PRIVILEGED & CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGED — ATTORNEY WORK PRODUCT
MEMORANDUM
TO: Marcus Trejo, Partner, Head of Growth Equity, Pinnacle Capital Management LLC
FROM: Andrew Fitzpatrick, Lead Associate, and Naomi Petersen, Working Associate, Calderwood & Harkness LLP
DATE: July 15, 2022
RE: Legal Due Diligence Summary — Verdana Software, Inc. (Proposed $60,000,000 Series D Preferred Stock Investment by Pinnacle Venture Fund II LP)
MATTER NO.: 1002-00004
CLIENT NO.: PIN-0042
CC: Harrison Wexford, Responsible Partner; Beatrice Holloway, Billing Partner
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I. EXECUTIVE SUMMARY
The purpose of this memorandum is to consolidate and present the findings of the legal due diligence review conducted by Calderwood & Harkness LLP ("C&H" or "we") of Verdana Software, Inc. ("Verdana" or the "Company") in connection with the proposed $60,000,000 minority growth equity investment by Pinnacle Venture Fund II LP ("Pinnacle" or the "Fund") through the purchase of newly issued Series D Preferred Stock (the "Series D Transaction" or the "Transaction"). This memorandum is intended to serve as a comprehensive summary of legal risks, outstanding issues, and recommended conditions to closing for the benefit of Pinnacle Capital Management LLC ("Pinnacle Capital") in its capacity as the general partner and investment manager of the Fund.
Diligence commenced on May 16, 2022, following the execution of the Exclusivity Agreement between Pinnacle and Verdana on May 12, 2022. The initial comprehensive due diligence request list was transmitted to Langford Price & Associates LLP ("Langford Price"), counsel to Verdana, under the direction of Jonathan Hale, Partner, and Rebecca Thornton, Senior Associate, on May 14, 2022. Supplemental diligence requests were issued on an ongoing basis as our review progressed, with the most recent supplemental request issued on July 8, 2022.
Access to the Company's virtual data room was provided through Langford Price utilizing the Pemberton Technologies platform. As of the date of this memorandum, the data room contains approximately 1,420 documents organized across 22 top-level folders. Our team has reviewed substantially all documents contained therein, with the exception of certain supplemental materials recently uploaded in response to our July 8, 2022 requests, which remain under review.
In addition to our document review, our diligence was informed by management discussion sessions conducted with the following individuals:
• Raj Anand, Chief Executive Officer and Co-Founder, Verdana Software, Inc.
• Lena Kovac, Chief Technology Officer and Co-Founder, Verdana Software, Inc.
• Thomas Brightwell, Chief Financial Officer, Verdana Software, Inc.
• Sandra Mikkelsen, General Counsel, Verdana Software, Inc.
These sessions were held both in person at Verdana's Portland headquarters and via videoconference between May 23, 2022 and June 28, 2022. In total, approximately sixteen hours of management discussions were conducted across seven separate sessions.
Certain financial and commercial data were facilitated by Hargrove Securities LLC ("Hargrove Securities"), Verdana's financial advisor, under the direction of Nathan Callister, Managing Director. Verdana's independent auditor is Whitfield & Greer LLP ("Whitfield & Greer"), 721 SW Oak Street, Suite 1200, Portland, Oregon 97205, with Gerald Whitfield serving as Engagement Partner. C&H has reviewed the Company's audited financial statements for fiscal years 2019, 2020, and 2021, as well as unaudited quarterly financial data through March 31, 2022, each as prepared or reviewed by Whitfield & Greer.
High-Level Conclusion: Based on our review, Verdana is a well-organized Delaware C-corporation with strong SaaS fundamentals. The Company reports $47.3 million in annual recurring revenue ("ARR") as of March 31, 2022, reflecting 63.7% year-over-year growth, with net revenue retention ("NRR") of 128% and gross margins of 74.2%. The Company has assembled a capable management team, maintains a growing customer base of approximately 185 enterprise and mid-market clients, and has developed a proprietary AI-powered supply chain optimization platform that appears to enjoy meaningful competitive differentiation.
Notwithstanding these positive attributes, our diligence has identified several material risk areas that require attention and, in certain cases, resolution as a condition to closing the Series D Transaction:
1. Significant Customer Concentration — Meridian Logistics Corp. Verdana's largest customer, Meridian Logistics Corp. ("Meridian"), represents approximately 24.9% of total ARR ($11.8 million of $47.3 million). The Meridian contract expires on December 31, 2023, and there is meaningful uncertainty regarding renewal, as Meridian has recently undergone a change in executive leadership and has issued a request for proposals ("RFP") for competitive supply chain optimization solutions. The loss of this single customer would constitute a material adverse impact on Verdana's revenue base and growth trajectory.
