A university consortium dedicated to developing the theory and practice
of negotiation and dispute resolution. Harvard | MIT | Tufts
Aerospace Investment: Balancing Venture and Relationship
Capital
Confidential Instructions for the Venture Capitalist
Scenario
You are a general partner for Aerovent Capital, a venture capital (VC) firm that focuses
on investing in early stage, high-growth companies in the aerospace industry. Aerovent
Capital prides itself on the very active role it assumes with its portfolio companies to
help build them into successful, industry leaders. You have worked with Aerovent for
over fifteen years and have become one of the most senior partners in the firm.
The current deal you are considering is a $100 million investment in a company called
Earth Escape. As the lead partner for this investment opportunity, you have met with
the founder several times and are ready to discuss a term sheet. During this
negotiation, you will discuss the most significant terms of the potential investment. If
this negotiation is successful, the agreed-upon terms will provide the basis for a detailed
term sheet to be signed later this week. You are extremely excited about becoming an
investor in Earth Escape, but you also realize that convincing the founder of your desired
terms while nurturing such a nascent relationship may be quite a challenge.
Aerovent Capital’s Investment Philosophy
Aerovent Capital focuses on leveraging its industry expertise by acting as lead investor
and “partner” to early stage companies. Aerovent strives to provide much more than
just a capital infusion to its portfolio companies. The firm seeks to add value to its
portfolio companies by recruiting outstanding board members and top management,
recommending company strategy based on its industry expertise, providing access to its
network of industry professionals, and eventually helping the company find a buyer or
go public. Aerovent hopes to attract the best entrepreneurs in the aerospace industry
by marketing itself as an investment partner that makes industry-revolutionizing success
This simulation was written by Nicholas Sabin, who gratefully acknowledges its genesis in Professor Edward Bergman's Negotiation
and Dispute Resolution course of the Wharton School’s Department of Legal Studies and Business Ethics. Copies are available from
the Teaching Negotiation Resource Center (TNRC), online at www.pon.org, by email: tnrc@law.harvard.edu, or by telephone at 800258-4406. This case may not be reproduced, revised or translated in whole or in part by any means without the written permission
of the TNRC Coordinator, Program on Negotiation at Harvard Law School, 501 Pound Hall, Cambridge, MA 02138. Please help to
preserve the usefulness of this case by keeping it confidential. Copyright © 2007, 2010, 2019 by the President and Fellows of
Harvard College. All rights reserved. (Rev. 06/19)
Aerospace Investment: Confidential Instructions for Venture Capitalist
possible. As a representative of such a firm, you consider developing well-functioning
relationships with your portfolio companies one of your greatest responsibilities.
Background on Potential Investment
Earth Escape was founded four years ago with the intent of revolutionizing the space
tourism industry. The founder, with whom you are negotiating, is an accomplished
management and engineering R&D (research and development) professional with over
25 years’ experience in the aerospace industry, specializing in launch vehicle
development. The founder is also Earth Escape’s current Chief Executive Officer (CEO).
The company’s mission is to make suborbital space flight an economically feasible
option for the general public. Earth Escape is well on its way to accomplishing such a
task. The company has privately developed a new reusable launch vehicle (RLV) based
on its own proprietary technology. The launch vehicle is capable of taking off from a
standard airport runway, exiting the earth’s atmosphere and entering outer space for
approximately twenty minutes at a peak altitude of over 100 miles above the earth’s
surface, and returning to the same runway, with a round-trip time of only two hours.
Earth Escape claims that the RLV is ten times as safe as any space craft to date and is far
less expensive to produce and maintain.1 By drastically reducing the safety and financial
concerns of space flight, Earth Escape intends to exponentially increase the number of
private citizens taking commercial space tours each year for the next decade. The tours
will offer anyone with the desire and financial means the opportunity to experience the
weightlessness of outer space, and to view the grandeur of the earth from a distance
previously reserved for only a select few astronauts.
Earth Escape has spent approximately $23 million, primarily funded through personal
contacts of the founder, over the past four years to develop its proprietary RLV.2 To
date, the company’s single test-RLV has made fifteen tours of space, catering to
extremely wealthy and eccentric individuals. The company currently employs 35
individuals, but intends to grow quickly. Earth Escape is currently seeking funding of
$100 million to produce a fleet of six RLVs and to develop the company infrastructure
necessary to begin servicing the general public.
