Interact Systems, Inc., has developed software tools that help hotel chains solve application integration problems. Interact's application integration server (AIS) provides a two-way interface between central reservations systems (CRS) and property management systems (PMS). At least two important trends in the hotel industry are relevant. First, hotels are shifting away from the manual booking of room reservations; electronic bookings will continue to increase as more bookings are made over the Internet. Second, competitive pressures are forcing hotels to implement yield management programs and to increase customer service. By integrating the CRS and PMS through Interact's AIS, the company can better manage inventories, improve yields, and enhance customer service.

All reservation traffic is routed from the CRS to individual hotel properties. This allows Interact Systems to create a database that can be used to track customers and to facilitate marketing programs, such as frequent-stay or VIP programs, as a way of increasing customer satisfaction. Interact forecasts application integration expenditures in the hospitality industry to exceed $1 billion by 2012.

Greg Thomas founded Interact Systems in 2006 and developed the firm's middleware software and hospitality applications. He has twelve years of systems applications experience and currently is Interact's chief technology officer. Eric Westskow joined Interact in early 2009 as president and CEO. He had worked in sales and marketing in the software industry for more than twenty years.

Interact Systems' AIS software development, which began in 2006, went through several design changes in 2007. The first product was sold and installed in 2005. Sales were only $500,000 in 2006. However, now that the firm has dependable market tested AIS products ready to be shipped, revenues are expected to reach $20.8 million in 2012.

Greg Thomas founded Interact Systems with $50,000 of his own savings plus $50,000 from friends. Two private investors provided an additional $200,000 in 2007. In addition, $1 million was obtained from a venture capital firm, Katile Capital Partners, in early 2009 in exchange for an equity position in Interact. The firm currently is seeking an additional $5 million to finance sales growth.

A. A VC is considering providing the additional $5 million. What type of fund (stage specialization, industry focus, etc.) would you approach? In what part of their investing cycle would you hope to approach them?

B. Discuss how Interact Systems would expect to fare in the VC screening process involving each element of given bellow.

1. Venture Capital Firm Requirements

a. Cash-out potential

b. Equity share

c. Familiarity with technology, product, market

d. Financial provisions for investors

e. Geographic location

f. Investor control

g. Investor group

h. Rate of return

i. Risk

j. Size of investment

k. Stage of development

2. Characteristics of the Proposal

a. Requirement for additional material

b. Stage of plan

3. Characteristics of the Entrepreneur/Team

a. Ability to evaluate risk

b. Articulate regarding the venture

c. Background/experience

d. Capable of sustained effort

e. Managerial capabilities

f. Management commitment

g. References

h. Stake in firm

4. Nature of the Proposed Industry

a. Market attractiveness

b. Potential size

c. Technology

d. Threat resistance

5. Strategy of the Proposed Business

a. Product differentiation

b. Proprietary product

C. Discuss typical issues that might be addressed in a term sheet using the following element given bellow as a reference.

Valuation Ongoing funding needs Size and staging of financing Preemptive rights on new issues Commitments for future financing rounds and performance conditions

Form of security or investment

Redemption rights and responsibilities

Dividend structure

Board structure (number of VCs and outsiders)

Additional management

Conversion value protection

Registration rights

Exit conditions and strategy

IPO-dictated events (e.g., conversion)

Cosale rights (with founders)

Lockup provision

Employment contracts

Incentive options

Founder employment conditions: compensation, benefits, duties, firing conditions, repurchase of stock on termination, term of agreement, postemployment activities, and competition

Founder stock vesting

Confidentiality agreements and protection of intellectual property