2. Existing Credit Facility with Pacific Summit Bank, N.A. Verdana maintains a $10,000,000 revolving credit facility with Pacific Summit Bank, N.A. ("Pacific Summit Bank"), of which $6,200,000 was drawn as of March 31, 2022. The credit agreement contains negative covenants that may restrict the issuance of new preferred equity securities, including the Series D Preferred Stock, without the prior written consent of the lender. Issuance without such consent could trigger an event of default.
3. Capitalization Complexity Relating to ESOP Pool Expansion. Verdana has proposed expanding its employee stock option plan ("ESOP") pool by 5,000,000 shares prior to closing, which would materially affect Pinnacle's effective ownership percentage. The treatment of this expansion — whether calculated on a pre-money or post-money basis — remains a significant structural negotiation point.
4. Certain Employment and IP Matters. We have identified potential gaps in intellectual property assignment documentation with respect to certain early-stage contractors, which should be remediated prior to closing.
Recommended conditions to closing are enumerated in detail in Section XII below.
II. CORPORATE ORGANIZATION AND GOOD STANDING
A. Formation and Jurisdiction
Verdana Software, Inc. was incorporated in the State of Delaware on March 14, 2016, under the Delaware General Corporation Law ("DGCL"). The original Certificate of Incorporation was filed with the Delaware Secretary of State and assigned File Number 6274913. Based on our review of the Company's corporate records, the original incorporator was Raj Anand.
The Certificate of Incorporation has been subsequently amended and restated on three occasions in connection with the Company's preferred stock financing rounds:
• First Amended and Restated Certificate of Incorporation, filed on or about September 18, 2018, in connection with the Series A Preferred Stock financing;
• Second Amended and Restated Certificate of Incorporation, filed on or about June 12, 2019, in connection with the Series B Preferred Stock financing; and
• Third Amended and Restated Certificate of Incorporation (the "Current Charter"), filed on or about February 26, 2021, in connection with the Series C Preferred Stock financing.
Each amendment and restatement was approved by the Company's Board of Directors and stockholders in accordance with applicable provisions of the DGCL and the then-applicable charter documents. We have reviewed copies of the relevant board resolutions and stockholder written consent actions authorizing each amendment.
C&H obtained and reviewed a Certificate of Good Standing for Verdana Software, Inc. issued by the Delaware Secretary of State, Division of Corporations, dated June 21, 2022. The certificate confirms that the Company is in good standing and current in its franchise tax obligations in the State of Delaware as of such date.
B. Registered Agent
Verdana's registered agent in the State of Delaware is Cascade Systems, located at 1209 Orange Street, Wilmington, Delaware 19801. We have confirmed that the registered agent designation is current and in effect as of the date of this memorandum. No change in registered agent is contemplated in connection with the Transaction.
C. Qualification to Do Business
Verdana is headquartered at 1175 NW Couch Street, Suite 800, Portland, Oregon 97209, where it maintains its principal offices and a significant employee presence of approximately 310 employees. The Company is qualified to do business as a foreign corporation in the State of Oregon, and we have reviewed the Company's Oregon business registration, which appears to be current and in good standing.
In addition to Oregon, we have reviewed the Company's foreign qualification filings in states where Verdana maintains a material employee presence, customer base, or other operational activities that may trigger qualification requirements under applicable state law. Based on our review, the Company appears to be qualified in those jurisdictions where a material nexus exists. However, we note that certain states where the Company has recently hired remote employees (including California, Washington, Texas, and New York) may warrant further analysis to confirm that the Company has timely filed for foreign qualification, as applicable, and is in compliance with all registration and tax filing requirements. We recommend that the Company's management and counsel confirm compliance with foreign qualification requirements in all states with material employee or customer presence as part of the closing process.
D. Subsidiaries
Based on our review of the diligence materials provided, including the Company's organizational documents, board minutes, financial statements, and representations made by management during our discussion sessions, Verdana does not appear to have any direct or indirect subsidiaries, whether domestic or foreign. The Company does not maintain any branch offices outside of the United States and conducts all of its operations through the single corporate entity. No intercompany agreements, subsidiary governance documents, or foreign entity registrations were identified in the data room.
E. Organizational Documents Reviewed
In the course of our diligence, we reviewed the following corporate organizational documents of Verdana:
• The Third Amended and Restated Certificate of Incorporation (the "Current Charter"), as filed with the Delaware Secretary of State on February 26, 2021, in connection with the Series C financing, together with all prior versions of the Certificate of Incorporation and amendments thereto;
• The Bylaws of Verdana Software, Inc., as adopted by the Board of Directors on March 14, 2016, and as subsequently amended through the date hereof (the "Bylaws");
• Resolutions adopted by the Board of Directors from the Company's formation through the present, including resolutions authorizing each preferred stock financing round, key executive hires, equity grants, the Pacific Summit Bank credit facility, and other material corporate actions;
• Written consent actions executed by the stockholders of the Company in lieu of meetings, including consents authorizing each amendment and restatement of the Certificate of Incorporation;
• Minutes of meetings of the Board of Directors held from 2016 through 2022, including all regular and special meetings; and
• Minutes of annual and special meetings of the stockholders of the Company, to the extent held.
