# MEMORANDUM **To:** CEO and Board of Directors, Northgate Metrics, Inc. **From:** Company Counsel **Re:** Series B disclosure defects — required corrective action before signing **Privileged & Confidential / Attorney Work Product** --- ## 0. Bottom line The deck contains at least three misstatements of present or historical fact, not projections. The disclaimer protects none of them. The CFO's email supplies scienter and will be read as an admission that the number was kept *because* investors would rely on it. The $8 million already wired cannot be cured by correction and requires a rescission election. The $32 million can be fully protected by correction before signing, but only if the correction is written, complete, and delivered with time to re-diligence. The founder's secondary cannot close as structured. The CEO's proposal — sign on schedule, fix it at Series C — would convert a serious but manageable disclosure failure into knowing securities fraud by the company, its officers, and every director who votes for it, outside exculpation, outside indemnification, and outside the D&O policy. **Do not sign in twelve days. Do not spend the $8 million. Do not touch the diligence folder.** --- ## 1. Present fact vs. protected projection Apply Rule 3 line by line. **"ARR: $14.2M."** This is a statement of the company's *current* recurring revenue run-rate — a present fact about the existing contract base, not a forecast. It is untrue in two respects: - **$2.6M of one-time implementation-services fees (18.3% of the stated figure).** Non-recurring revenue in a "recurring revenue" metric is not a definitional preference; it is a category error. There is no version of ARR that includes one-time services fees. This component is indefensible. - **$1.1M signed-but-not-live, terminable on 60 days' notice (7.7%).** Some issuers do report "contracted ARR" including pre-go-live contracts — *if labeled as such* and *if the termination right and go-live timing are disclosed*. Buried inside an unlabeled "ARR" headline, it is a misstatement. To the extent this component is forward-looking (revenue that may never begin), Rule 3 protection fails anyway: the deck nowhere identifies the specific risk (a customer who can walk on 60 days' notice before go-live). Recurring subscription revenue on the standard definition is **$10.5M**. The headline overstates the durable base by **$3.7M — 35% above truth**, and 26% of the stated figure does not qualify. **"Net revenue retention: 138%."** This is a historical computation over a completed period — quintessentially present/historical fact. The number was produced by excluding the two largest accounts lost during the year from the cohort. That is not a methodology choice; it is selection of the denominator to remove the adverse data. On the full cohort the figure is **111% — a 27-point gap**. Even if the 138% figure is arithmetically true of the truncated cohort, Rule 2's half-truth branch applies: the omission of the cohort exclusion is "necessary to make statements made not misleading." No cautionary language protects a misstatement of historical fact. **The disclaimer.** "Projections involve risks and uncertainties" is boilerplate by definition — it identifies no specific risk factor, does not mention metric definitions, services revenue, pre-go-live contracts, cohort construction, or concentration. Under Rule 3 it is not "meaningful, specific cautionary language," and in any event it addresses *projections*, while these are statements of present and historical fact. **The disclaimer does no work at all.** **"Everyone counts pipeline-adjacent."** Industry practice is not a defense to an untrue statement, and the claim is false on its own terms as to one-time services fees. It is also affirmative evidence that the CFO knew the figure departed from the standard the reader would assume. --- ## 2. Materiality Quantify it; the numbers answer the question. | | Represented | Actual | |---|---|---| | Recurring ARR | $14.2M | $10.5M | | Net revenue retention | 138% | 111% | | Implied price paid per $1 of ARR ($220M pre) | 15.5× | **21.0×** | | Forward ARR after the non-renewal (9% × $10.5M = $0.945M) | — | **$9.55M** | | Implied multiple on forward ARR | — | **23.0×** | The deck overstates the durable revenue base by **35%**, and by **49%** measured against the post-non-renewal run-rate. Holding the multiple constant, corrected ARR supports a pre-money of roughly **$163M** (and ~$148M on the forward figure) versus $220M — a **$57–72M** valuation gap. The retention gap is if anything more material: 38 points of net expansion versus 11 points is the difference between a top-decile compounder and a median company, and it drives both the multiple and the growth model. No reasonable investor pricing a growth-stage SaaS round would call a 35% ARR overstatement and a 27-point retention overstatement unimportant. Materiality is not seriously contestable. The CFO's own email — "keep the number" — is the company's admission that the number was doing pricing work. **The non-renewal notice.** The *delivery of the notice yesterday* is a present, historical fact, not a forecast. It removes 9% of subscription revenue in four months, and it lands directly on the pillar the deck oversold: retention. It is materially aggravated by context — the company has now lost its second-largest account after having already scrubbed its two largest prior losses from the retention cohort. It is material standing alone and doubly material against a total mix that includes a 138% retention claim. **Total mix / sophistication.