PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT PREPARED AT THE DIRECTION OF COUNSEL IN ANTICIPATION OF LITIGATION AND/OR IN CONNECTION WITH THE PROVISION OF LEGAL ADVICE
MEMORANDUM
To: Harrison Wexford, Responsible Partner, M&A, Calderwood & Harkness LLP Marcus Trejo, Partner, Head of Growth Equity, Pinnacle Capital Management LLC
From: Andrew Fitzpatrick, Lead Associate, M&A, Calderwood & Harkness LLP (with assistance from Naomi Petersen, Working Associate)
Date: May 25, 2022
Re: Valuation and Ownership Analysis — Proposed $60,000,000 Series D Preferred Stock Investment in Verdana Software, Inc.
Matter No.: 1002-00004 Client No.: PIN-0042
Right-click to update Table of Contents
I. Executive Summary
This memorandum provides a comprehensive valuation and ownership analysis in connection with Pinnacle Venture Fund II LP's ("Pinnacle" or the "Fund") proposed $60,000,000 Series D Preferred Stock investment in Verdana Software, Inc. ("Verdana" or the "Company"). The purpose of this analysis is to evaluate the $60,000,000 gap between Pinnacle's proposed pre-money valuation of $260,000,000 and Verdana's proposed pre-money valuation of $320,000,000, as set forth in Verdana's counter-term sheet dated May 3, 2022, which was prepared and delivered by Hargrove Securities LLC, Verdana's financial advisor.
The valuation differential directly impacts Pinnacle's target ownership stake in the Company on a fully-diluted, post-close basis. Specifically, Pinnacle's proposed pre-money valuation of $260,000,000 would yield an ownership position of approximately 18.75% of the fully-diluted post-close capitalization — consistent with the Fund's investment thesis and internal return benchmarks. By contrast, Verdana's proposed pre-money valuation of $320,000,000 would result in Pinnacle holding only 15.79% on a fully-diluted basis or, if Verdana's proposed pre-close expansion of its employee stock option plan ("ESOP") is effectuated on a post-money basis, as low as 15.00%. The difference between 18.75% and 15.00% represents a meaningful economic divergence that must be resolved before the transaction can proceed.
This memorandum examines the following issues in detail:
• The implied revenue multiples under each proposed valuation and the extent to which those multiples are supported by comparable B2B SaaS transactions in the 2021–2022 vintage;
• The effect of Verdana's proposed option pool expansion on the effective pre-money valuation and Pinnacle's post-close ownership percentage;
• A sensitivity analysis demonstrating how Pinnacle's ownership changes across a range of pre-money valuations;
• The impact of the valuation on existing stockholders and the interaction between valuation and other economic terms (principally, liquidation preference and anti-dilution protections); and
• A recommended negotiation strategy for resolving the valuation gap in a manner consistent with Pinnacle's economic objectives.
Conclusion preview: Based on our analysis of publicly available comparable transaction data, the current macroeconomic environment, and the Company's specific financial profile, market data supports a pre-money valuation range of approximately $260,000,000 to $300,000,000 for a company with Verdana's growth, margin, and risk characteristics. Verdana's proposed $320,000,000 pre-money valuation sits above the upper bound of this range and implies a revenue multiple that is difficult to justify given the compression in public and private SaaS multiples observed in the first half of 2022.
We recommend that Pinnacle maintain its $260,000,000 pre-money position as a firm anchor while signaling measured flexibility toward a compromise in the $280,000,000 to $290,000,000 range — contingent upon the satisfactory resolution of several other open economic terms, including (i) pre-money treatment of any ESOP expansion, (ii) a 1.5x non-participating liquidation preference (or an acceptable alternative), and (iii) Pinnacle's full protective provision package. This approach allows Pinnacle to preserve negotiating credibility while positioning for a holistic economic outcome that achieves appropriate risk-adjusted returns.
II. Background
A. Transaction Overview
Pinnacle Venture Fund II LP, a Delaware limited partnership whose general partner is Pinnacle Capital Management LLC, with its principal offices at 2400 Sand Hill Road, Suite 310, Menlo Park, California 94025, proposes to make a $60,000,000 minority growth equity investment in Verdana Software, Inc., a Delaware C-Corporation with its principal offices at 1175 NW Couch Street, Suite 800, Portland, Oregon 97209 (Delaware Secretary of State File No. 6274913). The investment is to be structured as a purchase of newly issued shares of Series D Preferred Stock of the Company.
The transaction process has proceeded as follows. Pinnacle delivered its initial non-binding term sheet to Verdana and its advisors on April 22, 2022, proposing a pre-money valuation of $260,000,000 and setting forth Pinnacle's proposed economic, governance, and protective provision terms. On May 3, 2022, Verdana responded with a counter-term sheet prepared by Hargrove Securities LLC (Nathan Callister, Managing Director, acting as Verdana's exclusive financial advisor) that proposed a pre-money valuation of $320,000,000 and modified several other material terms, including the liquidation preference, anti-dilution mechanism, and option pool treatment. A separate Term Sheet Comparison Memorandum, dated May 5, 2022, provides a complete side-by-side analysis of the two term sheets and is cross-referenced herein as Appendix C.
On May 12, 2022, the parties executed a mutual exclusivity agreement granting a 60-day exclusivity period through July 11, 2022, during which Verdana has agreed not to solicit, encourage, or engage in discussions with any other potential investors regarding an equity financing. This exclusivity window provides Pinnacle with a defined timeline within which to resolve the open economic and legal terms, complete diligence, and negotiate definitive documentation. Verdana's counsel in the transaction is Langford Price & Associates LLP.