Our review of these documents did not reveal any material irregularities in the Company's corporate governance history. Board and stockholder actions appear to have been duly authorized and properly documented in accordance with the DGCL and the Company's organizational documents.
F. Board of Directors — Current Composition
Verdana's Board of Directors currently consists of five (5) members, composed as follows:
Board composition rights are governed by the existing Voting Agreement (as defined and discussed below). The current board structure reflects the customary allocation of designation rights among the founders and each series of preferred stock investors.
In connection with the proposed Series D Transaction, the parties are negotiating an expansion of the Board of Directors from five (5) to seven (7) members. The proposed post-closing board composition would be as follows:
• Two (2) Founder Designees (Raj Anand and Lena Kovac);
• One (1) Series A Investor Designee (Ridgeline Ventures Fund III LP);
• One (1) Series B Investor Designee (Northgate Growth Partners Fund II LP);
• One (1) Series C Investor Designee (Brindoval Capital Group LLC);
• One (1) Series D Investor Designee (to be designated by Pinnacle — expected to be Marcus Trejo or his designee); and
• One (1) independent director to be mutually agreed upon by the Company and a majority of the preferred stock holders.
The addition of the Pinnacle board designee will be documented in the Amended and Restated Voting Agreement to be executed at closing. The selection and appointment of the mutually agreed independent director is expected to occur within ninety (90) days following the closing of the Transaction.
III. CAPITALIZATION
A. Authorized Capital Stock
Pursuant to the Current Charter (the Third Amended and Restated Certificate of Incorporation filed in connection with the Series C financing in February 2021), the Company is authorized to issue the following classes and series of capital stock:
• Common Stock: An aggregate number of authorized shares of Common Stock, par value $0.001 per share, sufficient to accommodate all outstanding Common Stock (including Founder shares) and the full ESOP pool;
• Series A Preferred Stock: 12,000,000 shares authorized, all of which are issued and outstanding;
• Series B Preferred Stock: 16,000,000 shares authorized, all of which are issued and outstanding; and
• Series C Preferred Stock: 12,000,000 shares authorized, all of which are issued and outstanding.
No Series D Preferred Stock is currently authorized under the Current Charter. The consummation of the Series D Transaction will require the adoption and filing of a further amendment to the Certificate of Incorporation (the "Fourth Amended and Restated Certificate of Incorporation") to create and authorize the Series D Preferred Stock, set forth its rights, preferences, and privileges, and increase the total number of authorized shares as necessary. Such amendment will require the approval of the Company's Board of Directors and stockholders in accordance with the DGCL and the terms of the Current Charter.
B. Outstanding Securities — Fully Diluted Capitalization Table (Pre-Investment)
Based on our review of the Company's stock ledger, option grant records, and representations of management, the Company's fully diluted capitalization as of the date hereof (prior to giving effect to the Series D Transaction) is as follows:
Total Fully Diluted Shares Outstanding (Pre-Investment): 80,000,000 shares
We note that the Founder Common Stock is divided between the two co-founders, with Raj Anand holding approximately 15,400,000 shares (19.25%) and Lena Kovac holding approximately 12,600,000 shares (15.75%). Both founders' shares are fully vested as of the date hereof, the original four-year vesting period having lapsed. No founder shares are subject to any repurchase right by the Company.
The ESOP pool of 12,000,000 shares includes both issued grants (options and restricted stock that have been granted to employees, officers, and consultants, whether vested or unvested) and the unissued reserve available for future grants. As discussed in Section IX.C below, a detailed breakdown of the issued versus unissued portions of the pool was reviewed as part of our employment and benefits diligence.
C. Historical Preferred Stock Issuances
We reviewed the transaction documents for each of Verdana's prior preferred stock financing rounds. A summary of the historical issuances is set forth below:
Series A Preferred Stock (2018):
• Investor: Ridgeline Ventures Fund III LP
• Investment Amount: $9,600,000
• Price Per Share: $0.80
• Shares Issued: 12,000,000
• Closing Date: On or about September 18, 2018
• Liquidation Preference: 1.0x non-participating
• Anti-Dilution Protection: Broad-based weighted average
Series B Preferred Stock (2019):
• Investor: Northgate Growth Partners Fund II LP
• Investment Amount: $32,000,000
• Price Per Share: $2.00
• Shares Issued: 16,000,000
• Closing Date: On or about June 12, 2019
• Liquidation Preference: 1.0x non-participating
• Anti-Dilution Protection: Broad-based weighted average
Series C Preferred Stock (2021):
• Investor: Brindoval Capital Group LLC
• Investment Amount: $36,000,000
• Price Per Share: $3.00
• Shares Issued: 12,000,000
• Closing Date: On or about February 26, 2021
• Liquidation Preference: 1.0x non-participating
• Anti-Dilution Protection: Broad-based weighted average
As noted above, all prior series of preferred stock carry a 1.0x non-participating liquidation preference, meaning that upon a liquidation event (including a deemed liquidation event such as a merger, sale of substantially all assets, or change of control), each series of preferred holders is entitled to receive an amount per share equal to the original issue price for such series (plus any declared but unpaid dividends), before any distribution to the holders of Common Stock. The non-participating feature means that preferred holders must elect between receiving their liquidation preference or converting to Common Stock and participating pro rata — they do not receive both. This structure is relevant to the ongoing negotiations regarding the terms of the Series D Preferred Stock, as discussed in Section III.D below.
