978-1119563228 Chapter 10

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MetaCarta

Teaching Note

Zacharakis

7/19/2012

Synopsis

The MetaCarta case MetaCarta: Growing a Company, Do We Take the VC Money? tells the

startup story of Doug Brenhouse, John Frank and Erik Rauch. The trio develops a new search

technology that coverts text names into geographic maps. When the project was initiated in

1999, the business model was going to be advertisement-driven, but with the dot-com bust,

Meta–Carta ends up selling the platform to government agencies and businesses, particularly in

the oil and gas sector. The main focus of the case is financing. We follow the company through

multiple rounds of financing and track the impact on equity dilution. The case ends with an offer

from Sevin Rosen, a premier venture capital firm, that has significant implications on the

founders and earlier round investors’ equity. The founders must decide if they should take the

VC money and if so, on what terms.

Learning Objectives

1. Understand the financing process of new ventures.

2. Learn about different types of investors, from angels, the government to venture capital.

3. Decipher a capitalization table (cap table) that tracks the impact on equity dilution for the

founders and early round investors.

Use in Class

This case is particularly useful to illustrate Capitalization Tables. It shows how equity is diluted

over subsequent rounds and what the implied value of the company is at various stages. This

case can be used for both MBA and advanced undergraduates. The case is best suited for

entrepreneurial finance courses, but can also be used in other entrepreneurship courses that have

a class or more on raising capital. The case may also be useful for finance courses that cover VC

financing.

Zacharakis, A., Corbett, A., & Bygrave, W. (2020) Entrepreneurship, 5th Edition. Hoboken, NJ: Wiley

Class Plan

Prior to class, students should read and prepare the case. To assist in their understanding, they

should read a chapter on entrepreneurial finance, especially on venture capital. If using the text

by Bygrave and Zacharakis, Entrepreneurship, 2nd edition, Chapter 10, Raising Money for

Starting and Growing Businesses, is directly relevant. It may also be useful to have students

review the National Venture Capital Association website (www.NVCA.org) where they can find

data on current VC activity.

This case can be covered in anywhere from 45-90 minutes depending on the level of depth and

topic covered.

I. Describe MetaCarta

A. The product – a search engine that converts text into maps (see wine example in

the case, p. 3-4.)

B. What was its original business model? Why didn’t it work?

C. Entrepreneurs need to be nimble to market and customer conditions. Have the

students examine the new business model in relation to the original vision and ask

them to explain what the changes were and explore why these were good changes.

2. Why would oil and gas companies buy this platform? What advantages does

the platform provide for government agencies?

II. Overview of the Capitalization Table, round by round. Students are likely

unfamiliar with capitalization tables. While they have a general sense of what

dilution is, the capitalization table makes the concept concrete. A useful exercise

derived from this case would be to have students build a capitalization table for a

venture that they are planning to launch (if applicable).

A. Pre-round

1. Point out the DARPA alternative financing on page 8 of the case and ask

students: what are the advantages of accepting the DARPA money?

2. Angel round – This deal raises $1 million as convertible debt. At the next

institutional round – the trigger – the note converts to equity at a 20% discount

off the price that the next round’s investor pays.

c. Example:

d. Ask the students the advantages and disadvantages of convertible debt

to both angel and entrepreneur. Responses should include the

following.

B. Series A One year later, founders set the share price at $.64 based on the number

of shares they had previously transferred to themselves and the pre-money

valuation negotiated with the investors. The share price could have just as easily

been set at $1/share – very common in first round financing – and then adjust the

number of issued shares to reflect the relative percentage of the company that the

founders would retain). There are a number of things to inquire/explain about this

round:

angel round, an 80% discount off share price. Thus, their share price is $.51

($.64 * .80). The convertible debt holders also accrued interest prior to the

conversion (8% per annum accruing). Since it has been one year since the

C. Series B (Proposed VC financing one year later). The main decision in the case is

whether the founders should accept the VC financing offered by Sevin Rosen

(SR). Before delving into that question, make sure students understand the

implications of the proposed offer.

1. Again, ask what is the pre-money valuation and how was this determined? At

this point, SR has submitted an offer of $6.5 million as the pre-money

valuation. The final valuation will be determined by negotiation between

entrepreneurs and SR. This is the starting point for the analysis and the case

asks whether the entrepreneurs can negotiate a better deal. Note that this pre–

money valuation does not have any relation to the previous rounds of post-

money valuation. It is determined independently of previous rounds based

upon these factors:

2. Ask the students to explain the impact of the current proposal. Most students

will note the significant dilution to the founders (from 63% to 16%). Some

will fixate on the dilution, ignoring that dilution is inevitable when seeking

new funding. The dilution is bad for entrepreneurs, but the more important

3. Ask students what is causing that cram down. Examining previous rounds of

post-money valuation ($6080) and comparing them to the current round’s pre-

money ($6500), the company has increased in value, although not very much.

The big factor driving the “cram down” is the inclusion of an option pool.

4. Ask any students if they’ve ever had options. This leads into an explanation

of an option pool. Basically, options are set aside to attract future key

employees and to reward existing employees who continue to perform well.

A couple of further points:

III. [VOTE] Should Meta Carta take the VC money? – I like to take an initial vote to see

where the class stands. Usually, 70% say don’t take the money, 30% say take it.

IV. Role Play – break the class into three groups (I usually have subgroups within the

main group where 2-3 people discuss the issues that each party is facing). I pose the

questions below and give the groups 10-15 minutes to think through their positions.

1. Group 1 – John, Doug and Erik

a. Do you take the money? Why or why not?

b. Can you negotiate better terms? What levers can you pull?