B. Verdana Company Overview
Verdana Software, Inc. was founded in 2016 by Raj Anand (Chief Executive Officer & Co-Founder) and Lena Kovac (Chief Technology Officer & Co-Founder). The Company has developed an AI-powered supply chain optimization software-as-a-service ("SaaS") platform marketed under the trade name "Verdana SCX." Verdana SCX targets mid-market and enterprise-scale manufacturers and logistics companies, providing predictive analytics, demand forecasting, inventory optimization, and supply chain visibility tools through a cloud-native, multi-tenant architecture.
The Company's management team is led by Mr. Anand and Ms. Kovac, with Thomas Brightwell serving as Chief Financial Officer. Mr. Brightwell was hired in 2021, bringing prior CFO experience from two other venture-backed enterprise software companies, which Verdana has positioned as preparation for a growth-stage financing and an eventual IPO. As of the date of this memorandum, Verdana employs approximately 310 persons across its Portland headquarters and satellite offices in Austin, Texas and Bangalore, India.
Verdana serves approximately 185 customers, predominantly under multi-year subscription contracts with annual billing terms. The Company's go-to-market model focuses on direct enterprise sales, supplemented by a growing channel partner ecosystem. We note certain customer concentration risks, which are discussed in greater detail in Section IV.C below.
The Company's financial statements are audited by Whitfield & Greer LLP, with Gerald Whitfield serving as the engagement partner. The most recent audited financials cover the fiscal year ended December 31, 2021. Quarterly unaudited financial data through Q1 2022 has been provided to Pinnacle in connection with the due diligence process.
C. Key Financial Metrics (as of Q1 2022, per Diligence Data Provided March 31, 2022)
The following key financial and operating metrics are derived from the Company's unaudited financial data and management-prepared schedules provided to Calderwood & Harkness and Pinnacle in connection with the ongoing due diligence process. All figures are as of or for the period ending March 31, 2022, unless otherwise noted:
• Annual Recurring Revenue ("ARR") (Q1 2022): $47,300,000
• Annual Recurring Revenue ("ARR") (Q1 2021): $28,900,000
• Year-over-Year ARR Growth: 63.7%, calculated as ($47,300,000 – $28,900,000) ÷ $28,900,000
• Net Revenue Retention ("NRR"): 128%, indicating that existing customer cohorts are expanding their spend at a rate that more than offsets churn and contraction
• Gross Margin: 74.2%, reflecting the Company's SaaS delivery model and the scalability of its platform infrastructure
• EBITDA (Trailing Twelve Months ending March 31, 2022): –$11,600,000, reflecting continued investment in sales and marketing and R&D at the expense of near-term profitability
• Cash on Balance Sheet (March 31, 2022): $22,400,000
• Existing Indebtedness: $10,000,000 revolving credit facility with Pacific Summit Bank, N.A., of which $6,200,000 was drawn as of March 31, 2022; the facility bears interest at SOFR + 3.50% per annum and matures on June 30, 2024. The credit agreement contains a minimum liquidity covenant requiring the Company to maintain at least $10,000,000 in unrestricted cash and cash equivalents at all times.
These metrics are central to the valuation analysis that follows. In particular, the Company's ARR, growth rate, and NRR are the primary drivers of comparable company valuation, while the cash burn rate and existing debt profile bear directly on the Company's negotiating leverage and urgency to close a financing.
D. Prior Funding History
Verdana has completed three prior rounds of institutional equity financing since its founding. The table below summarizes the Company's financing history:
The step-up pricing across Verdana's prior rounds illustrates the Company's valuation trajectory:
• Series A to Series B: $0.80 to $2.00 per share, representing a 2.50x per-share increase
• Series B to Series C: $2.00 to $3.00 per share, representing a 1.50x per-share increase
• Series C to Proposed Series D: $3.00 to either $3.25 (Pinnacle's position) or $4.00 (Verdana's position), representing a per-share step-up of 1.08x to 1.33x, respectively
The declining magnitude of per-share step-ups across successive rounds is typical for growth-stage companies as valuations rise and incremental appreciation becomes more difficult to sustain. However, the proposed step-ups under both Pinnacle's and Verdana's positions must be evaluated against the backdrop of both Verdana's operational progress since the Series C and the materially changed macroeconomic and SaaS valuation environment. This analysis is presented in Section IV.D below.
III. Pre-Money Valuation: The Parties' Positions
A. Pinnacle's Position: $260,000,000 Pre-Money
Pinnacle's initial term sheet, delivered April 22, 2022, proposes a pre-money valuation of $260,000,000 on a fully-diluted basis. This valuation is calculated on the basis of 80,000,000 existing fully-diluted shares outstanding (including all outstanding common stock, all outstanding shares of preferred stock on an as-converted basis, and all shares reserved under the Company's existing ESOP, whether issued or unissued). The resulting per-share price and ownership calculations are as follows:
• Price per share: $260,000,000 ÷ 80,000,000 existing fully-diluted shares = $3.25 per share
• Series D shares to be issued to Pinnacle: $60,000,000 ÷ $3.25 per share = 18,461,538 shares (rounded to the nearest whole share)
• Post-money fully-diluted share count: 80,000,000 existing shares + 18,461,538 new Series D shares = 98,461,538 total fully-diluted shares
• Pinnacle's post-close ownership percentage: 18,461,538 ÷ 98,461,538 = 18.75%
• Post-money valuation: $260,000,000 + $60,000,000 = $320,000,000
• Implied ARR multiple (pre-money): $260,000,000 ÷ $47,300,000 = 5.50x ARR
• Implied ARR multiple (post-money): $320,000,000 ÷ $47,300,000 = 6.77x ARR
Under Pinnacle's proposed terms, the Fund would acquire an 18.75% fully-diluted ownership position, which is consistent with the Fund's internal investment criteria for a lead Series D growth equity position in a company at Verdana's stage. The 5.50x pre-money ARR multiple, as discussed in Section IV below, falls within the range of comparable B2B SaaS growth equity transactions in the current market environment, and reflects both the Company's strong operational metrics and the emerging headwinds in the broader SaaS valuation landscape.