Expectations and Concerns
You are very optimistic for the potential of this investment, but you realize the
challenges that lie ahead. On the positive side, at this point you believe Earth Escape
has all the characteristics of an investment home run. Based on your experience and
1
Note that the risks and challenges of orbital space flight are significantly greater than those of suborbital
space flight. You estimate that orbital flight is currently at least 10-20 times as costly as suborbital flight
due to the additional speed and energy requirements of launching a vehicle into the earth’s orbit.
2
All funding to date has been given by wealthy individuals in exchange for common stock.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
2
Aerospace Investment: Confidential Instructions for Venture Capitalist
instincts, you think that Earth Escape could become the dominant industry leader for
public space travel. You believe the space tourism market is ripe for a growth explosion
if a company such as Earth Escape can reduce the cost and safety issues currently
restraining the market.
You are most concerned with the risks of the complicated and emergent technology.
Earth Escape seems quite confident that its proprietary design will make safety issues a
minor point. However, you realize the devastating effect even one non-routine flight
resulting in a casualty might have on the company’s credibility. Furthermore, you must
account for the risk of pioneering a young market, relying on a few key individuals from
Earth Escape, responding to new competitors in the future, and dealing with potentially
illiquid securities when you hope to exit the deal. Accordingly, you hope to set up the
terms of the Earth Escape investment so that you protect yourself from as much risk as
possible and generously compensate yourself and your firm in the event that the
investment is successful.
Alternatives to a Negotiated Agreement
Considering the substantial amount of risk involved in the investment, you have
quantified your Best Alternative To a Negotiated Agreement (BATNA). You may accept a
minimum of 45 substantive points. If you can not reach an agreement with Earth
Escape that meets your acceptable minimum, you would prefer to pass on the deal and
consider other companies for investment.
Aerovent Capital’s Process Interests
As the first negotiation of substantive terms with the founder, this discussion could set
the tone for the rest of your potential relationship. You hope to convince the founder
through your actions that Aerovent will strive to act as more of a partner than just as a
financial investor. Your process goals are to establish an open flow of communication
based on mutual respect and to actively consider the founder’s interests throughout the
entire negotiation. It is clear that you cannot control all of the founder’s perceptions of
the process, but you hope to convince the founder that your requested terms are
equitable to both parties and that partnering with Aerovent Capital will result in the
best possible working relationship with a venture capital firm. It is your hope that you
can achieve such process goals while agreeing to an investment structure that is highly
lucrative for Aerovent Capital.
To gauge your ability to achieve your process goals, the founder will complete a process
evaluation based on his or her experience during the negotiation. The evaluation will be
filled out after an agreement has been reached, but before any confidential information
is shared. Specifically, you will be scored on the following five process attributes:
§ Trust: How much does the founder trust you?
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
3
Aerospace Investment: Confidential Instructions for Venture Capitalist
Respect: Did the founder feel respected during the negotiation?
Equitability: How fair does the founder believe the process was?
Regard for Other’s Interests: How much did you attempt to understand the
founder’s interests?
§ Interest in Future Collaboration: How interested is the founder in working with
you in the future?
You will receive a score from 0 to 10 for each of the attributes for a potential total of 50
Process Points. The Process Points you receive will be added to your Grand Total Score.
§
§
§
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
4
Aerospace Investment: Confidential Instructions for Venture Capitalist
CONFIDENTIAL
Negotiable Terms for the Venture Capitalist
The following confidential information regards eight negotiable terms you will discuss
with the founder.3 The terms may be negotiated in any order. A confidential score
sheet is also included, which breaks down the specific point values for each term. Use
this score sheet to record the agreed terms of your negotiation and to calculate your
total score. For the purpose of this simulation, you must abide by the scoring
restrictions.
The point values for each term are based on the totality of Aerovent Capital’s
investment interests, e.g. industry analysis, risk profile, portfolio composition, etc. Note
that if the specified minimum terms are not agreed upon as outlined in the instructions
(unacceptable terms are reiterated as “No Deal” on the score sheet) or the substantive
BATNA is not reached, you will not proceed with the entire investment. Do not show
any of your confidential instructions to the founder.
