MetaCarta Case

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California State University, Northridge *

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Jan 9, 2024

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MetaCarta Case 1.) What are the previous and proposed rounds of financing presented in the case? When looking at the MetaCarta Capitalization Table, there is a section for “Preround Financing” of which we don’t have data for but this is where friends and family would typically invest. MetaCarta explored an unconventional funding source in series round A financing from DARPA. In 2001, Doug and his team were successful in securing $500,000 in funding from DARPA along with $1,000,000 from their first angel investment which came out to a total of $1,500,000. In series round B, MetaCarta attracted the interest of In-Q-Tel that alongside a second angel investment provided $1,000,000 total capital for MetaCarta in 2002. In series round C, MetaCarta attracted the interest of venture capital firms like “Sevin Rosen” and others in 2003 in which $6,500,000 was being offered. 2.) Why did the team seem particularly excited about financing from DARPA and IN-Q-TEL? Explain. DARPA and IN-Q-TEL funding was a big step for MetaCarta. It allowed them to move out of John’s living room and recruit new talented people along with affording to move into an office space. The team also were also able to consider small salaries for themselves. Not only could they pay themselves and hire more talent, but the DARPA money came in the form of a grant which meant their equity would not suffer from dilution of ownership and required no repayment/interest. DARPA also provided credibility to the team and their project. In ‐ Q ‐ Tel is a very interesting source of capital. They are the venture arm of the U.S. Central Intelligence Agency (CIA). This was important because it’s very prestigious and the government customer base that MetaCarta were focusing on viewed investment’s from IN-Q-TEL as vetted technologies. From a technology perspective, this solidified how important their tech really was. Once they got their seal of approval that the technology they had was exceptional, IN-Q-TEL agreed to invest and it was the best possible seal of approval. 3.) How does convertible debt work? What is a trigger event? What are the pros and cons for the angel investor and the entrepreneur? Convertible debt allows investors most commonly angel investors to provide funding to startups with debt/cash for a fixed interest rate and depending on the maturity date that it has or if it reaches a certain valuation or milestone that it would be converted at a discount or at a fixed valuation to equity in the next funding rounds. In MetaCarta’s case, a few of the trigger events included; “debt being convertible at a discount the following round or at a fixed valuation, which

2 was $4 million in eighteen months or if a venture capital round of financing occurred before November 1st, 2003”. The pros for entrepreneurs would include debt financing and little to no equity dilution having to be given up in the early stages while the founders continue to expand their business and cover expenses. This gives entrepreneurs the ability to raise money quickly without giving up equity straight away or having a valuation. It gives them time to protect their equity ownership (retain decision making), to build their business and fund necessary expenditures before the note gets converted to equity. A con for startups would be that they are racing against time to build up their valuation because otherwise investors could take up a huge amount of equity from the business (principal + any accrued interest) once the note converts. For investors, once a trigger event occurs or the maturity date for a convertible note passes, the company needs to pay back the loan. The investor can “convert the agreement into equity using the valuation cap or discount rate terms” — whichever gives note holders the lower price. This allows investors to add more shares for less money in future rounds. A con would be that if the company goes bankrupt or loses significant value the investor may have lost a huge amount of their investment with little to no recourse. 4.) What is an option pool? Explain. “An option pool is authorized but unissued stock which has been reserved for future grants of options to current and future employees.” Investors typically expect the company to have an option pool sufficient to attract needed additional employees. For example, in the case of MetaCarta, Sevin Rosen along with other venture capital firms would invest at a pre-money valuation of $6.5m giving majority ownership (50%) to themselves including an option pool that would account for another 25% of the equity leaving the founders with only 16% post money. The remaining 9% would go to the angel investors. 5.) Should MetaCarta take the Sevin Rosen VC money? Why or why not? A pro of taking venture capital money is that it can provide MetaCarta with financial stability. Accepting venture capital funding can provide MetaCarta with the financial resources that it needs to support its growth and expansion plans. This can help the company overcome cash constraints and invest in R&D, marketing, and hire talented employees. Another pro would be that venture capital firms can provide expertise and guidance: and they often bring valuable industry experience, expertise and networks to the table.

3 They can provide mentorship, strategic guidance and access to their network of contacts, which can be instrumental in solidifying MetaCarta's continued growth. An investment from Sevin Rosen can provide credibility to metaCarta in which it signals to other investors that they have been properly vetted and has potential for significant growth in being able to scale their operations, expand into new markets, and develop innovative products or services. Even though the major cons would be that MetaCarta would lose significant equity (64% to 16%) along with loss of decision making ability and external pressures, this can be mitigated through possible negotiations and the company would still have a greater opportunity to gain a competitive edge and capture a larger market share than their competitors because of Sevin Rosen. Alternatives to venture capital could include corporate acquisitions and debt/equity financing from companies, crowdfunding campaigns from social media platforms, and customer financing. 3 examples of customer financing. Instead of charging $1000 per unit (service/product/project) do small payment plans of $250 every week/month instead. The 2nd option is to divide up big projects into smaller phases and have your customers pay upfront before every stage. The 3rd option is to have customers pay the entire $1k upfront by way of presale with certain added incentives or enough value proposition to warrant the cost. This is especially important for new ventures and big projects who need lots of funding and take a long time to develop. If you're trying to get financed by your customers, especially large institutional investors or corporations, then exclusive deals or geographical rights to your product (exclusivity within Asia) can be provided on the basis that they provide you with the capital to fund the development of your product which can be non-dilutive. Donation pages such as GoFundMe can also be considered. Maybe your product is fighting for a good cause and you could start a movement. Other ways to get debt financing include collateralized loans and lines of credit from banks if you have grossing assets (can include accounts receivables, inventory and revenue) which can be used as working capital along with equipment financing. Other avenues include equity financing (convertible notes, warrants, SAFEs) and additional grants and loans from local, state & federal governments including nonprofits that may not require equity/interest payments. Look to programs within the DoD, DoE, Small Business Administration, VentureWell etc. Pitch competitions and additional investments from friends/family along with more private investments from angels & personal connections could go a long way in protecting your equity.