B. Verdana's Position: $320,000,000 Pre-Money
Verdana's counter-term sheet, delivered May 3, 2022, proposes a pre-money valuation of $320,000,000 on a fully-diluted basis. However, the effective valuation and ownership implications differ meaningfully depending on the treatment of the Company's proposed ESOP expansion, which introduces two distinct scenarios.
• Price per share: $320,000,000 ÷ 80,000,000 existing fully-diluted shares = $4.00 per share
• Series D shares to be issued to Pinnacle: $60,000,000 ÷ $4.00 per share = 15,000,000 shares
• Post-money valuation: $320,000,000 + $60,000,000 = $380,000,000
The two scenarios under Verdana's proposal are as follows:
Scenario 1 — Without ESOP Expansion:
In the event that no additional shares are reserved under the ESOP prior to closing, the post-money fully-diluted share count would be 80,000,000 + 15,000,000 = 95,000,000 total shares. Pinnacle's post-close ownership would be 15,000,000 ÷ 95,000,000 = 15.79%.
Scenario 2 — With Proposed 5,000,000-Share ESOP Expansion (Pre-Close):
Verdana's counter-term sheet proposes expanding the ESOP from 12,000,000 shares to 17,000,000 shares prior to the closing of the Series D financing. This expansion would increase the pre-investment fully-diluted share count from 80,000,000 to 85,000,000 shares. On a post-close basis, the total fully-diluted share count would be 85,000,000 + 15,000,000 = 100,000,000 total shares. Pinnacle's post-close ownership would be 15,000,000 ÷ 100,000,000 = 15.00%.
The implied revenue multiples under Verdana's proposal are as follows:
• Implied ARR multiple (pre-money): $320,000,000 ÷ $47,300,000 = 6.77x ARR
• Implied ARR multiple (post-money): $380,000,000 ÷ $47,300,000 = 8.03x ARR
The 6.77x pre-money multiple and 8.03x post-money multiple represent the upper boundary (and, in the case of the post-money multiple, a level above the upper boundary) of the range supported by comparable transaction data in the current environment, as discussed in Section IV.C. Verdana and its advisors at Hargrove Securities have justified this valuation by pointing to the Company's 63.7% ARR growth rate, 128% NRR, and the 2021 Series C pricing of $3.00 per share. While these are valid reference points, they must be weighed against the significant compression in SaaS valuation multiples that has occurred since the 2021 Series C, as well as Verdana-specific risk factors such as customer concentration and cash burn.
C. Summary of the Gap
The following summarizes the key dimensions of the valuation gap between the parties:
• Pre-money valuation gap: $320,000,000 – $260,000,000 = $60,000,000 (a 23.1% divergence from Pinnacle's position, or an 18.75% discount from Verdana's position)
• Per-share price gap: $4.00 – $3.25 = $0.75 per share
• Ownership gap: 18.75% (Pinnacle's target) versus 15.00%–15.79% (Verdana's proposal) = a difference of 2.96 to 3.75 percentage points of fully-diluted post-close ownership
Importantly, the gap is compounded by Verdana's proposed pre-close ESOP expansion, which effectively reduces Pinnacle's ownership by an additional 0.79 percentage points (from 15.79% to 15.00%) without any change to the headline investment amount or per-share price. As discussed in Section V below, the treatment of this option pool expansion — whether it is borne by existing stockholders (pre-money treatment) or shared with Pinnacle (post-money treatment) — is itself a valuation issue that adds a hidden layer to the headline valuation gap and must be resolved as part of the overall negotiation.
To put the ownership gap in dollar terms: at Verdana's proposed $380,000,000 post-money valuation, the difference between 18.75% and 15.00% ownership equates to approximately $14,250,000 in implied economic value ($380,000,000 × 3.75%). Even under a compromise post-money valuation of $340,000,000, the gap represents approximately $12,750,000. This magnitude underscores the materiality of the valuation negotiation to Pinnacle's return profile on this investment.
IV. Implied Revenue Multiples Analysis
A. ARR-Based Valuation Framework
Enterprise SaaS companies are most commonly valued as multiples of Annual Recurring Revenue ("ARR"), reflecting the recurring, subscription-based nature of the revenue model and the strong predictability of future cash flows that characterizes high-quality SaaS businesses. While other valuation methodologies — including discounted cash flow ("DCF") analysis, comparable public company multiples, and precedent transaction analysis — are used in the SaaS context, the ARR multiple approach remains the dominant framework for growth-stage venture and growth equity transactions in which the target company is not yet profitable on an EBITDA basis.
The appropriate ARR multiple for a given company is a function of several interrelated factors:
• ARR Growth Rate: The single most important driver of valuation. Companies with higher growth rates command higher multiples, reflecting the market's expectation of future revenue scale and the value of compounding growth.
• Net Revenue Retention ("NRR"): A measure of expansion and churn within the existing customer base. NRR above 120% is generally considered excellent and indicates that existing customers are increasing their spend over time, reducing the company's reliance on new customer acquisition for growth.
• Gross Margin: A proxy for the scalability and unit economics of the software platform. Gross margins above 70% are typical for SaaS companies and indicate a capital-efficient delivery model.
• Cash Burn and the Rule of 40: The Rule of 40 is a widely used SaaS benchmark that sums the revenue growth rate and the EBITDA margin. Companies at or above the Rule of 40 threshold (i.e., the combined figure equals or exceeds 40%) are generally considered to be balancing growth and profitability in an attractive manner.
