Implications. The proposed ESOP expansion is a material point of contention in the ongoing valuation and deal structure negotiations between Pinnacle and the Company. The significance of this issue is summarized as follows:
• If the 5,000,000 new ESOP shares are treated as outstanding on a pre-close basis (i.e., included in the pre-money capitalization), the fully diluted share count increases from 80,000,000 to 85,000,000 shares pre-investment.
• At a per-share price of $4.00, the Series D investment of $60,000,000 would result in the issuance of 15,000,000 Series D Preferred shares, bringing the post-investment fully diluted share count to 100,000,000 shares.
• Under this scenario, Pinnacle's post-investment ownership would be 15,000,000 / 100,000,000 = 15.00%, as compared to 15,000,000 / 95,000,000 = 15.79% if the ESOP expansion shares are not included in the pre-money capitalization.
• The difference of 0.79 percentage points of ownership represents a meaningful economic difference at the proposed valuation levels and has implications for Pinnacle's ownership target and return modeling.
Pinnacle's Position. Pinnacle's position, as communicated to the deal team, is that the existing 12,000,000 ESOP shares are already included in the pre-money fully diluted share count of 80,000,000 and that any increase to the option pool should be reflected in the pre-money valuation — that is, the dilutive effect of the ESOP expansion should be absorbed by the existing stockholders (including the founders and prior-round investors) and not by Pinnacle's incoming capital. This is a standard position for venture capital investors in connection with new financing rounds and is consistent with NVCA model term sheet conventions.
Coordination with Other Memoranda. C&H recommends coordination with the following separately prepared analyses for further detail on the dilutive impact and valuation implications of the ESOP expansion:
• Valuation and Ownership Analysis Memorandum (dated May 25, 2022), which addresses the treatment of the option pool increase in the pre-money vs. post-money valuation context; and
• Capitalization Table Analysis and Waterfall Memorandum (dated June 1, 2022), which models the dilutive impact of the ESOP expansion on each class of stockholders under various scenarios.
Corporate Approval Requirements. The current Plan provisions authorize the Board of Directors to increase the total number of shares reserved under the Plan, subject to stockholder approval. Under Delaware General Corporation Law, stockholder approval of an equity incentive plan amendment may be required to the extent that additional shares are being authorized or reserved. Accordingly, the proposed ESOP expansion would require both Board approval and the consent of the Company's stockholders. C&H recommends that any agreed-upon ESOP expansion be made a closing condition in the SPA, with the Company required to deliver evidence of duly adopted Board resolutions and stockholder consents authorizing the expansion prior to or concurrently with the closing.
C. Section 409A Compliance
Section 409A of the Internal Revenue Code imposes strict requirements on the design and administration of deferred compensation arrangements, including stock options. An option that is granted with an exercise price below the fair market value of the underlying stock on the date of grant is treated as deferred compensation subject to Section 409A, which can result in severe adverse tax consequences for the option holder, including immediate income inclusion, a 20% additional tax, and interest penalties.
Company Representations. The Company has represented, through its counsel and in the data room materials, that all option grants under the Plan have been made at exercise prices equal to or greater than the fair market value of the Company's Common Stock on the date of grant, as determined by independent 409A valuations.
409A Valuation Report. C&H reviewed the most recent 409A valuation report for the Company, which was prepared by an independent valuation firm and is dated approximately January 2022. The report appears to follow standard methodologies (including a combination of the income approach, the market approach, and the option pricing method for allocating enterprise value among the Company's various classes of equity). No material issues were identified in the valuation methodology or conclusions based on the materials reviewed.
Timing Gap. It should be noted, however, that the January 2022 409A valuation predates the Series D process and reflects an enterprise value that may be materially lower than the current enterprise value range of $260 million to $320 million under the parties' competing positions in the Series D negotiation. If the Company has granted any stock options between January 2022 and the date of this memorandum based on the January 2022 fair market value determination, there is a risk that those options may have been granted at below the then-current fair market value, particularly if the Company's Board was aware of the Series D process and the implied valuation at the time of grant. C&H recommends confirming with the Company's counsel whether any options were granted after January 2022, and if so, whether the Board obtained an updated 409A valuation or otherwise determined that the January 2022 valuation remained the best evidence of fair market value at the time of grant.
D. Outstanding Equity Awards — Key Employees
In addition to the co-founders' fully vested Common Stock holdings (which were issued as founder shares and not under the Plan) and Mr. Brightwell's option grant described in Section III.C above, the data room includes a comprehensive schedule of all outstanding option grants under the Plan. C&H reviewed this schedule and confirmed that the aggregate numbers are consistent with the summary figures set forth in Section IV.A above.
