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I DO NOT RECOMMEND IT and did not intend it but somehow I managed to crash the funeral of a dear business colleague. I confirmed this with the son of the deceased shortly after the funeral when I offered my apologies.
I became suspicious of my behavior when I realized I was among just a handful of non-family members at the event and later searched unsuccessfully for an announcement of the funeral in the local media. How this occurred was innocent enough. I was copied on an email from the wife of the former CEO of the company where the deceased had worked. The email was directed to board members of the company. In it, she announced their plan to attend the funeral and asked for recognition of the contribution made by the deceased to the company. Her email included the time and date of the visitation and funeral services. Unwittingly, I took this as an invitation to attend the funeral, made arrangements for flowers to be sent and showed up for the visitation. One of my law partners joined me to pay his respects as well. The wife and the former CEO arrived after we did to a more expected welcome by family members. In retrospect, that was my first clue to my mistake. Their physical appearance and demeanor was another clue. In the years since the CEO resigned and left town to retire, both he and his wife had changed. He stopped communicating with others who had been involved with the company so, even though they had both been good friends, I had been unable to speak with them for some time. A cold handshake was all I could muster from him as a greeting. My reaction to her email was based on who I remembered her to be, not to the woman who had been cut off from her company friends by her husband's decision. The email plea with its detailed information about the funeral was something other than an invitation. I did not understand that because I no longer knew her. My takeaway from all of this is that it is important to remember that the people who manage companies change over time. The ones you know and depend on, like all of us, react and adapt to changes they encounter and sometimes those changes are limiting or negative. In the context of running a company, especially one with outside stakeholders , it is important to be alert to this basic truth and diligent about evaluating the continued competence of your management. This was not the first time I had seen changes in a CEO. The pressures of the job are immense. And, sometimes, the drive to survive in the position can lead to behavior that disguises or obscures reality from the company’s board of directors. This was, certainly, an unusual example of how time and circumstances can change someone you know into someone you thought you knew. Things are not always what they seem. Image is from Buccioni’s The City Rises (1910). IT’S A SIMPLE QUESTION with a complex answer. Will your rocket ship of a business startup be better off joining a local business accelerator or not? If you have a ground breaking, earth shattering, market dominator in waiting in your business plan you might find yourself considering a local startup incubator or accelerator as a way to find your footing as you launch your new business. People use incubators for a variety of purposes with varying degrees of success. Some are pleased with the services. Others think the distractions outweigh the advantages. And no two incubators are the same. And no two startup teams are alike. Services these organizations provide can include inexpensive rent, access to shared conference rooms and shared services, short term rent agreements, free or reduced-cost consulting services from accountants, lawyers, or business consultants, assistance in seeking government grants and identifying sources of capital, assistance in marketing and public relations. Some facilities have specialized equipment that would be otherwise prohibitively expenses to purchase. Others have entrepreneur-in-residence programs that attract successful entrepreneurs to mentor startup teams. Educational programs are also common as are efforts to help new teams network with professionals and investors in their communities. Less common but not rare are incubators that provide small amounts of capital in exchange for ownership interests in their client companies. As you might imagine, the quality of the services and the professionals providing those services vary from incubator to incubator. So, what should you do? First, ask yourself why you are considering an incubator. What do you hope to accomplish by participating? And then evaluate the available options as you would any other business proposition. Diligence the programs you are considering. Network with participating teams and graduates of the program to evaluate its merit for your business proposition. Meet with the professionals and read the fine print about the terms and conditions of participating. Once you have completed your diligence make a decision and move on. You have plenty to do ahead of you. Next week - What crashing a funeral can tell you about your management team. UNICORNS ARE STARTUP COMPANIES that have yet to perform (generate revenues) to their assumed potential but already carry valuations in excess of $1.0 billion dollars. The designation came about when the Unicorns were rare as a way to acknowledge (and romanticize) their unique status.
