Creating Terms and Valuations for Investors

Terms and Valuation:

David Kirkpatrick

How Venture Capitalists Structure Investments

Durham, NC 919.530.1177 New York, NY 212.209.3042 www.sjfund.com

Getting Ready for Equity™ Disney Entrepreneur Center Orlando, FL July 23, 2008 >

TERMS AND VALUATION – Session Goals Understand role of term sheet Become familiar with the term sheet and due diligence process Learn how investors think about valuation and the role valuation plays in the deal Gain exposure to typical terms and term sheet issues RESOURCES: Glossary of equity investment terms Sample Series A Preferred equity term sheet Sample term sheet capitalization table 2

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TERM SHEET - Overview Defines the principal terms of a proposed investment Investing entities and $ amount being invested Valuation of the company, which determines ownership percentages Other financial terms: dividends, other return enhancers, redemption, dilution, stock option pool…

Other conditions: board of directors, management team recruitment requirements, protective provisions …

Part of building a relationship, how it is done is a good indicator for the future Get a good lawyer, who has done venture capital deals 3

© 2008 SJF Advisory Services

TERM SHEETS: A MARRIAGE CONTRACT DATING (BEFORE THE TERM SHEET)

Summary, plan, financials, projections, meetings, conference calls, references

ENGAGEMENT (AFTER THE TERM SHEET) Legal documents, further due diligence

WEDDING (CLOSING AND FUNDING THE DEAL) Not all deals make it to the altar!

MARRIAGE (UNTIL EXIT DO US PART) Board meetings, growth, acquisitions, mis-steps, corrections, additional funding, exit 4

© 2008 SJF Advisory Services

VALUATION CONSIDERATIONS FOR INVESTORS MERGER & ACQUISITION ACTIVITY – WHO IS BUYING AND WHY

Strategic and financial buyers

Valuations of comparable M&A transactions

IPO POTENTIAL OF THE INDUSTRY SECTOR

Valuations of comparable public companies

CONFIDENCE LEVEL IN COMPANY’S FORECAST AT EXPECTED EXIT

Current customer traction & operations as indication

Believability of sales pipeline - Year 5 projections are likely discounted heavily by investors

INVESTMENT RETURN EXPECTATIONS AT VARIOUS PRE-DEAL VALUATIONS 5

© 2008 SJF Advisory Services

M&A TRANSACTION COMPARABLES M&A Transactions of Plastics and Resins Manufacturers (Dollars in Millions)

Seller

Buyer

Acquisition Enterprise Value

Seller LTM Financials: Revs.

EBIT EBITDA

Polyurethanes Buss. of EniChem SpA

Dow Chemical Co

$370.0

$500.0

NA

Union Carbide Corp

Dow Chemical Co

$9,539.4

$5,500.0

$740.0

Sybron Chemicals Inc

Bayer AG

$320.2

$282.6

$14.6

Polyvinyl Alcohol Business of APC

Celanese AG

$326.0

$198.0

Geon Co (The)

Hanna (MA) Co

$706.5

$1,261.2

Thermoplastic Polyurethane Business

Huntsman Corp

$120.0

$75.0

McWhorter Technologies Inc

Eastman Chemical Co

$342.0

$450.9

$27.2

Furon Co

Cie de Saint-Gobain SA

$614.1

$487.3

$47.4

Amino Coating Resins Business

Cytec Industries Inc

$43.4

$25.0

Pacific Western Extruded Plastics Co

Eagle Pacific Industries

$79.6

$180.0

$11.9

Essef Corp

Pentair Inc

$428.3

$450.0

$31.6

NA $191.7 NA

NA

NA

0.7 x

NA x

NA x

$1,138.0

1.7 x

12.9 x

8.4 x

$27.5

1.1 x

22.0 x

11.6 x

1.6 x

NA x

NA x

0.6 x

3.7 x

3.0 x

1.6 x

NA x

NA x

$45.3

0.8 x

12.6 x

7.5 x

$71.8

1.3 x

12.9 x

8.5 x

1.7 x

NA x

NA x

$17.7

0.4 x

6.7 x

4.5 x

$44.5

1.0 x

13.6 x

9.6 x

1.1 x

12.2 x

8.7 x

NA $236.1 NA

NA

AVERAGE

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Acquisition Enterprise Value to: Revs.

EBIT EBITDA

PUBLIC COMPANY COMPARABLES Company

Ticker

Exchange

Stock Price

A. Schulman, Inc.

SHLM

OTC

$13.05

$458.4

$979.0

$59.6

0.47 x

7.7 x

Georgia Gulf Corporation

GGC

NYSE

$16.14

$1,167.4

$1,529.2

$177.0

0.76 x

6.6 x

InterSystems, Inc.

II

AMEX

$0.28

$27.2

$17.5

$3.0

1.55 x

9.2 x

Landec Corporation

LNDC

OTC

$4.50

$102.6

$225.2

$5.7

0.46 x

18.1 x

Planet Polymer Technologies

POLY

OTC

$0.36

$2.7

$0.5

($1.4)

5.06 x*

NM x

Polymer Group, Inc.

PGI

NYSE

$3.10

$1,142.9

$831.3

1.37 x

8.3 x

Polymer Research Corp. of America

PROA

OTC

$0.90

$1.2

$5.2

0.22 x

NM x

PolyOne Corporation

POL

NYSE

$10.25

$1,549.9

$2,252.0

$112.7

0.69 x

13.8 x

PVC Container Corporation

PVCC

OTC

$3.16

$59.7

$89.5

$7.7

0.67 x

7.8 x

Rogers Corporation

ROG

NYSE

$26.55

$405.4

$240.2

$38.2

1.69 x

10.6 x

Spartech Corporation

SEH

NYSE

$22.96

$940.8

$986.8

$141.2

0.95 x

6.7 x

Wellman, Inc.