• Customer Concentration: Revenue concentration in a small number of customers introduces risk and may warrant a discount to the multiple.
• Total Addressable Market ("TAM"): The size of the market opportunity influences the long-term revenue potential and, by extension, the multiple the market is willing to assign.
Applying these factors to Verdana's financial profile:
• ARR Growth: 63.7% year-over-year growth is strong by any measure and places Verdana in the upper quartile of growth-stage B2B SaaS companies. This metric supports a premium multiple.
• NRR: 128% is excellent and demonstrates that Verdana's existing customers are expanding their usage and spend on the platform. This is a material positive for valuation.
• Gross Margin: 74.2% is solid, though slightly below the top-tier SaaS companies that often achieve gross margins of 78–82%. This is a neutral-to-slightly-negative factor.
• EBITDA: –$11,600,000 on a trailing twelve-month basis, representing an EBITDA margin of approximately –24.5% (calculated as –$11,600,000 ÷ $47,300,000 ARR). This reflects significant cash burn and implies that the Company is investing aggressively in growth at the expense of near-term profitability.
• Rule of 40: Revenue growth rate of 63.7% plus EBITDA margin of –24.5% yields a Rule of 40 score of approximately 39.2%. This places Verdana approximately at, but slightly below, the Rule of 40 threshold. Companies that score above 40% are generally perceived as having achieved an attractive balance of growth and efficiency; Verdana's position at approximately 39.2% is respectable but does not command a premium.
• Customer Concentration: As discussed in Section IV.C below, this is a material negative for Verdana's valuation.
B. Implied Multiples at Each Proposed Valuation
The following table summarizes the implied ARR multiples at each party's proposed valuation:
The 1.27x difference between the implied pre-money ARR multiples (5.50x versus 6.77x) is substantial. As discussed below, the market data for comparable transactions suggests that a pre-money multiple of 5.50x to 6.50x is appropriate for a company with Verdana's profile in the current environment, meaning that Pinnacle's position is well within the supported range while Verdana's position is at or above the upper boundary.
The post-money multiples are equally instructive. Under Pinnacle's proposed terms, the post-money ARR multiple of 6.77x is broadly consistent with the multiples observed in recent growth equity transactions for high-growth SaaS companies. Under Verdana's proposed terms, the post-money multiple of 8.03x is aggressive and would require a more favorable macro environment or a stronger financial profile to justify.
C. Comparable SaaS Transaction Multiples
To benchmark the valuation proposals, we have compiled data on publicly reported growth equity and late-stage venture capital transactions involving B2B SaaS companies with the following characteristics: (i) ARR of $30,000,000 to $70,000,000; (ii) year-over-year ARR growth of 50% or more; and (iii) gross margin profiles broadly consistent with Verdana's. We have focused on transactions of 2021 and early-to-mid 2022 vintage to capture the relevant market conditions.
Market Conditions — 2021 Peak versus 2022 Compression:
The SaaS valuation environment has undergone a significant shift between the Company's Series C financing in 2021 and the current date. During 2021, public SaaS multiples reached historic highs, with the BVP Nasdaq Emerging Cloud Index trading at median forward revenue multiples of 15x–20x for high-growth names and the median for all constituents exceeding 12x at the peak. Private growth equity rounds during this period frequently priced at 10x ARR or higher for companies with 60%+ growth and strong unit economics. It was in this environment that Verdana raised its Series C at $3.00 per share.
However, beginning in late 2021 and accelerating through the first half of 2022, a material compression in SaaS multiples has occurred. Rising interest rates, inflation concerns, and a broader risk-off sentiment in the technology sector have driven public SaaS multiples down by approximately 30–50% from their 2021 peaks. As of mid-May 2022, the BVP Nasdaq Emerging Cloud Index median forward revenue multiple has contracted to approximately 7x–9x, and individual high-growth names that previously traded at 15x–20x are now trading at 8x–12x. Private market valuations, while typically lagging public market adjustments by one to two quarters, have begun to reflect this compression in recent transaction data.
Comparable Transaction Range:
Based on our review of available data for growth-stage B2B SaaS companies with Verdana's growth and margin profile, the comparable range for pre-money ARR multiples in the current (May 2022) environment is approximately 5.0x to 7.5x ARR, with the median trending toward the lower half of this range given the macro headwinds. Transactions that were pricing at 8x–10x ARR in Q3/Q4 2021 are now pricing at 5.5x–7.0x ARR for companies of comparable quality. A detailed summary of the comparable transaction data is set forth in Appendix B.
Verdana-Specific Adjustments:
While Verdana's 63.7% ARR growth rate is undeniably strong and positions the Company in the upper quartile of growth-stage peers, several Verdana-specific factors warrant a discount from the upper end of the comparable range:
Customer Concentration. Verdana's largest customer, Meridian Logistics Corp., accounts for approximately 24.9% of the Company's ARR, or approximately $11,778,000 in annualized recurring revenue. The Company's top five customers account for approximately 57.5% of total ARR. This level of concentration introduces material revenue risk, as the loss or significant contraction of a single customer relationship could have a disproportionate impact on growth, NRR, and overall financial performance. Customer concentration at these levels is well above the threshold that institutional investors and public market analysts consider acceptable for a company at Verdana's stage, and comparable companies with lower concentration levels are typically afforded higher multiples.
Cash Burn. Verdana's negative EBITDA of –$11,600,000 on a trailing twelve-month basis, combined with a cash balance of only $22,400,000, implies approximately 18–24 months of operating runway absent additional financing or a significant reduction in burn. This cash position means that Verdana is, to a significant degree, a compelled seller of equity — the Company needs this financing, which reduces its negotiating leverage on valuation. Moreover, the drawn portion of the Pacific Summit Bank revolving credit facility ($6,200,000 of $10,000,000) and the minimum liquidity covenant of $10,000,000 further constrain the Company's financial flexibility.
