Term Sheet





LEVEL
8 SYSTEMS, INC.

Corporate
Headquarters 

8000
Regency Parkway 

Cary, NC
27511




T
E R M S H E E T

 




October
6, 2004 

 




 

This
Term Sheet is an expression of intention only and, except as expressly set forth
below, is not to be construed as a binding agreement.





	
      Note
      & Warrant Offering 

	 	 
	
      Issuer:
	
      Level
      8 Systems, Inc., a Delaware corporation (the “Company”)

	
      Investors:
	
      Existing
      holders of outstanding warrants to purchase shares of the Company’s
      capital stock (the “Existing Warrants”)
      Exhibit A
      contains a list of Existing Warrants

	
      Investment
      Amount:
	
      Up
      to $1,706,575

	
      Securities
      Offered:
	
      $1,706,575
      million principal amount of Senior Secured Notes (the “Notes”) to be
      issued in integral amounts of $1,000. The first $1,000,000 principal
      amount of Notes purchased from the Company entitle the purchasers thereof
      to a proportionate number of the Re-load Warrants as described
      below.

       

      Each
      holder of Existing Warrants that purchases Notes will receive a warrant to
      acquire a number of shares of the Company’s common stock (the “Common
      Stock”) as set forth on Exhibit A (the “Additional Warrants”), having an
      exercise price, once exercisable, of $0.002 per share. The Additional
      Warrants will be subject to the Registration Rights described below and
      have a 7 year term. The Additional Warrants also will be subject to a
      forced cashless exercise upon consummation of the Restructuring, as
      described below. The Additional Warrants will not be exercisable unless
      and until the Restructuring is consummated.

	
      Coupon:
	
      10%
      per annum on the principal amount, payable in arrears in cash on the
      maturity date.

	
      Maturity
      Date:
	
      Consummation
      of the Merger (as defined below), but no later than December
      31, 2004.

       

      At
      maturity, the principal balance of the Notes, together with all accrued
      and unpaid interest, will become due and payable, subject to the Mandatory
      Exchange described below. 

	
      Events
      of Default:
	
      Standard
      events of default for debt instruments will be included in the
      Notes.

	
      Ranking:
	
      The
      Notes would constitute senior secured obligations of the Company. While
      the Notes are outstanding, the Company would not be permitted to incur
      indebtedness ranking senior or pari
      passu
      with the Notes, except for such senior indebtedness of the Company, if
      any, as is outstanding on the initial closing date of the sale of the
      Notes.











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T
E R M S H E E T

 

October
6, 2004

 









	
      Collateral:
	
      The
      Notes would be secured by a first-priority security interest in all of the
      Company’s tangible and intangible assets (the “Collateral”), subordinate
      only to existing security interests at the closing date.
  

	
      Administrative
      Agent:
	
      The
      security interest in the Collateral will be held by, and the
      administration of the note provisions would be conducted by Brown Simpson
      Partners I (or one of its wholly-owned subsidiaries) as administrative
      agent (“BSP”), the lead investor in this financing transaction. The
      investors in the offering will appoint BSP to serve as administrative
      agent for this purpose.

	
      Protective
      Provisions:
	
      The
      Notes would contain customary affirmative and negative covenants of the
      Company.

	
      Allocation
      and Closings:
	
      The
      Notes would be offered to the Investors for purchase at one or more
      closings. Each Investor would be offered the right to purchase its
      allocated share of the Notes (the “Allocated Share”) based on the
      proportion of the aggregate outstanding Existing Warrants (on an
      as-exercised basis) that the Investor owns, with a right of
      over-subscription for any un-subscribed Notes.

       

      The
      initial closing of the sale of the Notes would occur not earlier than 10
      days after the commencement of the offering, and closings would continue
      on a rolling basis.

       

      Any
      Notes not purchased at a closing could be re-offered to the Investors from
      time to time by the Company until the Maturity Date. The over-subscription
      rights and allocation rules described herein are subject to change by the
      Company.

	
      Restructure
      of Existing Warrants:
	
      In
      the event that an Investor purchases its entire Allocated Share, the
      exercise price of its Existing Warrants will be reduced to $.10, if the
      exercise price is greater than that. All of an Investor’s Existing
      Warrants having an exercise price of $0.10 per share or less (whether
      before or after the repricing) are referred to herein as the “Eligible
      Warrants.”

