Memorandum: Net Present Value and Apex Investment Partners

MEMORANDUM To Apex Investment Partners correspond to my analysis of the Accesslines proposed term tag end, I do not believe that Apex would serve its accept interests, or those of its investing partners, by investing in Accessline according to the terms proposed. By investing at the proposed rating, according to the proposed control and incentive structure, Apex would be shouldering a disproportionate sh are of the risk should Accessline expire to meet its performance targets, or require fresh inflows of capital from future investment rounds.Nor can Accessline understand the sort of steps necessary to protect its investment in the case of management failure. Should Apex organize a counter-offer, I would suggest the following terms Valuation Accesslines projected revenues in 1999 are $208m. Using the average price/revenue balance of 3com and Boston Technologies, it seems reasonable to expect an IPO rating at 3. 67 times revenues, producing gross proceeds of $764m with a pl ace value of $116m (using our 60% force out rate).Assuming that Accessline meets this revenue target, and that no future funding is required, Apex will take a slight passage on its required rate of return, barring the voluntary distribution of the dividend from the bestride of film directors, on which we are not offered a seat. The present price per share at much(prenominal) an exit would be approximately $7. 84. However, granted Accesslines historical electrocution rate, it seems unreasonable to expect the $16m investment produced in serial B to concluding Accessline until 1999.Assuming Accessline will need another $32m to reach its revenue targets by 1999, Apex takes a much to a greater extent severe loss relative to its required rate of return. The present price per share at such an exit, assuming the new shares are also offered at $8 per share, would be $6. 18 per share. I thus suggest using $6 per share as a point for a new valuation of the company, assuming the incl usion/revision of terms as described below. Rights and Preferences Apart from the valuation, other elements of the term sheet must(prenominal) be adjusted to allow Accessline to protect its interests and motivate or replace management in the case of performance failure.First and foremost, Apex must insist on the right to elect one director to the board. serial A investors already have one seat, and the current voting clauses allow Series A to effectively book control of decision making by requiring 2/3rds majority for many pick up decisions. Should future funding rounds be required, those investors may insist on seats on the board. Apex must remove antidilution protection from employee shares, as this removes a significant incentive for employees and management to reduce Accesslines burn rate.However, as Series A investors retain a veto over the deal, their shares must be allowed to retain anti-dilution protection. Additionally, we may propose a point at which additional investm ent rounds (above and beyond $32m of fresh capital) would piss dilution of ESOP shares at an accelerated rate. Dividends should be made cumulative and issuable upon a liquidation resultant or an IPO. Such dividends may be converted, if the holder desires, to common shares. This will encourage management to seek a quicker exit. Liquidation preference must be strengthened in other ways.In my opinion, the current administration allows management and employees to receive unjustified returns in the case of a liquidation. I suggest a ratio of 1. 5 times the Series B purchase price, applicable to Series A shares, with the remainder to be distributed among Series A, Series B, and common shareholders/ESOP on an as-if-converted basis. In an IPO, Series B shares should auto-convert at a ratio of one-to-one at a target price of $12 until June 30th and $15 aft(prenominal) June 30th 1996. After that, the targets must continue to ratchet upwards.The written consent of 3/4ths of Preferred share holders could subvert this requirement while preserving Apexs ability to veto auto-conversion. This voting ratio should also be employed in the voting clause, since without it Apex lacks any ability to control future funding rounds. Series B must be allowed to redeem all of their shares upon the failure of Accessline to come within 5% of its revenue and income projections for 2 consecutive years. Alternatively, Apex could require that unvested management/ESOP shares be returned to Series A and Series B on a pari passu basis in the case of performance failure.Alternatively, Accessline could insist on a right to replace management in the case of this eventuality. Given the large number of competitors already present in the market, it is likely that if Accesslines business fails, it will do so quickly and drastically. Negotiation considerations It is all-important(prenominal) to note that a counterproposal from Accessline that strengthens or enhances any of these provisions in Apex f avor in commuting for a higher issue price of the Series B shares should be considered.However, there are limits to the reward we should pay for enhanced control, and firm limits for how far such control can be reduced. A board member and the voting rules are non-negotiable. The dividend and the autoconversion terms, however, are places in which we can demonstrate flexibility. At this price, with these changes to the term sheet, we are still exposed. Significant competitive, regulatory, or technological changes in the marketplace could quickly destroy Accesslines profitability.This is, as it stands, a strong counterproposal that is bound to meet resistance from management and employees, but provided we preserve Series As valuation, I believe Series A investors will be inclined to allow us more control and latitude provided the performance requirements for management are strengthened. Since I believe our competitors will also propose lower valuations based on a view of these same n umbers, we must act tactfully. by chance some sort of parachute can be arranged for senior management in the event of a takeover.