Roaring Kitty, a founding partner at Palo Alto Capital Partners ("PACP"), looked at one of his struggling investments. It was a very tough year and hard to raise capital due to the recession and negative outlooks on internet companies. Roaring Kitty was looking at which companies in his portfolio to keep and to let go, despite the difficulty. One company Roaring Kitty couldn't decide on was Kool, Inc. ("Kool"), which needed to raise $2.5MM to finish development of its 3^rdgeneration technology.

Kool was an intriguing company focused on a form of data mining. Two years earlier, Kool raised $1MM from angel investors, and one year after it raised an additional $6MM in an initial institutional round, a Series A, equally split between 2 venture capital firm, PACP and El Camino Ventures ("ECV"). Since the Series A, , Kool started to sell its 2^ndgeneration product, acquiring 20 customers and generating $1MM in sales. Good traction. Among Kool's competitors were 3 public companies whose stocks had declined significantly in the prior 12 months. All 3 of the public companies possessed only 1^stgeneration technology.

After developing its 2^ndgeneration technology and building out its sales and marketing function, Kool was almost out of money. It needed to raise at least $2.5MM more to finish the development of its 3^rdgeneration technology, which could be completed in 1 year's time. Certain patents had been filed related to the 3^rdgenerational technology and if its development continue, components of the new technology could be phase in once completed and tested.

Completion of Kool 3^rdgeneration technology could put the company way ahead of its competitors. Assuming product development continued as planned, Kool forecasted $5MM in revenue for the upcoming year, with a $1.5MM net loss. However, the company did project a light profit in the fourth quarter. If Kool continued to prove successful after development of its 3^rdgeneration technology, it would later need to raise a larger financing round to build out its management team, ramp up its business and position itself for an IPO.

As Roaring Kitty and Kool attempted to raise a Series B round, they were not well received by the VC community. The unfavorable financing environment for internet-related companies and the performance of Kool's public competitors scared the investor pool. Thus, Kool's fate was in the hands of its existing investors, PACP and ECV.

But ECV was strapped for cash and was concerned about putting in "good money after bad" so declined any further investment. But Roaring Kitty at PACP thought Kool was an interesting play and wondered what he should do to determine if PACP should put more money into the company or let it go.

Questions

1. If you were Roaring Kitty performing the due diligence process, what merits/demerits of this investment opportunity do you see? List here the key investment merits (pros) and demerits (cons).
3. If you were Roaring Kitty, would you make the investment? Why or why not?
5. If you were Roaring Kitty, to ensure that PACP was not putting good money after bad, how would you structure your term sheet - namely, prioritize the top 5 terms and details for each of the terms so you are comfortable to invest the additional $2.5MM.
7. Is $2.5MM in the right amount for this round and why or why not?
9. Would you bring in a new VC partner into this deal and why or why not?

Answer rating: 100% (QA)

1 Investment Merits Pros Kool has successfully developed and sold its 2nd generation product showing traction with 20 customers and 1MM in sales The 3... View the full answer