All prior series also include broad-based weighted average anti-dilution protection, which adjusts the conversion price of the preferred stock in the event of a dilutive issuance (i.e., an issuance of equity securities at a price per share below the applicable conversion price) using a formula that takes into account the total number of shares outstanding on a fully diluted basis. This is the market-standard approach and is less favorable to investors than full-ratchet anti-dilution protection.
D. Proposed Series D Issuance — Ownership Scenarios
The commercial terms of the Series D Transaction remain subject to ongoing negotiation between Pinnacle and Verdana. As of the date of this memorandum, the parties have not reached agreement on certain fundamental economic terms, most notably the pre-money valuation, the per-share purchase price, and the treatment of the proposed ESOP pool expansion. We set forth below the competing positions of each party, together with an analysis of the resulting ownership implications.
Verdana's Position:
Verdana has proposed a pre-money valuation of $320,000,000 on a fully diluted basis. At this valuation, the per-share price for the Series D Preferred Stock would be $4.00 (calculated as $320,000,000 divided by 80,000,000 pre-investment fully diluted shares). Pinnacle's $60,000,000 investment would purchase 15,000,000 new Series D Preferred shares, resulting in a post-money fully diluted share count of 95,000,000 and a Pinnacle ownership percentage of approximately 15.79%.
However, Verdana has further proposed expanding the ESOP pool by 5,000,000 shares (from 12,000,000 to 17,000,000) on a pre-close basis, which would bring the pre-investment fully diluted share count to 85,000,000. If the pre-money valuation of $320,000,000 is applied to this expanded share base, the resulting per-share price remains $4.00 (assuming the $320M valuation absorbs the dilution from the expanded pool), and 15,000,000 new Series D shares would be issued, resulting in a post-money fully diluted share count of 100,000,000 and a Pinnacle ownership percentage of 15.00%.
Pinnacle's Position:
Pinnacle has proposed a pre-money valuation of $260,000,000 on a fully diluted basis (before giving effect to the proposed ESOP expansion). At this valuation, the per-share price for the Series D Preferred Stock would be $3.25 (calculated as $260,000,000 divided by 80,000,000 pre-investment fully diluted shares). Pinnacle's $60,000,000 investment would purchase approximately 18,461,538 new Series D Preferred shares, resulting in a post-money fully diluted share count of approximately 98,461,538 and a Pinnacle ownership percentage of approximately 18.75%.
Valuation Gap:
A valuation gap of $60,000,000 in pre-money valuation exists between the parties' respective positions ($320,000,000 vs. $260,000,000). This gap is the primary unresolved commercial issue in the Transaction and has downstream implications for every transaction document, including the price per share, the number of shares issued, the resulting ownership percentages, and the economic terms applicable to the preferred stock.
ESOP Expansion — Structural Considerations:
The treatment of the proposed 5,000,000-share ESOP expansion is a significant structural issue that independently affects the effective ownership dilution borne by Pinnacle. If the ESOP expansion is treated as a pre-money event (i.e., the additional 5,000,000 shares are included in the pre-investment fully diluted share count before the Series D price per share is calculated), the dilution from the expanded pool is effectively borne by the incoming investor (Pinnacle) to a greater degree. By contrast, if the ESOP expansion is treated as a post-money event, the dilution is shared among all stockholders, including the founders and existing preferred holders. The treatment of option pool increases in connection with new financing rounds is a frequently negotiated issue in venture capital transactions, and Pinnacle's position should be determined based on its assessment of the commercial dynamics of the deal.
We have prepared a separate Capitalization Table Analysis and Waterfall Memorandum (delivered June 1, 2022), as well as a Valuation and Ownership Analysis Memorandum (delivered May 25, 2022), which provide detailed modeling of ownership outcomes under various valuation and structural scenarios. We refer you to those memoranda for further detail.
E. ESOP
Verdana maintains an equity incentive plan (the "Plan") that was originally adopted by the Board of Directors and approved by the stockholders in 2016 and has been subsequently amended on multiple occasions in connection with the preferred stock financings to increase the share reserve. The existing ESOP pool consists of 12,000,000 shares of Common Stock reserved for issuance under the Plan, representing 15.0% of the Company's fully diluted capitalization.