Rule of 40 Performance. As noted, Verdana's Rule of 40 score of approximately 39.2% is respectable but falls marginally below the 40% threshold. Companies that comfortably exceed the Rule of 40 — particularly those that do so with higher growth rates — tend to command multiples at the upper end of the range. Verdana's position at approximately the threshold, driven by its significant cash burn, does not support a premium multiple.
Implied Fair Valuation Range:
Taking into account the comparable transaction data, the current macroeconomic environment, and the Verdana-specific factors discussed above, we believe the supported range for Verdana's pre-money valuation is:
5.5x to 6.5x ARR × $47,300,000 ARR = $260,000,000 to $307,500,000 (approximately $260M to $308M)
This range encompasses Pinnacle's proposed pre-money valuation of $260,000,000 at the lower bound and approaches, but does not reach, Verdana's proposed $320,000,000 at the upper bound. The midpoint of this range is approximately $284,000,000 (6.0x ARR), which corresponds to a compromise position that could serve as the basis for further negotiation.
D. Step-Up Analysis from Series C
An alternative lens through which to evaluate the proposed valuation is the per-share step-up from the Company's most recent prior financing round. Verdana closed its Series C in 2021 at a per-share price of $3.00, implying a pre-money valuation of approximately $192,000,000 based on the then-existing fully-diluted share count of approximately 64,000,000 shares (the precise figure is approximately 68,000,000 shares including the then-existing ESOP allocation; the pre-money calculation based on 68,000,000 shares would be $204,000,000, and the exact figure depends on the precise composition of the fully-diluted capitalization at the time of the Series C, which we are confirming with the Company's counsel).
The per-share step-up under each proposed valuation is as follows:
• Pinnacle's position ($3.25/share): A step-up of $0.25 per share, or 8.3% from the Series C price of $3.00.
• Verdana's position ($4.00/share): A step-up of $1.00 per share, or 33.3% from the Series C price of $3.00.
Given that approximately one year has elapsed between the Series C closing (2021) and the proposed Series D (mid-2022), and that Verdana's ARR has grown from approximately $28,900,000 (Q1 2021) to $47,300,000 (Q1 2022) — an increase of approximately 63.7% — some per-share appreciation from the Series C price is unquestionably warranted. The Company has executed meaningfully against its growth plan, added customers, and expanded ARR at an impressive rate.
However, the macroeconomic and valuation environment has deteriorated materially since the 2021 Series C. Public SaaS benchmarks, as noted, have compressed by 30–50% from their peaks. Private market step-ups that were routine in 2021 — where 50–100%+ per-share increases were common for high-growth companies — are no longer reflective of the current market. In the present environment, a modest step-up of 8–20% per share from the Series C price is more consistent with prevailing conditions for a company with Verdana's profile.
Under this framework:
• A $3.25 per share price (8.3% step-up) would be at the conservative end but defensible given the macro environment.
• A $3.50 per share price (16.7% step-up) would represent a moderate premium that acknowledges both the Company's operational progress and the market compression.
• A $3.625 per share price (20.8% step-up) would be at the upper end of what we believe the step-up data supports.
• A $4.00 per share price (33.3% step-up) is aggressive and assumes that the valuation environment for Verdana has not deteriorated from the 2021 period — an assumption we believe is not supported by the data.
V. Option Pool Treatment and Its Valuation Impact
A. Pre-Money vs. Post-Money Option Pool Inclusion
A critical — and often underappreciated — component of the valuation negotiation is the treatment of the Company's employee stock option plan. Verdana has proposed expanding its ESOP by 5,000,000 shares, from 12,000,000 to 17,000,000 shares, prior to the closing of the Series D financing. The existing ESOP of 12,000,000 shares is already included in the 80,000,000 fully-diluted share count that both parties have used as the denominator for their respective per-share price calculations.
The critical question is: Will the additional 5,000,000 newly reserved ESOP shares be included in the pre-money capitalization (such that the dilution from these shares is borne by the existing stockholders) or in the post-money capitalization (such that the dilution is shared proportionately between existing stockholders and Pinnacle)? The answer to this question has a material impact on the effective pre-money valuation paid by the existing stockholders and on Pinnacle's post-close ownership percentage.
This issue is commonly referred to as the "option pool shuffle" in venture capital parlance. It is one of the most consequential — and most frequently contested — structural issues in growth-stage financings, precisely because it operates as a hidden valuation lever that can shift significant economic value between the parties without any change to the headline pre-money valuation number.
B. Verdana's Position (Post-Money Inclusion)
Verdana's counter-term sheet proposes that the 5,000,000 new ESOP shares be created prior to the closing of the Series D financing, thereby expanding the fully-diluted share base to 85,000,000 shares before the Series D issuance. Under this approach, the 5,000,000 new shares are included in the pre-investment share count, but the headline pre-money valuation of $320,000,000 is not adjusted to reflect the increased denominator for existing holders — rather, the per-share price is calculated as $320,000,000 ÷ 80,000,000 (the original share count, not the expanded 85,000,000), and Pinnacle's investment amount and share count remain at $60,000,000 and 15,000,000 shares, respectively.
The practical effect is that the ESOP expansion creates additional dilution that is borne proportionately by all post-close stockholders, including Pinnacle. The arithmetic is as follows:
At $4.00 per share and 85,000,000 pre-investment fully-diluted shares, the post-close fully-diluted share count is 85,000,000 + 15,000,000 = 100,000,000 shares. Pinnacle's ownership is 15,000,000 ÷ 100,000,000 = 15.00%, compared to 15.79% without the ESOP expansion.