** These are sophisticated investors with data-room access, but the composition of the ARR figure was only "surfaced" internally this week; it was therefore not in the mix, and the anchor wired $8M without finding it. A reconciliation nobody had does not cure a headline nobody could check. --- ## 3. Scienter — who is exposed The CFO email is the case. Three clauses do three separate kinds of damage: - **"Everyone counts pipeline-adjacent"** — knowledge that the figure deviated from the standard definition. - **"Keep the number"** — a conscious decision to leave an untrue statement in soliciting materials after the question was raised. - **"We can true it up after the round"** — intent that investors close on the wrong number and learn the right one only after their money was committed. This is the sentence that converts recklessness into knowing fraud and defeats any good-faith-mistake narrative. **CFO:** primary exposure; actual knowledge, documented, contemporaneous. **Company:** the CFO acted within the scope of his role in producing financing materials; his scienter is imputed. The company is the issuer whose deck was "used with every prospective investor." **CEO:** scienter as of today. Whatever the state of knowledge before this call, from this moment forward any distribution of the deck, any oral reaffirmation of the metrics, and any execution of subscription documents is knowing. The proposal to "sign on schedule" and fix it later is, if adopted, conscious disregard indistinguishable from the CFO's. **Directors:** no scienter today; scienter in 48 hours if they vote to proceed. Approving a financing they have been told rests on misleading materials is participation, not oversight failure. **Founder:** if she signs the secondary while holding the non-renewal notice and the corrected metrics, Rule 5 exposure is direct and personal, and her $4M of proceeds becomes the motive evidence that anchors the scienter case against everyone else. "The founder took $4 million off the table at a price built on a 35% overstatement" is the first line of the complaint. **Immediate personnel step:** remove the CFO from ownership of the metrics and all disclosure materials pending independent review. He cannot be the person who prepares the correction. --- ## 4. The anchor's $8 million — correction cannot cure it The anchor signed a subscription agreement and wired. It is **irrevocably committed**. Rule 4's cutoff is prospective only: correction now cuts off reliance for investors not yet committed; it does nothing for an investor who already parted with cash on the strength of the deck. The anchor holds a completed claim for damages **or rescission**. Options: 1. **Do nothing / quiet fix.** Unavailable. It leaves a matured fraud claim, and concealment after discovery is a second violation. 2. **Disclose and offer rescission.** Return the $8M plus interest, unwind the shares, let the anchor re-subscribe on corrected terms if it wishes. This is the only step that reliably extinguishes the claim, because a rescission remedy voluntarily offered and either accepted or declined with full information leaves no injury. 3. **Disclose and offer amended terms.** Full corrective disclosure plus an economic reset — additional shares at the corrected price, or a price adjustment with a true-up — accepted in writing with a release of known claims and a representation of independent counsel. Commercially preferable and generally defensible, **but only if rescission is also genuinely on the table.** A reset offered as the only option is coerced and will not hold. **Recommendation: offer both, in writing, as a free election.** Deliver the corrective memorandum, state the corrected metrics and the non-renewal, present (a) full rescission with interest and (b) repriced participation, allow at least ten business days, recommend independent counsel, and impose no conditions and no cross-conditions on the rest of the round. **Critically: segregate the $8M today.** Do not spend it. A rescission offer the company cannot fund is not an offer, and inability to repay converts a curable problem into an insolvency-adjacent one. --- ## 5. The unsigned $32 million — what correction accomplishes The term sheet is unsigned and the commitment is not irrevocable. Under Rule 4, **complete correction before signing cuts off reliance for every one of these investors** and eliminates their claims prospectively. This is the single most valuable thing available to the company this week, and it is available only if the correction is genuine. The correction must be: - **Written and free-standing.** A "Corrective Disclosure Memorandum," delivered to every recipient of the deck, expressly withdrawing the prior deck and identifying which statements were incorrect. Not a footnote in a revised slide; not an oral explanation on a call. - **Delivered with time.** Push signing out. A correction handed over at the signing table with the signature pages is not a correction. Build in a defined window (10 business days minimum) for questions and re-diligence, and document the questions and answers. - **Acknowledged in the documents.