	
      Mandatory
      Exchange:
	
      Upon
      consummation of the Merger and simultaneously therewith, all of the Notes
      held by each Investor would automatically be exchanged for and in
      consideration of (without the payment of additional consideration) the
      shares issuable upon exercise of each such Investor’s Existing Warrants to
      the extent of the principal and accrued but unpaid interest then due and
      owing on the Notes. 

	
      Use
      of Proceeds:
	
      The
      Company would use the proceeds from this offering to finance its
      operations. The proceeds would not be
      used to repay any short-term or long term debt
  instruments.

	
      Re-load
      Warrants:
	
      The
      Investors who subscribe to the first $1,000,000 principal amount of Notes,
      will receive warrants to purchase an aggregate of two times their
      respective Eligible Warrant shares at an exercise price of $0.10 per share
      (collectively, the “Re-load Warrants”). The Re-load Warrants will be
      subject to the Registration Rights described below, have the Anti-Dilution
      Protection described below, and have a 7 year term. The Re-load Warrants
      will be issued upon consummation of the Restructuring.















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T
E R M S H E E T

 

October
6, 2004

 









	
      Merger
      Proposal

	 
	
      Company:
	
      Level
      8 Systems, Inc., a Delaware corporation (the “Company”)

	
      Overview
      of Merger:
	
      The
      Company will merge with a corporation owned by one or more of the
      Investors (in either event, “Newco”), with Newco being the surviving
      corporation (the “Merger”). 

       

      Each
      outstanding share of the Company’s common stock shall be converted into
      .05 shares of the surviving corporation’ common stock (the “Common Stock”)
      upon the closing of the Merger. The Company’s existing outstanding
      convertible notes and shares of convertible preferred stock
      (“collectively, the “Securities”) would be converted upon the closing of
      the Merger into shares of a newly created series of the surviving
      company’s preferred stock to be designated the Series A-1 Convertible
      Preferred Stock (the “Series A-1 Preferred”). Each of the Securities would
      be converted into the number of shares of Series A-1 Preferred that would
      convert into the same number of shares of Company common stock underlying
      the Securities being exchanged based on the Amended Conversion Price set
      forth below: 

      Security        Current
      Con. Price    Amended
      Con. Price

      
      

      

       ConvertibleNotes      $0.28                $0.02

                              $0.37                $0.026

                              $0.32                $0.023

                              $0.20                $0.014

                              $0.17                $0.012

                              $0.16                $0.011

                              $0.10                $0.0025

                              $0.08                $0.002

      
      

          Series D Convertible 

         
      Preferred               $0.32                $0.20

      
      

          Series C Convertible 

         
      Preferred Stock        $0.38                $0.25

      
      

         Series B3 Convertible 

        
      Preferred Stock        $12.50               $4.00

      
      

         Series A3 Convertible

        
      Preferred Stock        $8.33                 $3.50

	
       

      Upon
      consummation of the Merger, the Notes shall be exchanged for and in
      consideration of (without the payment of additional consideration) of the
      shares issuable upon exercise of the Existing Warrants to the extent of
      the principal and accrued but unpaid interest then due and owing on the
      Notes. 

	
      Special
      Shareholders Meeting:
	
      The
      Company shall convene a special shareholders meeting to approve the Merger
      at the earliest possible date, but in no event later than December
      31, 2004. 

	
      Fractional
      Shares
	
      The
      Company will issue cash in lieu of fractional
shares.











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6, 2004

 









	
      Terms
      of the Series A-1 Preferred:
	 
	
      Liquidation
      preference:
	
      In
      the event of any liquidation or winding up of the Company, the holders of
      the Series A-1 Preferred would be entitled to receive in preference to the
      holders of the Common Stock, an amount equal to $500 per share plus any
      accrued but unpaid dividends. After payment of such liquidation
      preference, holders of Common Stock would be entitled to receive, pro
      rata, the remaining assets of the Company available for distribution to
      its stockholders. A merger or consolidation to which the Company is a
      party, or a sale or exclusive license of all or substantially all of the
      assets or intellectual property of the Company, would be deemed to be a
      liquidation event unless the holders of a majority of the shares of Series
      A-1 Preferred then outstanding elect not to treat such event as a
      liquidation event. 

	
      Dividends:
	
      Holders
      of the Series A-1 Preferred would be entitled to receive an equivalent
      dividend (on an as-converted basis) whenever the Company declares a
      dividend on the Common Stock, other than dividends payable in shares of
      Common Stock.