The ESOP expansion therefore dilutes Pinnacle by 0.79 percentage points (from 15.79% to 15.00%) compared to a scenario in which no expansion occurs. In dollar terms, at Verdana's proposed post-money valuation of $380,000,000, the difference between 15.79% and 15.00% ownership is approximately $3,000,000 in implied economic value ($380,000,000 × 0.79% = $3,002,000). This dilution falls on Pinnacle without any offsetting benefit or adjustment to the investment terms.
From Verdana's perspective, the post-money inclusion approach is advantageous because it preserves the existing stockholders' relative ownership positions and distributes the cost of the ESOP expansion — which benefits the Company by providing equity incentive capacity to attract and retain employees — across all holders, including the incoming investor. Verdana's advisors at Hargrove Securities may argue that the ESOP expansion is necessary to support the Company's growth plan and that Pinnacle should share in the cost as a stakeholder in the Company's future success.
C. Pinnacle's Position (Pre-Money Inclusion)
Pinnacle's initial term sheet is based on a pre-money valuation of $260,000,000 and the existing 80,000,000 fully-diluted shares (which already includes the current 12,000,000-share ESOP allocation). Pinnacle's position is that any expansion of the ESOP prior to closing must be included in the pre-money capitalization — meaning that the dilution from the newly reserved shares falls exclusively on existing stockholders, not on Pinnacle.
Under Pinnacle's framework, if the ESOP is expanded from 12,000,000 to 17,000,000 shares prior to closing, the pre-investment fully-diluted share count would increase to 85,000,000 shares. The $260,000,000 pre-money valuation would then be divided by 85,000,000 shares, yielding a price per share of $260,000,000 ÷ 85,000,000 = $3.06 per share (rounded). Pinnacle would receive $60,000,000 ÷ $3.06 = 19,607,843 shares (rounded). Post-close, the total fully-diluted share count would be 85,000,000 + 19,607,843 = 104,607,843 shares, and Pinnacle's ownership would be 19,607,843 ÷ 104,607,843 = 18.75% — exactly consistent with Pinnacle's target ownership.
This approach is consistent with standard venture capital market practice. The National Venture Capital Association ("NVCA") model term sheet and the NVCA model certificate of incorporation both contemplate that option pool increases are treated as a pre-money expense, meaning that the cost of the increased option pool is borne by existing stockholders and is effectively deducted from the headline pre-money valuation. This convention is widely understood in the venture and growth equity ecosystem and is commonly referred to as the "option pool shuffle." The economic rationale is straightforward: the ESOP serves as a compensation tool for the Company's existing and future employees, and its cost should be borne by the stockholders who benefit from the management team's services — i.e., the existing holders — rather than by the incoming investor whose investment is the catalyst for the financing.
Recommendation: We recommend that Pinnacle firmly insist on pre-money treatment of any ESOP expansion. This is a market-standard position, is well-supported by venture capital convention and the NVCA model documents, and should be a non-negotiable element of Pinnacle's economic terms. Acceptance of post-money ESOP treatment would effectively raise the price Pinnacle pays for its ownership stake without any corresponding increase in the headline valuation, and would establish an unfavorable precedent for future financing rounds.
D. Effective Valuation Analysis
The interaction between the headline pre-money valuation and the ESOP treatment can be illustrated through an effective valuation analysis that quantifies the true economic cost to existing stockholders under different scenarios.
Scenario: ESOP Expansion Treated as Pre-Money Under Verdana's $320M Headline:
If the parties were to agree on Verdana's proposed headline pre-money valuation of $320,000,000 but apply pre-money treatment to the 5,000,000-share ESOP expansion (consistent with Pinnacle's position on option pool treatment), the effective pre-money valuation to existing stockholders would be calculated as follows:
Effective Pre-Money = $320,000,000 (stated headline) – (5,000,000 new ESOP shares × $4.00 per share) = $320,000,000 – $20,000,000 = $300,000,000
In other words, the "option pool shuffle" effectively reprices the deal from a $320,000,000 headline pre-money valuation to a $300,000,000 effective pre-money valuation for existing stockholders. The $20,000,000 difference represents the economic value of the ESOP expansion that is absorbed by the existing holders rather than by Pinnacle.
This analysis has two important implications for the negotiation:
First, it demonstrates that a $320,000,000 headline valuation with pre-money ESOP treatment is economically equivalent to a $300,000,000 effective valuation for existing holders. This means that if Verdana insists on a $320,000,000 headline for optics or internal signaling purposes (e.g., to communicate an "up-round" to employees and existing investors), Pinnacle may be able to accommodate the headline number while achieving a more favorable effective economic result through the pre-money option pool mechanism.
Second, it provides a framework for evaluating tradeoffs. Pinnacle could, in theory, accept a higher headline valuation (e.g., $300M–$310M) if the ESOP expansion is treated as pre-money, knowing that the effective pre-money to existing holders would be approximately $280M–$290M — within the supported range identified in Section IV.C.
Scenario: ESOP Expansion Treated as Post-Money Under Verdana's $320M Headline:
Conversely, if the ESOP expansion is treated as post-money (Verdana's preferred approach), Pinnacle bears the dilution proportionately, and the headline $320,000,000 is the true economic pre-money for all parties. There is no "shuffle" effect, and the stated valuation accurately reflects the economics of the deal for both existing holders and Pinnacle. Under this scenario, Pinnacle's ownership declines to 15.00%, as set forth in Section III.B.
The difference between the two approaches — from Pinnacle's perspective — is the difference between 18.75% ownership (with pre-money ESOP treatment at Pinnacle's valuation) and 15.00% ownership (with post-money ESOP treatment at Verdana's valuation). This spread is worth approximately $14,250,000 in implied value at a $380,000,000 post-money valuation and underscores the importance of resolving the ESOP treatment issue as part of the overall valuation negotiation.