Unicorns are no longer rare. In 2015, it was estimated that there were 80 startups with $1.0 billion valuations. In January of this year, the estimate had climbed to 229. Combined, these 229 companies had raised $175 billion in funding and had an aggregate paper valuation of $1.3 trillion. Twenty-one of these had startup valuations of $10 billion or more. If you are struggling to raise venture capital for your company, Unicorns can point you to why you may be having problems. They are a result of what industry players refer to as the barbell. Simply put, the image of a barbell with its two weighted ends and thin bar of the barbell reflects the reality of fundraising by venture capital firms in the last decade. The money flowing into venture funds is going disproportionately into fewer, larger funds that make later stage investments and investors in early stage investments. Much of the latter group consist of individual angel investors. The bar in the middle is where money is not freely flowing – into funds that bridge the gap between startups and later stage investors. The Unicorn investors come from the big funds fueled by this barbell investing craze that sees limited partner investors (the institutions that invest in venture funds) investing in ‘big brand name’ funds. These big funds, when they do invest in early stage companies, have to put big amounts of money into play to justify their involvement. Which means they look for industry shattering ideas. When their portfolio companies spend their first money, they reinvest at higher valuations, sometimes with new investor partners. Before you know it, big idea companies with little or no revenue, by virtue of their multiple repriced rounds, have billion-dollar paper valuations. If you read my last posting, you may remember the serial entrepreneur and venture investor who is leading his newest company and his company about how difficult he was finding the current venture investment market. He is a proven commodity with a promising business and he is having trouble raising expansion capital. You may be having issues as well in a fundraising market you thought you understood. Unicorns aren’t the cause but they are a reflection of how the venture industry has changed. Their rise tells us that the venture industry we thought we knew has changed. Maybe your fundraising approach should as well. LARRY GERDES, CEO AND EXECUTIVE CHAIRMAN OF PURSUANT HEALTH, spoke at this month’s meeting of the Southern Capital Forum about his experience as a business builder and venture investor. In an engaging presentation, Larry spoke without slides or a formal presentation. Instead, he shared stories about his long career in business and investing.
Larry has been building businesses in the health care industry for more than 35 years, beginning his career as the 24 year-old banking officer in Peoria, Illinois who convinced his bosses to lend the startup company HBO & Company it’s first $1.0 million. After two more investments, Larry became CFO of HBO & Company which moved to Atlanta in 1979 and went public two years later. Larry spoke about this and the addition of Silicon Valley pioneer Don Lucas (National Semiconductor, Oracle, etc.) to the HBO board. He went on later to invest with Don Lucas and Walter Huff, founder of HBO & Company in a number of early stage companies, including several health care related investments. One of those was a predecessor to Transcend Services, Inc., where he served as Chairman and Chief Executive Officer until Transcend was acquired by Nuance Communications, Inc. Among the stories he shared was one involving Sandhill Capital, a small venture fund turned syndicate Walter Huff started with Don Lucas. Larry became a co-general partner with Don Lucas a few years later. Don Lucas got curious about a small company in their Silicon Valley office building that was working late into the night. He introduced himself to the founder, Larry Ellison, and advanced a couple of payrolls before they invested in what became Oracle. He also discussed how they switched Sandhill Capital from the traditional venture fund limited partnership model after their first fund to adopt a syndicating model with their fund investors. Each fund investor was offered the opportunity to invest in companies they sourced up to their percentage ownership in the earlier fund. If they passed on a deal, their access to future deals ended. He noted that the model served them well. Pursuant Health is an Atlanta based company where Larry currently serves as CEO. It provides health data to the managed care and provider communities to help manage large healthcare populations and is, he says, finding it challenging to raise money. He characterized the current market for early stage company fundraising as one of the most difficult he has encountered in his long career. As an experienced venture investor himself, he wondered if modern venture investors are not so focused on business models that they are under appreciating the value of good management teams. The luncheon where Larry spoke was part of the Southern Capital Forum's regular meeting schedule. The organization, founded in 1984, serves both the venture and the private equity community in the Southeast and hosts the annual Southern Capital Forum each fall that brings fund managers and their limited partner investors together to discuss the business of investing and raising capital. Today’s audience consisted predominantly of regional venture and private equity fund managers. Image copyright Clinton Richardson 2016. Detail from the Arch of Constantine in Rome. I SPENT MORE THAN 40 YEARS in the trenches advising growing businesses and their investors as a lawyer but also making angel investments and serving on a few company boards. I also served in senior management of a couple of law firms, including one with more than 1,000 professionals and offices across the country. During the same period, I co-founded what is now the oldest and largest trade association for venture capital and private equity investment firms in the Southeast and wrote a few books on deal making and legal strategies for business operators.