No Single-Trigger Acceleration. The Plan does not provide for single-trigger acceleration of unvested awards upon a change of control. Acceleration is limited to change-of-control scenarios in which the acquiring entity does not assume or substitute outstanding awards, or in which the participant's employment is terminated in connection with or following the change of control (i.e., double-trigger acceleration). Importantly, a minority investment such as the proposed Series D does not constitute a "change of control" under the Plan, and accordingly, no acceleration provisions are triggered solely by the proposed Series D investment.
V. Benefits Programs
A. Health and Welfare Benefits
Verdana provides group health insurance benefits to its full-time employees and their eligible dependents, including medical, dental, and vision coverage. The Company's health insurance plans are provided through Cascade Health Insurance Co., an Oregon-based health insurance carrier.
Based on C&H's review of the plan summaries and enrollment materials in the data room, the Company's health plans appear to be fully insured — that is, the Company pays fixed premiums to Cascade Health Insurance Co., and the carrier bears the financial risk of claims. C&H did not identify any self-funded or self-insured health plans. The distinction is significant because self-funded plans are subject to additional ERISA fiduciary and reporting requirements and expose the plan sponsor to potentially unpredictable claims liabilities. The absence of self-funded plans reduces the Company's benefits-related risk profile.
In addition to group health insurance, the Company provides standard employer-sponsored life insurance and long-term disability insurance coverage to eligible employees. These benefits appear to be provided through group policies and are consistent with market practices for companies of Verdana's size and stage.
Affordable Care Act (ACA) Compliance. With approximately 310 full-time employees, Verdana qualifies as an "applicable large employer" (ALE) under the ACA, meaning it is subject to the ACA's employer shared responsibility provisions (the "employer mandate"). Under these provisions, ALEs are required to offer minimum essential coverage that is affordable and provides minimum value to substantially all (at least 95%) of their full-time employees and their dependents. Based on the materials reviewed, Verdana appears to satisfy these requirements. C&H did not identify any IRS notices (e.g., Letter 226J) or penalty assessments related to ACA compliance.
B. 401(k) Retirement Plan
Verdana maintains a 401(k) retirement savings plan (the "401(k) Plan") for the benefit of its eligible employees. The key terms and administration of the 401(k) Plan are summarized as follows:
Plan Administrator: Verdana Software, Inc.
Recordkeeper/Trustee: Evergreen Retirement Services LLC
Employer Match: The Company provides a matching contribution equal to 50% of employee elective deferrals, up to a maximum employee contribution of 4% of eligible compensation. This results in a maximum employer matching contribution of 2% of eligible compensation per participating employee.
Safe Harbor Status: The 401(k) Plan appears to satisfy the requirements for safe harbor status under Section 401(k)(12) of the Internal Revenue Code. Safe harbor plans are deemed to satisfy the ADP/ACP nondiscrimination tests, which eliminates the risk that highly compensated employees' contributions would be refunded or limited due to failed nondiscrimination testing.
Form 5500: C&H reviewed the most recent Form 5500 filing for the 401(k) Plan, covering the plan year ending December 31, 2021. The filing did not disclose any material audit findings, and no issues were identified by the plan's independent auditor (required for plans with 100 or more participants).
No Defined Benefit or Pension Obligations. Critically, the Company does not maintain any defined benefit pension plan, cash balance plan, or any other form of post-retirement benefit obligation. The absence of such plans eliminates the risk of unfunded pension liabilities, which can represent a significant and unpredictable financial obligation. This is a favorable finding from the diligence perspective.
C. Other Benefits
Paid Time Off (PTO). The Company maintains an "unlimited PTO" policy for salaried employees, under which eligible employees may take paid time off at their discretion, subject to manager approval and business needs. Hourly employees accrue PTO on a per-pay-period basis in accordance with the schedule set forth in the employee handbook.
The unlimited PTO policy has implications for accrued vacation liability. Under Oregon law (ORS 652.140 et seq.), employers are generally not required to pay out unused accrued vacation at the time of termination unless the employer's written policy or an employment agreement provides otherwise. Because the Company's unlimited PTO policy does not involve the accrual of a specific bank of vacation hours, the Company's accrued vacation liability is effectively reduced to zero for salaried employees. This is a favorable finding from the benefits liability perspective.