** Investor representations that it received and reviewed the Corrective Disclosure Memorandum dated \_\_\_, is not relying on the prior deck or any other prior materials, and had the opportunity to ask questions. These reps help prove non-reliance; they are not a substitute for the substance. **Required contents:** 1. Restated ARR of **$10.5M**, with a contract-level bridge: $14.2M → less $2.6M one-time implementation services → less $1.1M signed-not-live → $10.5M. 2. The **$1.1M contract** disclosed separately: counterparty (or anonymized), scheduled go-live, and the **60-day pre-go-live termination right**. 3. The company's **written ARR definition** going forward, and reconciliation of ARR to GAAP revenue. 4. **NRR of 111%** on the full cohort, with methodology, the prior 138% figure, and express disclosure that it excluded the two largest accounts lost during the year. 5. **The non-renewal notice**: received [date], second-largest customer, **9% of subscription revenue**, effective at term end in four months; pro forma recurring ARR of approximately **$9.55M**; expected effect on forward NRR; any retention or replacement efforts and their status, without spin. 6. **Customer concentration table** — top 10 accounts as % of recurring revenue — and full churn/logo-loss history for the period, including the two lost accounts. 7. **Pipeline separately labeled**, with specific, non-boilerplate cautionary language identifying the actual risks (pre-go-live termination rights, concentration, non-renewal exposure, ramp assumptions). 8. **Disclosure of the failure itself**: that metrics were prepared without a written definition, that the issue surfaced in diligence, that the CFO's role has been changed, and the remediation adopted. 9. **Disclosure of the anchor's rescission election** and of the disposition of the founder's secondary. Also purge and correct the data room, log every recipient of the old deck, and instruct the deal team and any placement agent in writing to stop transmitting it and to make no oral reaffirmation of the old figures. --- ## 6. The founder's $4 million secondary Rule 5 is dispositive as of yesterday: she cannot sell to buyers who do not know about the non-renewal notice, and she also cannot sell at a price built on a 35% ARR overstatement she is now on notice of. As presently structured, **the secondary is a violation waiting to be documented.** It could theoretically proceed on strict conditions: full corrective disclosure delivered to the *actual purchasers* before they commit; written acknowledgment from each; pricing at the corrected round price, not the $220M price; separate counsel for the founder; approval by disinterested directors with the founder recused; and no company facilitation of an information asymmetry. "Big boy" non-reliance letters help but do not immunize fraud. **Recommendation: pull it from this round.** Even fully cured, a founder liquidity event in the same closing where the company restates its headline metrics downward is the fact pattern that turns a disclosure correction into a fraud narrative — and it will be the reason plaintiffs argue the whole deck was intentional. It also poisons the repricing conversation, in which the founder must credibly argue the business is worth more than the investors now think. Defer any secondary to a later, separately negotiated window, after corrected metrics have been reported for a full quarter and the non-renewal has been resolved or replaced. --- ## 7. The board's position under the candor and oversight rules If the board follows the CEO's proposal, each voting director: - **Breaches loyalty, not care.** Rule 6 is explicit: approving a financing known to rest on misleading materials implicates loyalty. Knowing approval is bad faith, and bad faith is **not exculpable** under any charter provision. The "we fix it at Series C" framing is the definition of conscious disregard. - **Breaches candor to existing shareholders.** The round will require stockholder consents (charter amendment, preferred authorization, possibly waiver of preemptive rights). Soliciting those consents on a deck the board knows to be wrong is an independent candor violation running to the company's own holders. - **Forfeits indemnification and insurance.** Rule 7: no coverage for liability finally adjudicated to arise from fraud. Advancement may also be clawed back. And knowingly proceeding creates a known-circumstance that, if not noticed to the carrier now and disclosed on renewal, gives the insurer rescission grounds on the policy — leaving the innocent directors uninsured too. Governance steps for the two-day meeting: constitute a **disinterested committee** (exclude the founder/CEO and any conflicted investor designee) with authority over the correction, the anchor remediation, and the secondary decision; retain independent counsel for the committee; issue a **litigation hold immediately** — the CFO email stays exactly where it is, and any deletion from the diligence folder would be spoliation that dwarfs the underlying problem; and record any dissent in the minutes. --- ## 8. The repricing conversation **How to present it.