Hopefully, I have learned a few things that are not in the law books. Things about how the law and business can intersect effectively and creatively to the business operator's advantage. Things about how investors think and deals are negotiated. I hope the perspective I have gained and our interaction can help you avoid common entrepreneurial pitfalls and make me a more effective counselor. And, I hope we can have a lively discussion where we learn from one another. For instance, when does it make sense to consider venture capital as a financing alternative? And, when you seek venture capital, how do you go about it effectively? How should you deal with angel investors, particularly when they are family? If you are just starting, what kind of business form should you adopt? And, how should you allocate ownership among the founders? There are hundreds of these questions and few absolute answers that apply to every situation. So let's start with founder ownership for an emerging growth company, which for us will mean a company established with ambitious growth expectations that will likely need invested capital to sustain its growth. Let's say you have two founders, each with an important role in getting the company started and building its foundation for long term growth. Each is prepared to invest a similar amount to get things started. The right thing to do is give them equal shareholdings and seats on your board. Right? If you answered yes, you may be making your first big and potentially costly mistake. Between yourselves, you probably know who the driver of the new business is, the one who came up with the idea and has a real passion to make it succeed. You probably know who will be working the longer hours to get the business started and who is and will be otherwise contributing more in other ways. Try to recognize the opportunity driver from these factors and make sure the driver gets more of the stock and more rights on the board. First, it will assure you of having a person who can make decisions if there is a disagreement. Deadlock preserves the status quo which can be deadly in a new business that needs to innovate and respond quickly to survive. Second, it will force you to declare a leader and flesh out whether there are issues about who should lead and who should follow in the business. And, while you are at it, make sure you have a shareholders agreement and that ownership rights vest over time so that if a partner does not fulfill his or her anticipated future contribution, or worse, leaves the company, you can get back ownership from the non-contributing partner. Outside investors will expect management vesting of stock, so you might as well put it in place on your terms. Image (c) 2006. Galapagos scene. A FRIEND, SUCCESSFUL ENTREPRENEUR AND now advisor to a leading tech incubator asked my opinion about an online forms provider that promises to incorporate your business and give you and file the organizational forms, stock plans and restricted stock agreements you need for a modest fixed fee.
Should you use such a service when you form your new company? Does the online service site provide a budding entrepreneurial team with what it needs to get started? If you use the site, should you have a qualified attorney review the paperwork before it is signed and filed? Are there risks to using such a site that new entrepreneurs should be wary of? Of course, the knee jerk reaction of any lawyer who has advised entrepreneurial clients for a career is probably going to be negative. After all, the service web site is careful to acknowledge that it is not providing legal services while, at the same time, touting the "we have provided legal advise to start up for years" aspects of their founders and advisors backgrounds. No mention is made of tax or accounting issues at all, which can be important in choosing an entity for a business. But is there value in the service? And, can you use it confidently in forming a new company and dividing up the initial equity round? The answer is a qualified yes, if you are comfortable in accepting the choices made by the service to incorporate you in Delaware in a C corporation. Of course, that's a big "if" and you still have to make critical decisions about how to divide up the ownership of the company. The restricted stock documentation is a good idea, and available on the site I reviewed, for a number of reasons but shouldn't you get some counsel on the alternatives and mechanics? The particular site I reviewed offered incorporation in Delaware, form bylaws and initial minutes to form the company and issue the initial stock. I assume it included standard stock forms to fill in. It also offered restricted stock agreements and invention secrecy and assignment agreement forms as well as related board consents, all important stuff when you are starting out. I think you might save a few bucks with a site like this without compromising the future of your business if you engage a qualified lawyer to help you evaluate the decisions you are making by using the documents. The site reviewed was open to lawyer involvement (without charge) and allowed revisions to be made to the documents. Use the lawyer for what lawyers do best, helping you make decisions about type of form to select, using equity to incentivize performance, protecting intellectual property, and understanding the tax consequences of you decisions. Then if your plan for formation fits