We have reviewed the Plan document, the forms of option agreement and restricted stock agreement used under the Plan, and a detailed option grant schedule provided by management and the Company's cap table administrator. Our observations regarding the status of outstanding grants, vesting schedules, and exercise prices are summarized in Section IX.C (Equity Incentive Plan / ESOP) below.
As noted above, Verdana has proposed expanding the ESOP pool by 5,000,000 shares (from 12,000,000 to 17,000,000 total shares) in connection with the Series D Transaction. Management has represented that the expansion is necessary to support the Company's hiring plan over the next eighteen to twenty-four months, particularly with respect to senior engineering and go-to-market hires. The expansion would require approval by the Board of Directors and, depending on the terms of the Current Charter and the Investors' Rights Agreement, may require the consent of the existing preferred stock holders. The ESOP expansion is a material negotiation point in the Transaction and, as discussed above, its treatment (pre-money versus post-money) has significant implications for Pinnacle's effective ownership.
F. Stock Transfer Restrictions, Rights of First Refusal, and Co-Sale Rights
The Company and its stockholders are parties to the following agreements governing the transfer and voting of the Company's capital stock:
• Investors' Rights Agreement, dated as of February 26, 2021, by and among the Company, the founders, and the holders of Series A, Series B, and Series C Preferred Stock (the "IRA");
• Right of First Refusal and Co-Sale Agreement, dated as of February 26, 2021, by and among the Company, the founders, and the holders of Series A, Series B, and Series C Preferred Stock (the "ROFR Agreement"); and
• Voting Agreement, dated as of February 26, 2021, by and among the Company, the founders, and the holders of Series A, Series B, and Series C Preferred Stock (the "Voting Agreement").
Each of these agreements was most recently amended and restated in connection with the Series C financing. The IRA provides for, among other things, registration rights (demand and piggyback), information rights, pro rata rights for future issuances (subject to customary exceptions), and certain protective provisions requiring preferred stockholder consent for specified corporate actions. The ROFR Agreement provides for a right of first refusal in favor of the Company and the preferred holders in the event a founder or key holder proposes to transfer Common Stock, as well as a co-sale (tag-along) right permitting preferred holders to participate in any such transfer on a pro rata basis. The Voting Agreement governs board composition and voting commitments for the election of directors as described in Section II.F above, and includes drag-along provisions (which are the subject of ongoing negotiation, as discussed in Section XII.A.5 below).
In connection with the closing of the Series D Transaction, each of these agreements will be amended and restated to add Pinnacle as a party and to incorporate the terms negotiated in connection with the Series D investment. Drafts of these amended and restated agreements are currently under negotiation between C&H (on behalf of Pinnacle) and Langford Price (on behalf of the Company and, to an extent, coordinating with counsel to the existing investors).
G. Convertible Instruments and Warrants
Based on our review of the diligence materials, including the Company's stock ledger, board minutes, financial statements, and representations of management and the Company's counsel, Verdana does not have any outstanding convertible promissory notes, Simple Agreements for Future Equity ("SAFEs"), convertible securities, or warrants as of the date hereof. The Company has not issued any such instruments at any point in its history, and all prior equity financing rounds were structured as priced preferred stock rounds. This simplifies the capitalization analysis and eliminates the need to assess potential conversion or exercise scenarios that would affect the fully diluted share count.
IV. MATERIAL CONTRACTS
A. Overview
Verdana operates a business-to-business ("B2B") software-as-a-service ("SaaS") platform marketed under the brand name "Verdana SCX." The Verdana SCX platform is an AI-powered supply chain optimization application designed for mid-market and enterprise-scale manufacturers, logistics companies, and distribution businesses. The platform is sold on a multi-year subscription basis, typically with annual or multi-year contract terms. As of the diligence date, the Company maintains subscription agreements with approximately 185 customers, generating $47.3 million in ARR as of March 31, 2022.
Our review of the Company's material commercial contracts encompassed the top customer agreements by ARR, as well as a representative sample of the Company's standard-form subscription agreements, vendor contracts, and other commercial arrangements. The following subsections summarize our findings with respect to revenue concentration, the material terms of key customer contracts, and other commercial agreements.
B. Customer Contracts — Revenue Concentration
A summary of the Company's top five customers by ARR, together with the aggregate contribution of all remaining customers, is presented in the table below:
As reflected in the table, Verdana's revenue base exhibits significant customer concentration. The Company's largest customer, Meridian Logistics Corp. ("Meridian"), accounts for approximately 24.9% of total ARR, or $11.8 million. The top five customers collectively represent $27.2 million, or 57.5% of total ARR. While some degree of customer concentration is common in enterprise SaaS businesses, particularly those in the earlier stages of scaling, the magnitude of the Meridian concentration is notably elevated and presents a material risk factor for the investment, as discussed in detail in Section IV.C below.
The remaining approximately 180 customers collectively contribute $20.1 million in ARR (42.5% of total). Management has represented that the Company's long-tail customer base is diversified across a range of industries and geographies, with no individual customer in the long-tail cohort representing more than 1.5% of total ARR.