VI. Ownership Sensitivity Analysis
To illustrate the range of potential outcomes across varying pre-money valuation levels, the following table presents Pinnacle's post-close ownership percentage for pre-money valuations ranging from $240,000,000 to $340,000,000, in $10,000,000 increments, under two scenarios: (i) no ESOP expansion (i.e., the pre-investment fully-diluted share count remains at 80,000,000) and (ii) with the proposed 5,000,000-share ESOP expansion included in the pre-investment share count (resulting in 85,000,000 pre-investment fully-diluted shares). In both scenarios, the ESOP expansion is treated as pre-money for purposes of the share price calculation — consistent with Pinnacle's position — meaning the per-share price is derived from the pre-money valuation divided by the pre-investment fully-diluted share count (80,000,000 or 85,000,000, as applicable).
Key Observations:
1. Target ownership threshold. To achieve Pinnacle's target ownership of 18.75% without any ESOP expansion, the pre-money valuation must be at $260,000,000 or below. Every $10,000,000 increase in the pre-money valuation reduces Pinnacle's ownership by approximately 0.3 to 0.6 percentage points, with the marginal impact increasing as the valuation rises (due to the fewer shares issued at higher per-share prices).
2. ESOP expansion impact. With the 5,000,000-share ESOP expansion treated on a pre-money basis, Pinnacle's ownership at any given headline valuation is reduced by approximately 0.80 to 0.95 percentage points compared to the no-expansion scenario. This is because the ESOP expansion increases the total share count without increasing the number of shares Pinnacle receives (assuming the per-share price is set by the original 80,000,000-share base).
3. Compromise range. At a compromise valuation of $280,000,000 to $290,000,000 (without ESOP expansion), Pinnacle would achieve an ownership position of 17.14%–17.65% — approximately 1.1–1.6 percentage points below its 18.75% target but still representing a meaningful minority position. If Pinnacle can simultaneously secure favorable liquidation preference and anti-dilution terms, this ownership range may be acceptable given the overall economic package.
4. Equivalence point. To achieve approximately 18.75% ownership with the ESOP expansion included, Pinnacle would need to negotiate a pre-money valuation of approximately $243,000,000 (interpolating from the table), which is $17,000,000 below Pinnacle's current stated position. This illustrates why the ESOP treatment is, for Pinnacle, a non-negotiable structural issue — accepting post-money ESOP treatment at Pinnacle's proposed valuation would itself cost Pinnacle nearly a full percentage point of ownership.
VII. Impact of Valuation on Existing Stockholders
A. Existing Cap Table (Pre-Investment)
The following table sets forth Verdana's fully-diluted capitalization as of the date of this memorandum, prior to the proposed Series D investment:
This capitalization table reflects the Company's fully-diluted ownership on an as-converted basis, treating all shares of preferred stock as if converted to common stock at the applicable conversion ratios (which are currently 1:1 for each series) and including all shares reserved under the existing ESOP, whether or not such shares have been issued, exercised, or vested. The precise breakdown between issued and unissued ESOP shares, and the weighted-average exercise price of outstanding options, is being confirmed through the ongoing due diligence process and will be reflected in the final capitalization table workbook referenced in Appendix A.
B. Post-Investment Ownership at Each Valuation Scenario
The following table illustrates the post-close ownership of each existing stockholder and Pinnacle under three valuation scenarios: (i) Pinnacle's proposed $260,000,000 pre-money, (ii) a midpoint compromise of $290,000,000 pre-money, and (iii) Verdana's proposed $320,000,000 pre-money. For simplicity, this table assumes no ESOP expansion; the impact of the ESOP expansion is shown in the accompanying column.
Scenario 1: $260M Pre-Money (No ESOP Expansion)
Scenario 2: $290M Pre-Money (No ESOP Expansion)
Scenario 3: $320M Pre-Money (No ESOP Expansion)
As the table illustrates, the dilutive impact of the Series D investment on existing stockholders is inversely correlated with the pre-money valuation. At Pinnacle's proposed $260,000,000 pre-money, the Founders' ownership declines from 35.00% to 28.44% — a dilution of 6.56 percentage points. At Verdana's proposed $320,000,000 pre-money, the Founders' dilution is limited to 5.53 percentage points (from 35.00% to 29.47%). The pattern is consistent across all existing holder groups.
This dynamic is a core driver of the negotiation: existing stockholders — and particularly the Founders and the Company's board (which includes representatives of each existing investor) — have a strong incentive to maximize the pre-money valuation in order to minimize their dilution. Pinnacle must be aware that the Company's board will evaluate the proposed valuation not only in absolute terms but also through the lens of its dilutive impact on each existing holder class.
It is also worth noting that the existing preferred stockholders — particularly Brindoval Capital Group LLC, which acquired its Series C shares at $3.00 per share in 2021 — have an interest in ensuring that the Series D pricing represents an "up-round" (i.e., a per-share price above $3.00). A price of $3.25 per share (Pinnacle's position) technically represents an up-round, but the margin is thin and may trigger concerns among existing investors and employees that the Company's valuation trajectory has stalled. A price below $3.00 per share would constitute a "down round" and could trigger anti-dilution protections in the existing preferred stock. While this scenario is not currently contemplated by either party, it underscores the floor below which the per-share price is unlikely to fall.
C. Interaction with Liquidation Preferences
The valuation negotiation cannot be evaluated in isolation from the other economic terms of the Series D, particularly the liquidation preference. The two parties' positions on the liquidation preference are as follows:
• Verdana's position: 1.0x non-participating liquidation preference. Under this structure, Pinnacle's preference claim in a liquidation event (including a deemed liquidation event such as an acquisition) would be equal to the original investment amount of $60,000,000. Pinnacle would have the right to receive the greater of (a) its $60,000,000 preference or (b) its pro rata share of the distribution as if converted to common stock. There is no participation feature.