Other Programs. The Company provides the following additional benefits, as described in the employee handbook:
• Tuition reimbursement program for job-related educational expenses
• Employee wellness programs (gym membership subsidy, mental health resources)
• Commuter benefits (pre-tax transit and parking benefits)
No Employee Stock Purchase Plan. C&H did not identify an Employee Stock Purchase Plan (ESPP) under Section 423 of the Internal Revenue Code or any non-qualified employee stock purchase arrangement. The Company's equity compensation is provided exclusively through the 2016 Equity Incentive Plan discussed in Part IV above.
VI. Employment Policies and Compliance
A. Employee Handbook and Policies
C&H reviewed the Company's employee handbook, which was last updated in January 2022. The handbook is a comprehensive document that addresses the Company's employment policies and procedures across a range of topics. The handbook contains policies that are standard for a company of Verdana's size, industry, and geographic location, including the following:
• Equal Employment Opportunity (EEO): A policy statement affirming the Company's commitment to providing equal employment opportunities to all employees and applicants without regard to race, color, religion, sex, national origin, age, disability, genetic information, sexual orientation, gender identity, or any other protected characteristic under applicable federal, state, or local law.
• Anti-Harassment and Anti-Discrimination: A detailed policy prohibiting harassment and discrimination in the workplace, including sexual harassment, and outlining the Company's complaint and investigation procedures. The policy identifies multiple reporting channels and contains an anti-retaliation commitment.
• At-Will Employment Disclaimer: A prominent disclaimer confirming that employment with the Company is at-will and may be terminated by either the employer or the employee at any time, with or without cause or notice.
• Confidentiality and Proprietary Information: A policy reminding employees of their obligations to protect the Company's confidential and proprietary information, consistent with the CIIAA discussed below.
• Electronic Communications and Acceptable Use: A policy governing the use of Company-provided electronic communications systems, including email, internet access, and Company-owned devices, and reserving the Company's right to monitor such systems.
• Whistleblower Protections: A policy providing protections for employees who report suspected violations of law or Company policy in good faith.
• Workplace Safety: A policy outlining the Company's commitment to providing a safe and healthy workplace, including compliance with applicable Occupational Safety and Health Administration (OSHA) requirements.
Oregon-Specific Policies. The handbook includes policies addressing several Oregon-specific employment law requirements, including:
• Oregon Family Leave Act (OFLA): Compliance with OFLA's provisions regarding family, medical, and pregnancy-related leave for eligible employees.
• Oregon Sick Leave: Compliance with Oregon's mandatory paid sick leave law, which requires employers with 10 or more employees (or 6 or more employees in the City of Portland) to provide paid sick leave.
• Oregon Pay Equity: Compliance with Oregon's pay equity law (ORS 652.220), which prohibits wage differentials based on protected characteristics for work of comparable character.
C&H did not identify any material deficiencies or omissions in the employee handbook based on its review. The handbook appears to be reasonably current and comprehensive.
B. Confidentiality and IP Assignment Agreements
Verdana requires all employees and contractors to execute a Confidential Information and Invention Assignment Agreement ("CIIAA") at the commencement of employment or engagement. The CIIAA is a critical document for protecting the Company's intellectual property and ensuring that all work product and inventions created by employees and contractors in the course of their service to the Company are properly assigned to the Company.
C&H reviewed the Company's standard form CIIAA, which contains the following key provisions:
• Assignment of Inventions: All inventions, discoveries, improvements, original works of authorship, trade secrets, and other intellectual property that are conceived, developed, or reduced to practice by the employee during the period of employment and that relate to the Company's business or are created using the Company's resources or proprietary information are assigned to the Company.
• Confidentiality Obligations: The employee agrees to hold in confidence and not to disclose, use, or exploit the Company's confidential and proprietary information, both during and after the term of employment. The confidentiality obligations survive the termination of employment indefinitely (or for a specified period, depending on the nature of the information).
• Non-Solicitation: The CIIAA includes a non-solicitation provision prohibiting the employee from soliciting the Company's employees and customers for a specified period following termination.
• Prior Inventions Disclosure: The CIIAA includes a schedule in which the employee must disclose any prior inventions, original works of authorship, or other intellectual property that the employee wishes to exclude from the scope of the assignment provisions. This disclosure is important for identifying and ring-fencing any pre-existing IP that does not belong to the Company.
Coverage. The data room includes a representation from the Company that CIIAAs have been executed by substantially all current employees. The Company's General Counsel, Sandra Mikkelsen, has confirmed that CIIAA coverage is at or near 100% of the current employee base. C&H did not independently verify this representation on a name-by-name basis but reviewed a sampling of executed CIIAAs in the data room.