C. Meridian Logistics Corp. Contract — Detailed Analysis
Given the significance of the Meridian relationship to Verdana's revenue base, we have conducted an in-depth review of the Meridian customer contract and related commercial considerations. Our findings are summarized below.
Contract Type and Scope: The Meridian contract is structured as a three-year enterprise license agreement for the Verdana SCX platform, encompassing full platform access, implementation and integration services (substantially completed), ongoing support and maintenance, and certain customization and professional services components. The contract includes a minimum annual commitment of approximately $11.8 million in subscription and support fees, subject to escalation provisions based on utilization tiers.
Contract Term and Expiration: The initial three-year term of the Meridian contract commenced on January 1, 2021, and expires on December 31, 2023. The remaining term as of the date of this memorandum is approximately seventeen (17) months.
Renewal Terms: The contract provides for automatic renewal for successive one-year terms following the expiration of the initial three-year term, unless either party provides written notice of non-renewal at least 180 calendar days prior to the expiration of the then-current term. For the initial term, this means that the non-renewal notice deadline falls on approximately July 4, 2023 — approximately twelve (12) months from the date of this memorandum and potentially within three to six months of the anticipated closing date of the Series D Transaction (assuming a September or October 2022 closing).
Risk Factors Identified:
We have identified the following risk factors relating to the Meridian relationship:
(i) Executive Leadership Change at Meridian. During our management discussion sessions, Raj Anand (CEO) confirmed that Meridian recently underwent a change in its Chief Executive Officer. The former CEO, who was described by management as a strong advocate of the Verdana SCX platform and instrumental in the initial procurement decision, departed in approximately March 2022. The new CEO was described as having a background in operational restructuring and cost optimization, and management indicated that the new leadership team at Meridian has been conducting a comprehensive review of Meridian's vendor relationships and technology spending, including its supply chain technology stack. While management expressed confidence in the value that Verdana SCX delivers to Meridian's operations, the executive transition introduces uncertainty regarding the renewal decision.
(ii) Competitive RFP Process. Management disclosed that Meridian has issued a request for proposals (RFP) for competitive supply chain optimization solutions. The issuance of an RFP does not necessarily indicate an intention to switch vendors, as it may reflect standard procurement practices under the new leadership's vendor review initiative. However, the fact that Meridian is actively soliciting competitive bids introduces a meaningful risk that Verdana may not secure the renewal, or that Verdana may be required to offer significant pricing concessions to retain the account.
(iii) Material Revenue Impact of Non-Renewal. The loss of the Meridian contract would eliminate approximately $11.8 million of ARR, representing 24.9% of total ARR. Such a loss would reduce total ARR from $47.3 million to approximately $35.5 million and would materially impair the Company's year-over-year revenue growth rate, net revenue retention metrics, and the revenue multiple underpinning the proposed Series D valuation. The downstream effects on the Company's cash flow, operating runway, and ability to service its credit facility obligations should also be considered.
Recommendation: The Meridian concentration risk is, in our assessment, the single most significant risk factor identified in the legal due diligence process. We recommend that this risk be addressed through one or more of the following mechanisms, which should be negotiated as part of the Transaction:
• A valuation adjustment reflecting the risk-adjusted value of the Meridian revenue stream;
• A customer retention escrow whereby a portion of the investment proceeds is held in escrow and released to the Company upon confirmation of Meridian's renewal (or achievement of specified replacement revenue milestones);
• An earnout component tied to the retention of the Meridian account or to aggregate revenue performance;
• A specific representation and warranty from the Company regarding the status and health of the Meridian relationship, backed by a meaningful indemnification obligation; and/or
• Protective provisions granting Pinnacle enhanced information rights and consent rights with respect to the Meridian contract, including prompt notification of any material communications, contract modifications, or renewal developments.
A separate Customer Concentration Risk Analysis Memorandum was delivered on July 5, 2022, providing additional detail on this topic.
D. Other Material Commercial Contracts
We reviewed the subscription agreements for the Company's other top customers, including Caldera Manufacturing Inc. (ARR of $5.2M), Atlas Freight Holdings LLC (ARR of $4.1M), Brannock Industrial Group (ARR of $3.4M), and Solaris Warehousing Co. (ARR of $2.7M). Each of these contracts is structured on standard multi-year SaaS subscription terms that are substantially consistent with the Company's form customer agreement. Our review of these contracts did not identify any unusual termination provisions, most-favored-nation pricing clauses, exclusive dealing obligations, or other non-standard terms that would present material risk to the investment. Each contract includes customary auto-renewal provisions with notice periods ranging from 90 to 180 days.
We also reviewed a representative sample of the Company's vendor and supplier agreements, including agreements with cloud infrastructure providers (Ridgeway Industries for hosting), data sub-processors, and professional services vendors. No material concerns were identified with respect to these agreements. The Company's Meridian Technologies hosting agreement is on standard commercial terms and does not contain any provisions that would restrict the Company's operations or create material contingent liabilities.