	
      Anti-dilution
      Protection:
	
      The
      conversion price of the Series A-1 Preferred would be subject to customary
      adjustment in the event of any stock splits, stock dividends and the like
      undertaken by the Company.

	
      Optional
      Conversion:
	
      The
      holders of Series A-1 Preferred would have the right to convert the Series
      A-1 Preferred, at the option of the holder, at any time, into shares of
      Common Stock. Each share of Series A-1 Preferred will initially be
      convertible on a one for one thousand (1:1,000) basis .

	
      Mandatory
      Conversion:
	
      The
      Series A-1 Preferred shall automatically be converted into Common Stock at
      the then applicable conversion rate upon the occurrence of one of the
      following: 

      a)   The closing of an additional
      $5,000,000 equity financing from institutional or strategic investors;
      and/or

      b)    The
      Company having 4 consecutive quarters of positive cash flow as reflected
      on the Company’s financial statements prepared in accordance
      with generally accepted accounting principles ( “GAAP”) and filed
      with the Securities and Exchange Commission (the
      “SEC”).

	
      Redemption:
	
      The
      Series A-1 Preferred is not redeemable.

	
      Board
      of Directors:
	
      The
      holders of a majority of the outstanding shares of the Series A-1
      Preferred shall be entitled to appoint two board observers who shall be
      entitled to receive all information received by the Board of Directors and
      to attend and participate without vote at meetings of the Board of
      Directors and its committees. At the option of the holders of a majority
      of the outstanding shares of the Series A-1 Preferred, the holders of the
      Series A-1 Preferred may temporarily or permanently exchange their board
      observer rights for two seats on the Board of Directors, each having one
      vote.

	
      Company
      Milestone:
	
      If
      the Company does not have aggregate consolidated revenues of more than
      $1,500,000 as reflected on its financial statements for the six months
      ended December 31, 2004 prepared in accordance with GAAP and filed with
      the SEC, the holders of the Series A-1 Preferred shall have the right, but
      not the obligation, to elect a majority of the voting members of the Board
      of Directors. 











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T
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October
6, 2004

 









	
      Voting
      Rights:
	
      Each
      share of Series A-1 Preferred shall represent that number of votes equal
      to the number of shares of Common Stock issuable upon conversion of a
      share of Series A-1 Preferred. The Series A-1 Preferred and the Common
      Stock shall vote together as a class except (i) regarding the election of
      the Board of Directors as set forth above, (ii) as required by law,
      and (iii) as set forth below under “Protective
  Provisions.”

	
      Protective
      Provisions:

       

       

       
	
      Until
      the closing by the Company of an additional $5,000,000 equity financing
      from institutional investors, approval of the holders of at least 2/3 of
      the outstanding shares of the Series A-1 Preferred voting together
      separately as a class will be required for:

       a)   a
      merger, sale of all, or substantially all of the assets or intellectual
      property, recapitalization, or reorganization  the
      Company;

       b)   the
      authorization or issuance of any equity security having any right,
      preference or priority superior to or on parity with the Series A-1
      Preferred (excluding debt not convertible into any such senior or
      pari
      passu
      equity security);

      
       c)   the
      redemption, repurchase or acquisition, directly or indirectly, through
      subsidiaries or otherwise, of any equity securities (other than the
      repurchase of equity securities of the Company at cost upon termination of
      employment or service pursuant to vesting agreements or stockholder
      agreements or a repurchase of the Series A-1 Preferred) or the payment of
      dividends or other distributions on equity securities by the Company
      (other than on the Series A-1 Preferred);

       d)   any
      amendment or repeal of any provision of the Company’s certificate of
      incorporation or by-laws that would adversely affect the rights,
      preferences, or privileges of the Series A-1
      Preferred;

       e)  
      a significant change in the principal business of the Company as conducted
      at the time of the   consummation of the closing of the Merger;
      

       
      f)  the making of any loan or advance to any entity other than in the
      ordinary course of business unless it is wholly owned by the
      Company;

       g)  
      the making of any loan or advance to any person, including, without
      limitation, any employee or director of the Company or any subsidiary,
      except advances and similar expenditures in the ordinary course of
      business or under the terms of an employee stock or option plan approved
      by the Board of Directors and Investor; or

       h)   
      the guarantee, directly or indirectly, of any indebtedness or obligations,
      except for trade accounts of any subsidiary arising in the ordinary course
      of business.