• Pinnacle's position: 1.5x non-participating liquidation preference. Under this structure, Pinnacle's preference claim would be 1.5 times the original investment amount, or $90,000,000. This provides Pinnacle with enhanced downside protection, ensuring a minimum return of $90,000,000 before the preference is eclipsed by the value of Pinnacle's converted common stock interest.
The interaction between valuation and liquidation preference is significant. A higher liquidation preference provides Pinnacle with downside protection that may partially compensate for accepting a higher headline valuation. For example, if Pinnacle accepts a pre-money valuation of $290,000,000 (yielding 17.14% ownership) but secures a 1.5x non-participating preference, Pinnacle's downside is protected at $90,000,000 — a level at which Pinnacle would receive its preference until the aggregate distribution pool exceeds approximately $525,000,000 (the level at which 17.14% × $525M ≈ $90M, making conversion more attractive). By contrast, if Pinnacle accepts the same $290,000,000 valuation with only a 1.0x preference, the downside protection is limited to $60,000,000, and the conversion crossover occurs at approximately $350,000,000 in aggregate proceeds.
The broader point is that the overall economic package — encompassing valuation, liquidation preference, anti-dilution protection, and other protective provisions — should be evaluated holistically. A concession on one dimension may be acceptable if offset by a favorable outcome on another dimension. The anti-dilution and liquidation preference terms are analyzed in greater detail in separate memoranda prepared by this office, which should be read in conjunction with this analysis.
VIII. Negotiation Strategy Recommendations
A. Anchor and Range
Based on the foregoing analysis, we recommend the following negotiation posture:
1. Maintain $260,000,000 as the stated anchor. Pinnacle should continue to communicate $260,000,000 as its proposed pre-money valuation. This figure is supported by the comparable transaction data (5.50x ARR), reflects the current macroeconomic headwinds, and establishes a credible negotiation floor. Retreating from this position prematurely — or signaling flexibility before Verdana has made any concessions — would weaken Pinnacle's leverage and invite further demands from the Company's side of the table.
2. Signal willingness to move toward $280,000,000–$290,000,000, contingent on concessions. If and when the negotiation progresses beyond the initial anchor positions, Pinnacle should indicate openness to a compromise in the $280,000,000 to $290,000,000 range (implying approximately 5.9x to 6.1x ARR), contingent on the following conditions being met:
(a) ESOP expansion treated as pre-money. Any expansion of the Company's ESOP must be included in the pre-money capitalization, consistent with the "option pool shuffle" convention and NVCA model document practice. This is a non-negotiable structural condition.
(b) 1.5x non-participating liquidation preference. Pinnacle should secure a 1.5x non-participating liquidation preference (or, at a minimum, a meaningfully enhanced preference above 1.0x) to provide downside protection that partially compensates for the higher valuation.
(c) Resolution of other protective provisions. Pinnacle's full protective provision package — including board representation, consent rights on specified actions, information rights, and registration rights — must be agreed upon as part of the overall economic package.
3. At $290,000,000 pre-money (no ESOP expansion): Pinnacle would receive 16,551,724 shares at $3.625 per share, achieving approximately 17.14% post-close ownership. While this is below the 18.75% target, it falls within a range that may be acceptable when combined with strong protective provisions and a 1.5x liquidation preference. The implied ARR multiple of 6.13x is within the supported range.
B. Leverage Factors Favoring Pinnacle
Several factors strengthen Pinnacle's negotiating position and support the Fund's ability to hold firm on valuation:
• Market environment. SaaS valuation multiples are compressing in mid-2022, and the trend is accelerating. Every week that passes without a signed term sheet potentially strengthens Pinnacle's argument that the macro environment has deteriorated further. This is a time-sensitive dynamic that the Company must weigh.
• Verdana's cash position. With $22,400,000 in cash and –$11,600,000 in annual EBITDA, Verdana has approximately 18–24 months of runway (depending on the trajectory of the burn rate and any working capital fluctuations). The Company needs this capital to fund its growth plan and maintain operational continuity. This fundamental necessity reduces Verdana's ability to walk away from the table or pursue alternative financing on meaningfully better terms.
• Customer concentration risk. Meridian Logistics Corp. accounts for approximately 24.9% of Verdana's ARR ($11,778,000), and the Company's top five customers account for approximately 57.5%. This level of concentration is a material risk factor that would be penalized by any sophisticated investor. Pinnacle's willingness to invest despite this concentration is itself a form of value that should be reflected in the valuation.
• Credit facility constraints. The Pacific Summit Bank revolving credit facility ($6,200,000 drawn of $10,000,000 total commitment), combined with the minimum liquidity covenant of $10,000,000, further constrains Verdana's financial flexibility. If the Company's cash balance approaches the $10,000,000 covenant threshold — which could occur within 12–18 months absent new capital — Verdana would face a covenant compliance crisis that would significantly impair its negotiating position in any future financing.
C. Leverage Factors Favoring Verdana
Pinnacle should also be aware of the factors that strengthen the Company's negotiating position:
• Strong operational metrics. Verdana's 63.7% year-over-year ARR growth rate and 128% net revenue retention are objectively strong and position the Company well relative to its peer group. These metrics are the foundation of any argument for a premium valuation, and Pinnacle should expect Verdana and Hargrove Securities to emphasize them heavily.
• Gross margin quality. A 74.2% gross margin demonstrates efficient SaaS economics and supports the Company's narrative of a scalable, capital-efficient platform. While not at the very top of the SaaS distribution, this margin level is solidly within the range of well-regarded B2B SaaS companies.