WLM

NYSE

$16.42

$894.6

$1,131.2

$126.8

0.79 x

7.1 x

AVERAGE

0.87 x

9.6 x

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Enterprise Value ($MM)

LTM Financials: Revenues EBITDA ($MM) ($MM)

$137.7 ($0.2)

Enterprise Value to: Revenues EBITDA

DETERMINING PRE-DEAL VALUATION Prospect's LTM Financials

Prospect's Enterprise Valuation

Prospect's Equity Valuation

Less, Net Debt

M&A Industry Multiples

Revenue

1.1

x

$

5,138,000

=

$ 5,651,800

-

$ 500,000

=

$ 5,151,800

EBITDA

8.7

x

$

585,000

=

$ 5,089,500

-

$ 500,000

=

$ 4,589,500

Public Company Multiples

Revenue

0.9

x

$

5,138,000

=

$ 4,624,200

-

$ 500,000

=

$ 4,124,200

EBITDA

9.6

x

$

585,000

=

$ 5,616,000

-

$ 500,000

=

$ 5,116,000

AVERAGE EQUITY VALUATION

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$ 4,745,375

PRE-DEAL VALUATION AND VC OWNERSHIP

A

PRE-DEAL EQUITY VALUATION

B

VC INVESTMENT

C

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4,000,000

4,500,000

5,000,000

5,500,000

6,000,000

+

2,000,000

2,000,000

2,000,000

2,000,000

2,000,000

POST-DEAL EQUITY VALUATION

=

6,000,000

6,500,000

7,000,000

7,500,000

8,000,000

VC OWNERSHIP

=B/C

© 2008 SJF Advisory Services

33%

31%

29%

27%

25%

VALUATION AND CAP TABLE 9/10/2007

Green Company, Inc. Capitalization Table Prior to Series A Issuance

Company Shareholder Founder A Founder B Employee stock option plan Preferred A shareholders

% of fully diluted shares 51.00% 44.00% 5.00% 100.00%

After Series A Issuance

Number of Shares 2,550,000 2,200,000 250,000 5,000,000

% of fully diluted shares

Number of Shares

34.00% 29.33% 10.00% 26.67% 100.00%

Extra 500,000 shares added to option plan ($500,000 value) $2MM in VC financing for 26.67% ownership (after option plan included) $5MM pre-money valuation, $7.5MM post-money valuation 7,500,000 shares outstanding at $1/share 10

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2,550,000 2,200,000 750,000 2,000,000 7,500,000

CONDITIONS TO TYING THE KNOT

ADDITIONAL DEBT FINANCING EQUITY CO-INVESTORS OR SYNDICATE MANAGEMENT CHANGES OR NEW RECRUITS USES OF FUNDS – Acquisitions, marketing, expansion DUE DILIGENCE

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TERM SHEET: Team Issues CEO, FOUNDER, FAMILY MGMT ISSUES NEW RECRUITS MANAGEMENT CONTRACT, NON-COMPETES STOCK OPTION PLAN

Incentives available for additional mgmt team members or full team

BOARD OF DIRECTORS

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Designate seats for management, investors, independent directors Voting rights for management and investor classes Establish committees © 2008 SJF Advisory Services

THE BELLS AND WHISTLES DIVIDENDS 7% to 15% is common, cash or stock, sometimes compounding, usually accrues and paid at exit event

LIQUIDATION PREFERENCE Venture capitalists often get one times their investment back before participating pro-rata with other shareholders

ANTI-DILUTION RIGHTS FOR FUTURE FINANCINGS IF THEY OCCUR AT A LOWER VALUATION Weighted average ratchet adjustment is most common

CONVERSION RIGHTS Ability to convert preferred stock to common stock in event of IPO or other exit valuation hurdle 13

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THE BELLS AND WHISTLES, continued REPS AND WARRANTIES

Statement of facts, opinions, estimates

WARRANTS

Additional stock purchase options at predetermined price or valuation adjustments based on milestones

FEES

Legal fees typically paid by company out of investment proceeds, sometimes additional management fees

NO SHOP

Prevents company from negotiating with other investors during a specified due diligence period

RIGHT OF FIRST REFUSAL, TAG ALONG OR CO-SALE

Investors’ rights to participate in future financings

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FRIENDLY DIVORCE? Æ REDEMPTION CLAUSE Defines right of investor to redeem investment, typically five years Not typically exercised, right time to exit usually evident to all If exercised, what are the teeth?

How is the price set – greater of purchase price + dividends, market valuation, valuation multiple?

Term for the pay-out if a recapitalization?

How about a call as well as a put?

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PROTECTIVE PROVISIONS ACTIONS THE BOARD MUST APPROVE, SUCH AS…

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Creating new series or classes of equity or changing their rights Pay dividends or repurchase securities Amend the Certificate of Incorporation or Bylaws Incur debt or capital expenditures over a certain amount Merge, consolidate, lease license or sell significant assets File for bankruptcy, dissolve, or liquidate Increase or decrease size of Board of Directors Hire or fire executive officers

© 2008 SJF Advisory Services

VALUATION RESOURCES FOR ENTREPENEURS Mergerstat (www.mergerstat.com) SEC Filing (www.sec.gov/edgar/searchedgar/companysearch.html) Analysts’ Research Reports (http://screen.yahoo.com/reports.html) Yahoo Finance (http://finance.yahoo.com) Alumni database resources - business schools Ask VC funds for their comps & analysis

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© 2008 SJF Advisory Services

David Kirkpatrick

THANK YOU! Durham, NC 919.530.1177 New York, NY 212.209.3042 www.sjfund.com

Getting Ready for Equity™ Disney Entrepreneur Center Orlando, FL July 23, 2008 >