Based on our review, Verdana is not a party to any material partnership, joint venture, strategic alliance, or distribution agreements. The Company's go-to-market strategy is primarily direct (enterprise sales team) with a nascent channel partner program that has not yet generated material revenue.
V. INDEBTEDNESS AND CREDIT FACILITIES
A. Pacific Summit Bank, N.A. — Revolving Credit Facility
Verdana is party to a Revolving Credit and Security Agreement (the "Credit Agreement") with Pacific Summit Bank, N.A. ("Pacific Summit Bank" or the "Lender"), a national banking association with its principal offices at 350 California Street, San Francisco, California 94104. The material terms of the Credit Agreement, as identified in our review, are summarized below:
Facility Type: Revolving credit facility.
Facility Size: $10,000,000 maximum borrowing capacity.
Amount Drawn (as of March 31, 2022): $6,200,000. The Company has therefore utilized approximately 62% of the available facility.
Maturity Date: June 30, 2024. Absent a renewal, the Company will be required to repay the outstanding principal balance in full by this date.
Interest Rate: Secured Overnight Financing Rate ("SOFR") plus a margin of 3.50% per annum, with interest calculated on the outstanding principal balance and payable monthly.
Security: The Credit Agreement is secured by a first-priority lien on substantially all assets of Verdana, including, without limitation, accounts receivable, inventory, equipment, intellectual property (to the extent pledgeable), and general intangibles. A UCC-1 financing statement has been filed in the State of Delaware. We have reviewed the security agreement and UCC filings and confirmed their scope.
Financial Covenants: The Credit Agreement contains the following financial covenants, among others:
(i) Minimum Liquidity Covenant: The Company is required to maintain a minimum unrestricted cash balance of $10,000,000 at all times. As of March 31, 2022, the Company reported cash on its balance sheet of $22,400,000. The Company is currently in compliance with this covenant.
(ii) ARR-Based Coverage Ratio: The Credit Agreement includes a financial covenant based on the ratio of ARR to outstanding indebtedness under the facility. We have reviewed the applicable thresholds and confirmed that the Company is currently in compliance based on the most recent compliance certificate delivered to Pacific Summit Bank.
The Credit Agreement also contains customary affirmative and negative covenants governing the Company's operations, including restrictions on the incurrence of additional indebtedness, the creation of liens, the making of investments and acquisitions, the payment of dividends or other distributions, and changes in the Company's organizational structure or capitalization, as discussed further below.
B. Negative Covenants — Lender Consent Issues
Critical Finding: Our review of the Credit Agreement has identified negative covenants that may restrict the Company's ability to issue the Series D Preferred Stock without the prior written consent of Pacific Summit Bank. Specifically, the Credit Agreement contains restrictions on:
(i) Issuance of Equity Securities with Debt-Like Features. The Credit Agreement restricts the Company from issuing equity securities that carry debt-like features — including liquidation preferences, cumulative dividends, or mandatory redemption obligations — without the Lender's prior written consent. The Series D Preferred Stock, as currently contemplated, would carry a liquidation preference (either 1.0x or 1.5x, depending on the outcome of negotiations) and, under certain proposals, a cumulative dividend. These features could reasonably be characterized as falling within the scope of this restriction.
(ii) Changes in Capitalization Structure. The Credit Agreement includes a covenant prohibiting material changes to the Company's capitalization structure without the Lender's consent. The issuance of a new series of preferred stock with significant economic and governance rights, together with an amendment and restatement of the Certificate of Incorporation, may constitute a material change to the capitalization structure triggering this covenant.
(iii) Change of Control. The Credit Agreement includes a "Change of Control" provision, which defines "Change of Control" by reference to beneficial ownership thresholds. While the Series D Transaction, as a minority investment, is unlikely to trigger a Change of Control under most standard definitions, the specific definition in the Credit Agreement should be analyzed carefully in the context of the proposed post-closing ownership structure, board composition, and voting rights, particularly if Pinnacle negotiates significant protective provisions or consent rights that could be viewed as conferring negative control.
Recommendation: Obtaining an affirmative consent letter or waiver from Pacific Summit Bank, N.A. expressly permitting the issuance of the Series D Preferred Stock on the terms contemplated, and confirming that such issuance will not constitute a breach of any covenant or trigger an event of default under the Credit Agreement, should be a condition precedent to the closing of the Series D Transaction. Failure to obtain such consent could expose the Company to an event of default under the Credit Agreement, which could result in acceleration of the outstanding principal balance ($6,200,000 as of March 31, 2022), termination of the revolving commitment, and enforcement of the Lender's security interest in substantially all of the Company's assets.
A separate memorandum addressing the Pacific Summit Bank Credit Facility was delivered on June 28, 2022, and a further Lender Consent Analysis Memorandum was delivered on June 30, 2022. We refer you to those memoranda for a more detailed analysis of the Credit Agreement provisions at issue and the recommended approach to securing lender consent.