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4 I forgot to mention that Special Purpose Acquisition Companies (SPACs) and (SPAVs) would be another great way for companies to acquire funding if needed. SPACs allow private companies to go public and raise capital quickly through a merger rather than a traditional IPO. This can provide ready access to public markets. The SPAC raises money upfront through its own IPO and holds that capital in trust for the future merger. This provides committed capital ready for the private company and allows the private company to become publicly traded. Being acquired by a SPAC can be faster, less expensive, and involve less uncertainty compared to an IPO process. Once merged, the company has publicly traded shares which can be used to raise additional capital. Once the acquisition is completed, the combined public company could seek debt financing options through its assets and through issuing bonds etc. SPAVs raise private capital with the intent of making acquisitions or investments in companies, typically through private equity structures. They primarily provide equity financing by taking ownership stakes in companies through warrants, convertible notes, SAFEs etc. This comes from the pooled capital raised from investors. However, SPAVs could also utilize debt financing instruments like mezzanine debt as part of their investment strategy. This is more flexible than SPACs. The investment mandate of a SPAV may allow for both equity and debt investments into a company. https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introducti on/ Extra Credit Bonus Question: Explain how the founder and angel investors would be crammed down. Show your calculations and your conclusions regarding pre-money and post-money valuations. At first we look at the MetaCarta Capitalization table and see that regarding the pre-seed funding round the founders kept all their shares and equity at 100%. Regarding first series round A the founders held all their shares pre money and there was no dilution. But when post-money is considered the founders still kept all their equity since the convertible note that was received from the angel investment syndicate did not convert yet and DARPA gave a grant which comes with no dilution of equity and no interest payments. When looking at series round B pre-money the founders equity is still 100% because no equity dilution occured from last round. However when considering post-money, the founders lost 37% of equity (63%) and the

5 first angel investors gained 21% because DARPA took nothing and IN-Q-TEL took 16% which adds up to 100%. We found this answer by taking stock price ($0.64) x # of shares-in millions (6,250) =$4,000. Based on the terms of the convertible bond with interest included, the 1st angel investment syndicate got equity converted at a 20% discount to price which is ($0.64x20%) = $.512. When we take the total investment $1m + (interest) 80,000 = $1,080,000. Then we do $1,080,000 / stock price ($0.512) we get 2,109,375 shares. That equates to a total value of $1.08m. For the 2nd angel investment + IN-Q-TEL we get $1m / $.64 (same as founders) = 1,562,500 shares. Pre-money valuation. The company's pre-money valuation of $4,000 + the 1st angel syndicate investment of $1,080 = $5,080. Founders equity would be 79% (4,000/5,080=79%) + 1st angel investment (1,080/5,080=21%). Without the 2nd angel investment or the funds from IN-Q-TEL this is how the equity pool would have been but with the 2nd $1m being proposed you would do (1,000 / the new valuation 6,080=16%). Then you would take the highest equity valuation - lowest valuation to get post-money valuation (79%-16%=63%). So when we put it all together we get 63% for founders, 21% for 1st angel syndicate and 16% for 2nd angel/IN-Q-TEL investment. Total Series Round B Invest/Share= $1m from 2nd angel investment/IN-Q-TEL. Average price is $.613, # of shares is 9,922, and value is $6,080 which gets us to 100% post money. For series round C we take Sevin Rosin’s investment of $6.5m / stock price ($.33) which gets us 19,697,000 shares. Pre-money their equity is 0% but post-money it’s 50% ($6,500/13,000=50%). For the equity pool we add up all the values ($6,500+2,063+696+516=$9,775) x stock price ($.33) = $3,226,000. The total Series C valuation would be ($9,775 + $3,226 = $13,000) To get the shares outstanding for equity pool we do ($3,226 / .33 = 9,775). Post-money the valuation is 25% ($3,226/13,000=25%). To calculate the founder’s post-money valuation we take the number of shares (6,250) x stock price ($.33) = $2,063. Their equity post-money is 16% ($2,063/13,000=16%) For the 1st angel investment group we take the number of shares they had (2,109) x stock price ($.33) = $696. Pre-money it’s 21%, but post-money it’s 5% ($696/13,000=5%). For the 2nd angel investment group we take (1,563 x .33) = $516. Pre-money it’s 16%, but post-money it’s 4% ($516/13,000=4%).

6 When we add up the values it equals (50%+25%+16%+5%+4%=100%), while the total shares will be (19,697+9,775+6,250+2,109+1563=39,394). Total series round C Invest/Share= $6.5m from Sevin Rosen and other VCs. Average price is $.33, # of shares is 39,394, and total value is $13,000 which gets us to 100% post-money. When it's all said and done the founders lost about 84% of their total equity to venture capital firms, angel investment syndicates and IN-Q-TEL. Founders no longer have majority control over their business and while they can perform executive decision making it can be sidestepped by Sevin Rosen and the board of directors. The venture capitalists having majority control over 50% means that they have final say in all executive decision making and the appointment of board members.

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7 Appendix: The founders and both angel investor syndicates were put in the unfortunate situation of suffering major dilution and every financing round the share prices dropped significantly (due to down rounds), sometimes more than 40% which left the valuation of the business significantly less and limited the amount of ownership that the original investors could have kept.