Term #1: VC Equity Percentage
You will receive equity in Earth Escape for your $100 million investment. One of your
most basic interests in this negotiation is to receive as great an equity percentage as
possible. In your previous meeting with the founder you both agreed that a $100
million investment is the appropriate amount to help Earth Escape reach the next stage
of its development, a cash flow positive business running a small fleet of suborbital
RLVs.4 To determine the approximate percentage of equity your investment is worth
you have considered your valuation of Earth Escape. The equity percentage and
valuation are related such that the higher the valuation you attach to the company, the
smaller the equity percentage you will receive for the fixed $100 million investment. 5
Determining the value of a company in its early stages can be a subjective analysis.
With Aerovent Capital you have found that detailed financial projections of startup
companies are of secondary value to experience and recommendations from industry
contacts and consultants. By forecasting a range of values for Earth Escape five years
from now and discounting them to the present, you think that Earth Escape deserves a
post-investment valuation between $150 and $200 million. These valuations suggest
that you should receive between 50% and 67% of the company equity for your $100
million investment, but you would be eager to receive even more.6 You justify the
higher equity percentage by considering your desired risk/reward ratio. The unproven
3
Additional terms of the investment will not be considered during this negotiation. For the purpose of this
negotiation it can be assumed that any terms not scored will be in accord with Aerovent Capital’s standard
term sheet.
4
If extremely attractive terms are reached you might be interested in investing more capital. However, this
investment (as is) would be the largest to date for Aerovent and you do not have the resources to invest
more than $100 million at this time.
5
Valuation in this sense refers to “post-money valuation” and relies on the venture capital industry
standard of assuming all stock issued is common stock for simple valuation purposes.
6
Assume percentages of the company are on a fully-diluted basis post-financing.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
5
Aerospace Investment: Confidential Instructions for Venture Capitalist
management team, uncertain future of the public space travel market, unrefined
technology, and potentially illiquid nature of the investment all support your receiving a
large portion of the company to offset the high risk factors.
One other significant consideration you should make during the negotiation of your
equity percentage is who will have the majority of shareholder control.7 As a legal
matter, though a business corporation is run by its board of directors, a majority
shareholder has the ability to take control of the company.8 Thus, if Earth Escape begins
to fail, there is an importance difference in the influence Aerovent Capital would have
over the company if it owns 51% versus 49% of the equity. You want to make it clear to
the founder that you do not intend, nor desire, to control the future of Earth Escape
through shareholder influence. However, having a shareholder majority offers you
significantly more security in the event that the company begins to fail and Aerovent
must take on a more active role.
Therefore, you have a strong incentive to settle on an equity percentage significantly
over 50% by establishing a low valuation based on your idea of fair compensation for
the substantial risk involved in the venture.9
Term #2: Type of Stock
You must also agree on the nature of the security you will receive for your investment.
You are considering three forms of stock for your equity share: common, convertible
preferred, and redeemable preferred.10 This is an important term for you because it
affects your risk and the proceeds you would receive in a liquidation event.
The most basic option is common stock. If you are issued common stock you will be
placed on an even footing with the existing shareholders without any liquidation or
conversion preferences. As a respected venture capitalist, you find it laughable to
consider not receiving some type of preferred stock given the amount of risk associated
with this investment.
The industry standard for venture capital investments tends to be convertible preferred
stock.11 If you were issued convertible preferred shares, in the event of a liquidation
your preferred shares would entitle you to recoup your investment before holders of
common stock receive anything. Additionally, you would have the option of converting
7
Earth Escape’s bylaws detail that for governance issues requiring a shareholder vote, a simple
shareholder majority is required for approval. Regardless of the type of stock agreed upon in Term #2,
Aerovent shall have votes representative of the Term #1 VC Equity Percentage and shall vote as a class
with all holders of preferred and common stock. Note that you will negotiate your representation on the
board of directors as a separate term.
8
See Bartlett, Joseph W. Fundamentals of Venture Capital. New York: Madison Books, 1999.
9 You may use the company’s valuation to negotiate this term, but settle on the specific equity
percentage for the venture capital firm.
10
At this point all shareholders have been issued common stock.
11
See Cardis, Joel, et al. Venture Capital: The Definitive Guide for Entrepreneurs, Investors, and
Practitioners. New York: John Wiley & Sons, 2001. p. 198.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
6
Aerospace Investment: Confidential Instructions for Venture Capitalist
your preferred shares into common stock.12 With this option, in the event that the
value of your equity percentage exceeds the value of your investment, you would
convert your preferred shares into common stock. This option allows you to protect
your initial investment with the benefit of sharing pro rata in the upside potential.