the model promoted by the site, use their documents with a quick review by your lawyer to take care of the mechanics. And, while you are at it start a relationship with a good accountant. Numbers and the planning that accompanies numbers are going be very important going forward. More of a risk taker? Then you might just use the service after getting agreement from your formation team and informal advisors, if you have them. Do your best and pour your efforts and limited resources into testing whether your idea has legs. If it does, you can revisit the decisions on formation that you made then. But one caveat. If you are going this alone, you might consider starting with a single member LLC agreement instead. It's easy to prepare, gives you a flow through organization (so you can write off losses to your personal tax return) and creates a see-through entity that merges into your personal tax return as long as you only have one owner. You can then revisit the organizational form later when you add parties or raise money. Of course, you'll want to check with your lawyer or accountant about that. Photo copyright 2016 from Newspaper Rock in Canyonland National Park. WE WERE ON A PLANE RETURNING TO ATLANTA after closing an acquisition for a client in Texas. It was 1985 and I was a young partner in a business law firm sitting next to my boss in first class. He was catching up on the day's news in the aisle seat and I was reviewing a draft of a manuscript I was working on for an entrepreneur's guide to the terms and deal points commonly negotiated in venture capital transactions. When he finished his paper he looked over at what I was doing and snatched the manuscript. He wasn't much for conversation. "What are you doing?" he said. "Working on a book I hope to publish." He took a sip from his drink and then flipped through the manuscript, tossing it back to me when he was finished. I expected a comment, maybe some encouragement, but instead he got out of his seat and headed to the toilet. Half way there, he stopped and turned around. Looking me straight in the eye and with a voice that could be heard by everyone, he shook his head and proclaimed "that's the dumbest f*!#ing idea I ever heard of." And then he turned around and walked to the bathroom. If I was wavering in my resolve to complete the manuscript or face the gauntlet of publisher submissions and rejections, this was now my great motivation. No way in the world was I going to give my boss the satisfaction of my failing in this endeavor. No matter how long a shot this was, somehow, someway it was going to succeed. You know the rest of the story if you read my earlier posting called "I can't possibly know anything about venture capital." The book published as The Venture Magazine Complete Guide to Venture Capital in 1987 and sold out quickly. Since then, we have published four additional editions under the Growth Company Guide moniker. The Guides, available through Amazon.com, have been in print now for nearly three decades. Entrepreneurs and angel investors have used the books, as have business schools and business accelerators. U.S. and European venture funds have used them to train associates and in help with planning. Even the Soviet Union purchased case quantities for their business training courses during Glasnost. If you are curious, here's what readers have had to say about the book. So, what's the point of the story? And, what does my personal publication story have to do with entrepreneurs or growing businesses? Two things, actually. First, other people are going to routinely misunderstand or under appreciate your entrepreneurial efforts. My boss was an accomplished lawyer who had negotiated numerous deals. Even so, he could not see the value in what I was doing. Second, it's only a dumb idea until you prove it isn't. Once you succeed, many of your greatest detractors will remember themselves as proponents. Many will wish they had the gumption and patience you had to strike out and make something new happen. Some will want to emulate you. That's what happened to me. Just months after publication of the book was announced, the boss man stopped by my office to let me know he had secured a contract to write a treatise on corporate law. He was going to assign lawyers in the firm to write the chapters and I was going to organize the effort and ghost write his book. Now that was the dumbest idea I ever heard of. I was polite. I didn't express an opinion. I just said no. I was too busy following up on my own dumb idea to help him with his. IS IT BETTER TO USE STOCK OR CASH with an important vendor when your business is cash strapped and in it's development stage? This was the subject of a recent discussion with a local medical device developer whose first blockbuster product was ready for clinical testing and regulatory guidance in obtaining required FDA approval. After seeing the product in development, one of the firms he was vetting to possibly run the nearly $1.0 million testing and application process offered to exchange some of their services for equity in his company. What should he do and how should he think about the process of deciding? Like most enterpreneurs in his position, the founder/CEO was already deeply involved in fundraising. He had to be. There were limits on his personal funds and the business could generate no product sales until it had an approved product to sell. He had investors lined up and committed for a first fundraise to keep his business running through the end of the year and a key inflection point in his product development. He was finding success selling promissory notes that converted into equity in his next substantial round, defined by a minimum amount raised within a given period. The factors we discussed included:
After discussing these and other relevant issues, we turned our attention to the convertible note terms being used successfully by the company and how bring potential investors to a decision point. We also talked about when and how you change the terms of those convertible notes as the company's progress de-risks the investment. We discussed some ideas on both topics that might help better rationalize the fundraising process. In the end we left the discussion open but noted that a structure like the convertible note might be used with the vendor if other criteria were met. Those criteria included removing the debt feature, as some companies do when they use SAFE documents in lieu of convertible notes, and linking both the vesting/grants and the conversion provisions to the timing of services delivery. Fishing for the right answers? Above, an ancient Sarmatian coin from the 6th century BC. Subscribe to Venture Moola through this link. I AM CULTURALLY IMPAIRED. DEFICIENT BECAUSE OF WHERE I LIVE, where I engage in business and practiced law. I know this for a fact. It was told to me in no uncertain terms by someone who should know. I learned this important fact in 1987, while trying to find a publisher for my first book. I had a stack of rejection letters. It really does not hurt to receive one. Twenty five, maybe, but not one. But one publisher, one of the biggest business book publishers on the planet, did not send the letter saying no thank you. Instead, they reviewed the book and thought. Month after month they thought. Never accepting. Never rejecting. Over time, a relationship developed with the editor assigned to take my regular status calls. She was patient. She was kind. And, eventually, she delivered the news. After more than a year of serious consideration they would not take the book. She could not tell me why. Company policy. But she faltered. Took pity and told me. They liked the subject and the content a lot. It was fresh. It was unique. But it was about venture capital and they just could not take the risk because "no one will believe that anyone from the South knows anything about venture capital." There you have it. My fatal flaw. I live in the South. Time to give up. (There are no businesses in the South, no investors and I could not possibly have traveled to Boston, Silicon Valley, Texas or Europe to close venture fundings for client companies.) But wait. Novel ideas like new companies are not easy to launch. They can be painful to get off the ground. And there are other publishers and magazines and . . . . Then, four days later (I kid you not) it happened. The editor-in-chief of a leading magazine for entrepreneurial companies called. He had seen the manuscript. He wanted it and would find a publisher. Just one condition he said. The magazine name had to be in the title. I said give me a day to find a publisher and he laughed. I timed it. When I called, the No One Will Believe publishing company took less than 5 minutes to accept the book and agree to publish it. It's first printing sold out quickly, making the author, the magazine and the publisher happy. And that is how The Venture Magazine Complete Guide to Venture Capital, just the second book ever published in a category now filled with titles, came to be. So, what did I learn? Maybe I inherited a little persistence from my dad. I like to think so. He grew businesses. And it was not work for sissies. He always said, half jokingly, that he would rather be lucky than smart. But maybe Gary Player had it right when he said "the harder I work the luckier I get." And, what have I learned since? Something that thousands of successful southern businesses have proven over the last 30 years. Southern entrepreneurs create great and sustainable businesses, venture backed or not. ONE OF THE MORE CHALLENGING THINGS a new entrepreneur must deal with is fundraising. It is a time consuming distraction from business operations that is made more difficult by the challenge of setting a realistic company valuation and the expense of complex funding documents.
This reality has led many to try and use convertible notes instead of stock in their early funding rounds. But using convertible note to raise funds presents its own challenges as I was recently reminded by two separate entrepreneurs at Georgia Tech. First, there is the question of whether you use a convertible note or a SAFE (simple agreement for future equity) document of the sort developed at the Y combinator. The advantage of a SAFE document, when investors will use it, is that it gets rid of the fiction that the seed stage company using it will be in a position to repay the money if it does not raise needed funds in a next financing. Instead, if a fundraising does not occur, the holder of the instrument converts to equity at a predetermined formula. Whether it is a SAFE document or a convertible note, several questions remain about how it should be structured. A partial list would include:
Photo of the 'post office' on the Galapagos Islands. Copyright 2008 by Clinton Richardson. |
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