C. Other Indebtedness
Based on our review of the diligence materials, including the Company's financial statements, board minutes, and representations of management and Company counsel, Verdana does not have any material indebtedness outstanding other than the Pacific Summit Bank revolving credit facility described above. Specifically, we did not identify any outstanding term loans, subordinated debt, mezzanine debt, convertible promissory notes, equipment financing arrangements, capital leases, or other material debt obligations. The Company's lease for its Portland headquarters appears to be an operating lease and is not classified as a capital lease for accounting purposes.
VI. INTELLECTUAL PROPERTY
A. Verdana SCX Platform
Verdana's core product is the Verdana SCX platform, an AI-powered supply chain optimization SaaS application designed to help mid-market and enterprise manufacturers and logistics companies optimize inventory management, demand forecasting, supplier relationship management, logistics routing, and overall supply chain efficiency. The platform leverages proprietary artificial intelligence and machine learning ("AI/ML") algorithms that were developed in-house by the Company's engineering team under the leadership of Lena Kovac (CTO and Co-Founder).
Our intellectual property diligence focused on confirming Verdana's ownership of, and freedom to operate with respect to, the technology underlying the Verdana SCX platform, including the proprietary AI/ML algorithms, the application software, and associated data processing and analytics capabilities. We also reviewed the Company's trademark portfolio, patent filings (if any), open-source software usage, intellectual property assignment practices, and exposure to third-party intellectual property claims.
A separate IP and Technology Due Diligence Memorandum was delivered on July 12, 2022, providing a comprehensive analysis of the intellectual property matters summarized herein.
B. Trademarks
We reviewed the Company's registered and pending trademark filings with the United States Patent and Trademark Office ("USPTO") for the marks "VERDANA," "VERDANA SCX," and related brand marks and logos. The Company maintains active registrations and/or pending applications for these marks in the relevant classes of goods and services (primarily International Class 42, covering SaaS and related technology services, and International Class 9, covering downloadable software).
Our review did not identify any material oppositions, cancellation proceedings, or third-party challenges to the Company's trademark registrations or applications. We note, however, that the mark "VERDANA" shares certain similarities with the well-known "Verdana" typeface name associated with Brightmoor Partners LLC. While the marks are in different classes of goods and services and the Company has not received any correspondence from Ashbury Holdings regarding potential confusion, this similarity warrants monitoring, particularly as the Company's brand recognition grows. The Company's counsel has indicated awareness of this issue and has expressed the view that the risk of a successful challenge is low given the distinct industries and goods/services involved.
C. Patents
We reviewed the Company's patent portfolio and prosecution history. The Company has filed a limited number of patent applications with the USPTO relating to certain AI/ML methodologies and supply chain optimization algorithms embodied in the Verdana SCX platform. As of the date of this memorandum, these applications remain in prosecution and no patents have been granted. We reviewed the pending applications and their prosecution status, including any office actions received and the Company's responses thereto. The applications appear to be progressing through the normal course of prosecution.
We note that the Company's intellectual property strategy has historically been oriented more toward trade secret protection than patent prosecution. The proprietary AI/ML algorithms and data models that constitute the core of the Verdana SCX platform are maintained as trade secrets, protected through technical measures (access controls, encryption) and contractual measures (confidentiality agreements with employees, contractors, and business partners). This approach is common among enterprise SaaS companies whose competitive advantage derives from the continuous development and refinement of proprietary algorithms rather than from patentable inventions.
D. Open-Source Software
We reviewed the Company's use of open-source software ("OSS") components in the Verdana SCX platform, including the Company's OSS inventory list and the applicable license terms for each component. The Company utilizes range OSS libraries and frameworks in its technology stack, licensed under the following principal open-source licenses:
• Apache License 2.0 — Permissive license; generally compatible with proprietary software distribution;
• MIT License — Permissive license; minimal restrictions on use, modification, and distribution;
• BSD Licenses (2-clause and 3-clause) — Permissive licenses; substantially similar to MIT in effect; and
• GNU General Public License (GPL) variants — Copyleft licenses that require derivative works to be distributed under the same GPL license terms.
With respect to the GPL-licensed components, we evaluated the potential copyleft risk — that is, the risk that the Company's proprietary source code could be deemed a "derivative work" of a GPL-licensed component and therefore subject to the GPL's requirement that such code be made available under the GPL. Based on our review, the Company's use of GPL-licensed components appears to be limited to stand-alone tools and libraries that are not directly integrated into the proprietary core of the Verdana SCX platform in a manner that would trigger copyleft obligations. However, given the complexity of OSS licensing and the evolving interpretation of derivative work concepts, we recommend that the Company conduct an ongoing open-source audit as a best practice, and that the Company implement or enhance its OSS governance policies, including automated scanning tools to identify and track OSS components in its codebase.
No material non-compliance issues with applicable open-source license terms were identified in our review.