Redeemable preferred shares would be the most favorable to you.13 Like convertible
preferred stock you would have a liquidation preference that allows you to recoup your
investment before common shareholders receive anything. The additional benefit of
redeemable preferred is that in the event the company is worth more than your initial
investment, you are allowed to fully redeem your initial investment and then also split
the remaining proceeds above your investment with the common shareholders pro rata.
Thus, you are not choosing between recouping your investment and sharing in the
equity. Rather, you may do both. Redeemable preferred shares are your first choice
because they best compensate you for the risk you are taking.
Term #3: Dividends
You may also negotiate the right to receive dividends on your equity share. Potential
dividends will not be paid in cash. Rather, they shall accrue until a liquidation event and
be paid in equity, commonly referred to as payment in kind. Negotiate dividends as a
percentage per annum of the original VC owned equity.14 Your primary interest in
agreeing to dividends is to increase your equity share and thus, your upside potential.
From your experience, the industry average, when dividends are issued, is 8% per
annum. You value receiving dividends rather highly because you realize the substantial
increase in your final equity stake a moderate compounding dividend can produce over
a number of years. You would like to receive as high a dividend as possible without
damaging the relationship.
Term #4: Antidilution Rights
You would like to negotiate an antidilution provision in the term sheet to protect your
equity share from excessive dilution in future rounds of financing.15 The provision you
will be discussing with the founder is your right of first refusal. If Earth Escape requires
additional capital in the future, the right of first refusal would give Aerovent the right to
buy the additional shares of equity before they are offered to another party. You would
prefer to have this provision in place because it allows you to protect your equity
position from dilution by future investors. This provision could be extremely important
if Earth Escape requires more funding at a later date, but can only negotiate the funding
at a valuation lower than the valuation you invest at. You are hopeful that the founder
may even agree that VC antidilution rights are beneficial to both parties in the long run.
12
Assume a one to one conversion ratio.
Redeemable preferred stock would be issued along with common stock equal to the agreed upon VC
equity percentage.
14
Assume cumulative annual compounding of dividends.
15
Dilution refers to a reduction of your fractional ownership of the company.
13
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
7
Aerospace Investment: Confidential Instructions for Venture Capitalist
You must negotiate this term as either “VC Right of First Refusal” or “No Antidilution
Rights.”
Term #5: VC Appointed Board Members
Achieving adequate representation on Earth Escape’s board of directors is critically
important to your investment. Not only does it offer you influence over the company’s
strategy, but it is one of the principle ways you hope to add value to the company. The
board of directors has many responsibilities that effect the future of a company, such as
setting strategic goals, reviewing management’s performance, approving major financial
transactions, etc.
You are negotiating the number of directors that Aerovent Capital may appoint to the
board. The board currently consists of three members: the founder and two
independent directors selected by the founder. You emphatically want to appoint at
least one member to the board, but the more you appoint the more influence you
would have over Earth Escape.16 If the founder is receptive to Aerovent appointing
multiple board members, you would like to appoint as many as possible for the benefit
of the company and your investment.
Term #6: Vesting of Founder’s Shares
You believe the founder’s vision and technical expertise are critical to the success of
Earth Escape. Vesting the founder’s shares of stock is a way that you can entice the
founder to stay with the company. If the founder’s shares are vested, the founder’s
equity stake would be returned to Earth Escape and each year the founder stays with
the company a portion of the equity is given back to the founder. Assume that the
founder would receive an equal percentage of equity back each year and will be fully
vested after staying the number of years agreed upon. You are not sure of the
founder’s intentions at this point, but you are positive that if the founder left the
company in less than four years it would be a disaster for your investment. Four years is
the minimum vesting schedule you will accept. Every additional year further secures
your investment.
Term #7: CEO Replacement Provision
Though the founder is critical to the success of the company, as the company expands
you think it would benefit everyone involved if the founder served on the board of
directors and Earth Escape hired a professional CEO. The founder has acted as CEO
since the company’s inception and has done an excellent job to date considering that
running an entire company is a markedly new experience for a former R&D manager.
However, the CEO is one of the top variables in a company and the attributes that make
a CEO successful in an entrepreneurial company can be drastically different from those
that make a CEO successful in a mature company. Personally, you would like to bring in
a professional CEO immediately to begin implementing the next major stage of growth
16
Decisions made by the board rely on a simple majority approval. Split decisions are broken by the
chairman of the board.