Recommendation. Given the critical importance of CIIAA coverage to the integrity of the Company's intellectual property portfolio — which is the core asset underlying the Verdana SCX platform — C&H recommends that the SPA representations and warranties include a specific representation that all current employees and contractors have executed CIIAAs (or substantially equivalent agreements) and that no exceptions exist that could materially impact the Company's ownership of its intellectual property. Any known exceptions should be disclosed on the applicable Disclosure Schedule. This recommendation is coordinated with the IP and Technology Due Diligence Memorandum (dated July 12, 2022), which addresses CIIAA coverage from the perspective of the Company's IP portfolio.
C. Immigration / Work Authorization
Verdana has represented, through its counsel, that all of the Company's employees are authorized to work in the United States. Based on the data room materials, approximately 15–20 employees have been identified as holding H-1B visas or other employment-based work authorization (e.g., L-1, O-1, or TN visas). The Company appears to maintain standard I-9 (Employment Eligibility Verification) compliance practices, including the timely completion and retention of I-9 forms for all employees.
C&H did not conduct a comprehensive I-9 audit but reviewed the Company's stated compliance practices and did not identify any material immigration compliance issues. For employees holding H-1B or other employer-sponsored work visas, C&H notes that changes to the Company's corporate structure, ownership, or control could potentially affect the validity of certain visa petitions or require amended or new filings with U.S. Citizenship and Immigration Services (USCIS). However, because the proposed Series D investment is a minority equity investment and does not involve a change of control or a restructuring of the employing entity, C&H does not anticipate any immigration-related complications arising from the closing of the transaction.
VII. Employment-Related Claims and Litigation
A. Pending Claims
Based on the representations of the Company's General Counsel, Sandra Mikkelsen, and the materials reviewed in the data room, there are no pending employment-related lawsuits, arbitrations, or administrative charges against the Company as of the date of this diligence review. Specifically:
• No lawsuits or arbitration proceedings have been filed against the Company by any current or former employee.
• No charges have been filed with the U.S. Equal Employment Opportunity Commission (EEOC) or any state or local fair employment practices agency.
• No complaints have been filed with the Oregon Bureau of Labor and Industries (BOLI).
• No investigations or audits have been initiated by the U.S. Department of Labor (DOL), the Oregon Employment Department, or any other governmental agency relating to employment, wage and hour, or workplace safety matters.
The absence of pending employment-related claims is a favorable finding and is consistent with C&H's overall assessment that the Company's employment practices are well-managed and compliant with applicable law.
B. Threatened Claims
C&H identified one pre-litigation demand letter in the data room. The circumstances are as follows:
A former engineering manager whose employment was terminated by the Company in November 2021 sent a demand letter through his personal counsel in January 2022. The demand letter alleged wrongful termination, claiming that the termination was without proper cause and was motivated by personal animus rather than legitimate business reasons. The former employee demanded approximately $180,000 in severance payments and damages, including alleged lost wages, emotional distress, and attorney's fees.
The Company's General Counsel, Sandra Mikkelsen, has indicated that the Company reviewed the claim with its outside employment counsel and determined that the claim was without merit. The Company's counsel responded to the demand letter with a detailed rebuttal, asserting that the termination was for legitimate performance-related reasons and was consistent with the Company's at-will employment policy. Following the Company's response, no formal legal proceeding has been filed by the former employee, and no further communications have been received from the former employee or his counsel as of the date of this diligence review.
Assessment. Based on the information available, this claim appears to be a low-risk, low-value matter that is unlikely to result in material liability for the Company. The absence of a formal legal filing for approximately six months following the demand letter suggests that the former employee may have abandoned the claim or determined that it lacks sufficient merit to pursue further. However, C&H notes that applicable statutes of limitations for wrongful termination and related claims in Oregon have not yet expired, and there is no assurance that the former employee will not file a legal proceeding in the future.
Recommendation. C&H recommends that this matter be included as a disclosed item in the Disclosure Schedules under the SPA's representations and warranties relating to litigation and employment matters. By disclosing the demand letter, Pinnacle can ensure that any future liability arising from this matter is subject to the Company's indemnification obligations under the SPA to the extent it exceeds the disclosed amount. C&H also recommends that the Company continue to monitor this matter and promptly notify Pinnacle if any formal legal proceeding is filed or if the former employee resumes communication regarding the claim.
C. Workers' Compensation
The Company maintains workers' compensation insurance through the Evergreen Workers' Compensation Fund, an Oregon state-approved workers' compensation insurance carrier. C&H reviewed the Company's workers' compensation insurance policy and claims history in the data room.