2. Group 2 – Angels; I make the assumption that the earlier round investors (angels)

have a board seat and can influence the founders on the decision.

a. How would you advise the founders?

b. In hindsight, what terms could you have imposed to protect your earlier

round investment?

3. Group 3 – VCs (Sevin Rosen and syndicate)

a. Why do you like MetaCarta?

b. Why did you structure the deal the way that you did? What are the

implications to the founders?

c. If a deal can be negotiated, what role will you take going forward?

4. Before the role play, I ask the VC group why they like MetaCarta. This helps set

the stage for what VCs look at when finding and investing in companies. In

MetaCarta’s case, a couple of issues come to the forefront.

a. Validation – The team has strong earlier investors (In-Q-Tel); they have

customers (government and oil and gas companies); if Sevin Rosen

invests, it is easy to envision how MetaCarta can gain many more

customers.

b. Progress to date – The founders have demonstrated their adaptability;

changing the business model after macro factors eliminated the

advertisement model; the technology is proven.

5. Role Play – I call on a spokesperson from each of the three groups and have him

or her engage in a negotiation.

a. I track the main points on the board and then discuss them afterwards,

dividing the board in half. On one half, I write the VC’s questions and

concerns, and on the other half I write how the entrepreneur addresses the

question. I try to do this as inconspicuously as possible so that it does not

distract the role players.

b. The role play usually shows that the VC has most of the power. The main

drivers of that power include:

i. Meta Carta is almost OOC (out of cash) and it takes time to get

another investor on the hook. If it turns down Sevin Rosen, it

could take another six months to get another investor.

ii. The macro environment is unfavorable and VC and angel

financing are down, meaning lower valuations in general. Waiting

might improve macro conditions, but since MetaCarta is OOC, that

is a luxury it cannot afford.

c. Engage students in a discussion on the areas where founders have

negotiating room. All these areas have positives and negatives and can

lead to a rich discussion.

i. Size of option pool – smart entrepreneurs will track the newly–

hired employees and performance-based awards they expect to

give out over the coming funding period (usually a year or so) and

then negotiate a smaller option pool.

ii. Options set aside for founders – founders may also be able to

negotiate some options reserved for founders based upon their

continued performance.

iii. Founders may be able to get the Sevin Rosen to have the options

equally dilute entrepreneurs and Sevin Rosen, although this is

unlikely.

iv. Amount of money raised (grow slower approach) – this can be

risky in that it may lengthen time to exit and may mean that the

entrepreneur is out raising money again sooner (without the

environment having improved) and the company does not appeaer

as exciting because growth has slowed.

v. Earlier round angels may invest because of the severe dilution they

face if Sevin Rosen invests. While that would protect the angel’s

equity position, the question becomes whether the added value of

Sevin Rosen offsets the dilution. Sevin Rosen is a premier VC

firm with a strong rolodex, experience taking companies public

and/or selling them for a strong return, and deep pockets to lead

any future rounds of financing. These value added aspects

increase the overall valuation of the firm going forward.

d. At the end of the role play, the issues in the table below are often

highlighted. If not, consider raising them as discussion points.

PROS

CONS

Need money to continue development

and fuel growth

Dilution to founders and early stage

investors. It may be difficult to get early

round investors to agree to the deal.

Credibility of a Grade A VC firm

Sevin Rosen will likely be heavily

involved – loss of control for founders

and early round investors.

Access to larger rolodex

Angels might be able to provide a bridge

round and hope that MetaCarta can find

another investor on more favorable terms

and that macro conditions improve, but…

there is always a risk that things will not

get better.

Mentoring and board service

While there is dilution, hopefully it will

be offset by future growth.

V. Founders – If time permits, consider talking about how the founders came together.

A. Talk through how the founders came together. They met at a networking function

at MIT. Is this a good approach? Or should you work with people who you

already know well?

B. What is the value of having co-founders? It offers validation of your idea,

provides more bandwidth and offers founder support as others join and share in

the highs and lows of a startup.

C. How do you ensure a good fit (marriage)? A trial period (dating) is often a good

idea so that the parties can see how they work together. It is important to be clear

that you are doing this on a trial basis so everyone has similar expectations.

D. How would you divide up the founder shares? Why? Generally, two factors

drive equity split: contribution to date and expected contribution going forward.

John and Erik would have more equity based upon work done prior to Doug

joining, and then the trio should take into account future expectations for their

respective contribution. For example, Erik is planning on working part-time, so

his equity share would be lower. John will assume the CEO position and Doug

will take on other executive positions. Thus, John would likely demand more

equity than Doug or Erik. Interestingly, John used a rather unique system

counting email correspondence between the three founders. His presumption was

that the more email correspondence, the more equity that party should get.

E. It seems like they have a strategy to replace/demote themselves later. Why? The

founders likely realized that they may need a more experience executive team to

foster faster growth. In fact, after this case, the trio hired a more experienced

CEO. This topic is address in a Bcase that looks at the liquidity event MetaCarta

ultimately pursues.

F. How do you reward future hires? This can be used to reiterate the topic of

options, along with salary and bonuses.

VI. Epilogue – MetaCarta did take the VC money, believing that they would make up

the dilution with an attractive harvest. Ultimately, the company was acquired by

Nokia. The deal was large enough that all the early round investors were made whole

(meaning they recovered their investment) and earned reasonable returns. The

founders and Sevin Rosen earned better returns. Nokia was only interested in the

technology and allowed Doug the opportunity to sell the customer-facing portion of

the business, which he did to QBase. Thus, all parties came out ahead in the

transaction. A side note: tragedy befell the founders when Erik Rauch died in a freak

hiking accident in 2005. Although Erik was not full-time in the venture, it was hard

on John and Doug.