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
8
Aerospace Investment: Confidential Instructions for Venture Capitalist
for Earth Escape. However, your previous discussions made it clear that the founder is
adamant about remaining CEO, and you believe the deal will not proceed if you request
an immediate replacement.
To protect your investment interests and allow the founder a chance to retain the CEO
title, you have suggested the use of performance benchmarks. If an agreed upon annual
benchmark is not met, Aerovent Capital will have the right to immediately replace the
CEO with no further negotiation. Vesting of the founder’s stock would not be affected
by a CEO replacement if the founder continued to work for the company as a member
of the board of directors, which you sincerely hope would be the result.
For this term you are negotiating the performance benchmarks that will be used to
determine if the CEO should be replaced. You have suggested that the benchmarks be
the very revenue projections that the founder presented to you in your first meeting.
The founder presented three potential scenarios categorized as conservative
projections, moderate projections, and aggressive projections. The scenarios detailed
annual revenue projections for the next five years. You are most interested in agreeing
to the aggressive projections because the founder will likely not be able to meet them
year after year, in which case Aerovent would have the option of replacing the founder
as CEO. If the founder is capable of meeting the aggressive projections, so much the
better for your investment. The moderate projections would be acceptable, but you are
extremely hesitant to accept the conservative projections as benchmarks. If only the
conservative projections are met, you will not achieve your required rate of return on
the investment.
Term #8: No Shop Provision
A “no shop” provision would prevent the founder from shopping the deal around to
other VCs in an attempt to negotiate better terms before the formally binding Stock
Purchase Agreement is signed. If the no shop provision is included, Aerovent Capital will
have the right to exclusive negotiations with Earth Escape for sixty (60) days, after which
the provision will expire if the Stock Purchase Agreement has not be signed.
You aren’t sure if other firms are interested in Earth Escape at this point, but you realize
the devastating effect even one misinformed VC can have if it offers overly generous
terms. From your experience you have seen deals easily spin out of control when
multiple VCs begin offering competing term sheets, with valuations doubling and all
leverage going to the entrepreneurs.
For those reasons, the no shop provision is an important term for Aerovent. Without it
you might have to renegotiate all the other terms, and you might even have to walk
away from the deal if overbidding occurs. You hope to make it clear to the founder that
the no shop provision is not intended to be detrimental to Earth Escape. Though other
VC firms might offer the founder a higher valuation, they cannot match the value added
that Aerovent Capital provides its portfolio companies through its close working
relationships. You must negotiate this provision as simply “included” or “not included.”
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
9
Aerospace Investment: Confidential Instructions for Venture Capitalist
Confidential Score Sheet for Venture Capitalist
Instructions: When an agreement has been reached, circle the agreed upon options and record the
results in the Points Awarded column. You may negotiate the VC Equity Percentage and Dividends in
terms of any whole percentage. Note that receiving zero points for an item does not equal No Deal,
unless No Deal is specifically noted.
Options
Point
Allocation
Points
Awarded
25% or less:
26% to 34%:
35% to 39%:
40% to 45%:
46% to 49%:
50%:
51% to 59%:
60% to 69%:
70% or more:
No Deal
2
3
6
9
11
15
18
20
________
Common:
Convertible Preferred:
Redeemable Preferred:
0
8
12
________
No dividends:
1% to 3%:
4% to 7%:
8% to 9%:
10% or more:
0
3
6
9
12
________
#4: Antidilution Rights
No Antidilution Rights:
VC Right of First Refusal:
0
6
________
#5 VC Appointed Board Members
0 members:
1 member:
2 members:
3 members:
More than 3 members:
0
3
5
7
10
________
#6 Vesting of Founder’s Shares
Less than 4 years:
4 years:
5 years:
More than 5 years:
No Deal
8
12
14
________
#7 CEO Replacement Provision
No provision:
Conservative Projections:
Moderate Projections:
Aggressive Projections:
No Deal
6
10
16
________
#8 No Shop Provision
Provision NOT included:
Provision included:
2
10
________
Substantive Terms
#1: VC Equity Percentage
#2: Type of Stock
#3: Dividends
(Possible Process Points from Evaluation: 50)
BATNA: 45 Substantive Points
Total Substantive Points Awarded:
Total Process Points Awarded:
(Possible Grand Total Points: 150)
Grand Total Points Awarded:
(Possible Substantive Points: 100)
Copyright © 2007, 2010, 2019 by the President and Fellows of Harvard College. All rights reserved. (Rev. 06/19)
_________
_________
_________
10