** Lead with the reconciliation, not the apology. "Here is the bridge from $14.2M to $10.5M, contract by contract. Here is the full-cohort retention calculation. Here is the non-renewal we received yesterday and its pro forma effect. Here is our written metric definition, our new controls, and what we did about the person who kept the number." Investors forgive a corrected number found in diligence far more readily than a number they discover after wiring. Voluntary, immediate, complete correction is also the best available evidence that the board acted in good faith. **Likely impact.** At a constant 15.5× multiple, corrected pre-money is ~$163M; on forward ARR, ~$148M. But the multiple itself should be expected to compress: 111% NRR with visible concentration does not command a 138%-NRR multiple, and there will be a credibility discount. Realistic range: **$130–165M pre-money, a 25–40% haircut**, plus tougher terms — participating or structured preferred, milestone tranching, expanded protective provisions and information rights, a board seat, possibly refreshed founder vesting. **Delay, reprice, or restructure.** Delay is only attractive if runway supports it and if it buys a real fact — a replacement for the lost account or the go-live of the $1.1M contract. Repricing alone concedes the maximum haircut on the worst day, with the non-renewal freshly disclosed and unresolved. **The best structure is a corrected reprice with a milestone reset:** a smaller first close at a corrected valuation, with the balance at a formula price tied to verified recurring ARR and full-cohort NRR at two or three quarters out. That converts the credibility gap into an earn-back rather than a permanent write-down, gives investors verification instead of trust, and avoids "dirty" structure (ratchets, multiple liquidation preferences) that is more expensive later than a lower headline price now. Size the round to actual need; do not over-dilute at a trough price. --- ## 9. Concrete 48-hour plan **Hours 0–6 (today)** 1. Litigation hold issued to all officers, the finance team, and the deal team. Preserve the diligence folder and the CFO email verbatim; explicit no-deletion instruction. 2. Written instruction: **stop all distribution of the deck**; no oral confirmation of $14.2M or 138% by anyone; suspend or flag the affected data-room materials. 3. Compile the distribution log — every recipient of the deck, with dates. 4. **Segregate the $8M**; freeze any spending against it. 5. Notice the D&O carrier of circumstances. 6. Engage independent counsel; identify the disinterested committee. 7. Remove the CFO from disclosure and metrics ownership pending review. **Hours 6–18** 8. Forensic metric rebuild under counsel: contract-level ARR schedule, ARR-to-GAAP reconciliation, full-cohort NRR recomputation, concentration table, churn history, pro forma for the non-renewal. 9. Sweep for further defects — other one-time fees, ramped or non-binding contracts, discounting, any other cohort constructions. Assume this is not the only one. 10. Confirm status of the $1.1M contract and the go-live date; confirm the non-renewal notice terms and any cure path. **Hours 18–30** 11. Draft the **Corrective Disclosure Memorandum** (contents per §5) and the restated deck marked "Restated — supersedes and withdraws the deck dated \_\_\_." 12. Draft the **anchor letter** with a two-option election (full rescission with interest / repriced participation with release), 10-business-day window, recommendation of independent counsel. 13. Draft the **founder secondary memo** recommending withdrawal. 14. Draft board resolutions and the revised timetable. **Hours 30–42 — Board meeting (day 2)** 15. Resolutions: (a) find the prior materials materially misleading and formally withdraw them; (b) approve and authorize delivery of the Corrective Disclosure Memorandum to all recipients; (c) authorize the anchor rescission/reset election and reserve the $8M; (d) **postpone signing** — no execution until at least 10 business days after delivery of the correction; (e) **withdraw the founder secondary** from the round; (f) constitute the disinterested committee and retain its counsel; (g) approve remediation — written metric definition policy, CEO/CFO certification of metrics in any financing material, board disclosure review of all investor materials, quarterly ARR-to-GAAP reconciliation; (h) authorize CFO personnel action; (i) confirm carrier notice; (j) set repricing negotiating parameters. 16. Minutes reflecting the record, the advice received, and any dissent. **Hours 42–48** 17. **Deliver the Corrective Disclosure Memorandum simultaneously** to the anchor and all term-sheet investors; offer calls and diligence access. 18. Announce the revised signing date; communicate as needed to any stockholders whose consent will be solicited (candor duty attaches to the consent solicitation). 19. Open the repricing conversation on the corrected numbers with the milestone-reset structure. --- **The one-sentence version for the board:** correcting the record this week costs Northgate roughly $60 million of paper valuation and a delayed close; signing on the CEO's schedule costs the company rescission of $40 million, its officers and directors personal liability that no charter provision, indemnity, or insurance policy will reach, and its founder a personal insider-selling claim — for a "fix" she has already put in writing that she intended to defer until after the money cleared.