       

      Any
      liquidation, dissolution, recapitalization or reorganization of the
      Company would require a unanimous
      vote of the Board

	 	 
	
      Closing
      Condition- Series D:
	
      The
      Company further agrees to release approximately $780,000
      held in Escrow to SDS Merchant Fund upon closing. SDS shall in lieu ‘put’
      back the equivalent Series D stock as per the agreement laid out in the
      Series-D Securities Purchase Agreement dated March, 2003.
  

	
      Other
      Terms

	
      Transaction
      Costs:
	
      Legal
      fees associated with the Note offering and the Merger will be paid out of
      proceeds from the Note Offering.

       

      BSP
      will receive a fee of 50,000 shares of common stock issued by Newco upon
      consummation of the Merger.











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6, 2004

 









	
      Board
      Approval:
	
      This
      Term Sheet has been negotiated in good faith between the Investors and the
      Company's management but requires approval by the Company’s Board of
      Directors, whose approval is to be sought no later than
      October 31, 2004.

	
      Indemnification
	
      Whether
      or not the Note Offering or the Merger is consummated, the Company agrees
      to indemnify and hold harmless BSP, and its directors, partners, members,
      managers, officers, employees and agents (collectively, the “Indemnified
      Parties”) from and against any and all losses, claims, damages, expenses
      or liabilities to which any of them may become subject, insofar as such
      losses, claims, damages, expenses or liabilities (or actions, suits or
      proceedings, including any inquiry or investigation or claim in respect
      thereof) arise out of, in any way relate to, or result from any claim by a
      third party in respect of this Term Sheet or the transactions proposed
      herein (whether or not any Indemnified Party is a party to any action or
      proceeding out of which any such losses, claims, damages, expenses or
      liabilities arise), and to reimburse the Indemnified Parties, upon demand,
      for any reasonable expenses (legal or otherwise) incurred by any of them
      in connection therewith (including any costs incurred in investigating,
      preparing to defend, defending or otherwise participating in any such
      claim, action or proceeding related to any such loss, claim, damage or
      liability).

	
      Miscellaneous
	
      This
      Term Sheet may be signed in counterparts, each of which shall be deemed an
      original, but all such counterparts shall constitute one and the same
      agreement. Any party which is not in breach of the binding provisions of
      this Term Sheet, may terminate this Term Sheet by delivery of written
      notice to the other party, and in the event of such termination, the
      parties hereto shall be relieved of all liability hereunder, except for
      breaches of such provisions prior to their termination and except that the
      provisions captioned “Transaction Costs,” “Indemnification,”
      “Miscellaneous” and “Governing Law” shall survive any such
      termination.

	
      Governing
      Law:
	
      The
      binding provisions of this Term Sheet and all duties, obligations and
      rights arising herefrom shall be governed by, and construed in accordance
      with, the laws of the State of New York

	
      Memorandum
      of Terms:
	
      This
      Term Sheet does not set forth all of the terms and conditions of the
      transactions proposed hereby. Rather it is only an outline, in summary
      format, of the major points of understanding, which will form the basis of
      the final documentation. Except as provided in this paragraph and under
      “Transaction Costs,” “Indemnification” “Miscellaneous” and “Governing
      Law,” which are binding, this Term Sheet does not constitute a legally
      binding obligation of any of the parties hereto, BSP may terminate
      discussions with the Company at any time with respect to the matters
      proposed herein.
















[Signatures
on Next Page]








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T
E R M S H E E T

 

October
6, 2004

 








 

AGREED TO
AND ACCEPTED THIS _________ DAY OF OCTOBER 2004.

 




LEVEL
8 SYSTEMS, INC.

 



	
      By:
	
       

	
       
	
       Name:
      John Broderick

		 Title:
      Chief Financial
Officer





 

 

 

SDS
MERCHANT FUND, L.P.,

a
Delaware limited partnership

 

	
       By:
	 
	 	 Its
      Managing Member
	 	 SDS
      Capital Partners, L.L.C.





	 	 
	
       By:
	 
	 	Name:
      Steven Derbly
	 	 Title:
      Managing Member



 

 

 

BROWN
SIMPSON PARTNERS, LTD

 



	
       By:
	 
	 	 Name:
      James Simpson
	 	 Title:
      Managing Director





 







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