Start-Ups have been around for a long time. Traditionally, they have been local enterprises run by small business entrepreneurs. Today, however, thanks to the Internet’s global reach, entrepreneurs have the ability to tap networks and establish Start-Up operations all across the world.
Recognizing the potential of international markets, global IT development teams and other types of human capital, Start-Ups are emerging in areas beyond the typical US breeding grounds of Silicon Valley, Boston, New York, Washington, D.C. and Dallas. An increase in technical innovation and start-up activity is now also being seen in cities such as Bangalore, Helsinki, London, Shanghai, Singapore, Sydney, Tel Aviv, Toronto and Zurich.
No matter what the geographic origin, decisions made by Start-Ups at their earliest stages are likely to be among the most critical – as these decisions will impact their future ability to raise funds, engage in mergers or other business transactions, as well as impact their tax position and that of their outside investors.
This is a comprehensive set of answers to many of the typical questions investors have regarding private equity. The answers are roughly organized into sections along these lines: General questions/background, legal questions, performance questions, due diligence questions, and exit questions. That said, there is overlap between the answers. The author’s originally published this article for VC Experts, while most of the information is current (and all of it is informative) there have been some changes with the Dodd Frank Act. In particular this is true of the information related to the investment adviser registration. We will add some updated information to that section in the near future. Read More
Effects of the Financing Environment and Intangibles
The supply of and demand for capital play an important but measured role in the valuation a company is likely to command. Capital is most restricted or expensive and valuations under greatest pressure during and following a period involving a sudden market correction or a downturn in the economy. None of us has a crystal ball for future economic growth; pricing is therefore more a function of the current or most recent nature of the marketplace.
During periods of economic softening or market correction, the public markets, as well as the market for mergers and acquisitions, are in flux and directly affect venture investors’ valuation analyses. Venture investors look to the prices established in the marketplace to put a prospective exit value on their investments. The values investors are willing to pay in a public offering and the values corporations are willing to pay to make acquisitions come under pressure and typically decline during a market correction or economic downturn. There is consequential downward pressure on valuations during these periods and, at times, a disconnect between a company’s expectations with respect to valuation and those of investors. As a result, the feeling in the marketplace is a tightening of sources of capital.
The following post consists of a comprehensive “Equity Joint Venture” Checklist prepared by Gene Barton, a Principal in the Boston office of Fish & Richardson P.C. The purpose of this checklist is to ensure that you cover all of your bases when considering a Joint Venture to ensure there are no surprises. It originally appeared in VC Experts ‘Intellectual Property and Joint Ventures’ Reference book.
VC Experts has teamed up with Aspatore Books to reprint some of the more salient sections of Alex Wilmerding’s Deal Terms, The Finer Points of Venture Capital Deal Structures, Valuations, Term Sheets, Stock Options and Getting Deals Done. This excerpt features an interview with a leading legal expert in the private equity arena, James M. Crane, who has served as counsel at the Boston law firm of Testa, Hurwitz & Thibeault, LLP.
Jim’s perspective is representative of the candid, forthright demeanor that entrepreneurs and venture professionals look for in counsel. And it’s a fascinating look at what a seasoned lawyer thinks you should look out for term sheet. Read More
Employee Incentive Plans for Privately-Held Companies
Despite the recent improvement in capital markets activity, many small, privately-held technology companies continue to face reduced valuations and highly dilutive financings, frequently referred to as “down rounds.” These financings can create difficulties for retention of management and other key employees who were attracted to the company in large part for the potential upside of the option or stock ownership program.
When down rounds are implemented, the investors can acquire a significant percentage of the company at valuations that are lower than the valuations used for prior financing rounds. Lower valuations mean lower preferred stock values for the preferred stock issued in the down round, and as preferred stock values drop significantly, common stock values also drop, including the value of common stock options held by employees.
Consequently, reduced valuations and “down round” financings frequently cause two results: (i) substantial dilution of the common stock ownership of the company and (ii) the devaluation of the common stock, particularly in view of the increased aggregate liquidation preference of the preferred stock that comes before the common stock. The result is a company with an increasingly larger percentage being held by the holders of the preferred stock and with common stock that can be relatively worthless and unlikely to see any proceeds in the event of an acquisition in the foreseeable future.
This post by Robert Fisher, the CEO of Fisher Tanner Associates, originally appeared in VC Experts Daily Buzz. In it, Fisher talks about pitfalls to the implementation of 506(c) General Solicitation provisions under the JOBS Act and why we are not seeing an explosion in deals marketed under the 506(c) provision. Basically, the article looks to answer the question, ‘Why aren’t we seeing deals being marketed more broadly now that it is legal to do so?”
With speed approaching perilously close to that of light itself, recent deregulation has freed huge and heretofore inaccessible pools of private monies to fund new investment and unshackle innovation…
Just kidding – that didn’t happen. Would have been nice, eh? One could argue it wasn’t for lack of good legislative intention. As part of the JOBS act – Congress did indeed instruct the SEC to remove the ancient prohibition against General Solicitation and Advertising under Regulation D. The concept: make it easier for start-ups to cast a wide net when seeking investors. You may recall good ol’ Reg D which provides exemptions from SEC registration. The Reg D exemption relied on by most private investors – now called 506(b) continues the solicitation ban. The new exemption since last September – 506(c) – eliminates the ban but not without a new gotcha of its own.
What are the hidden ‘gotchas?’
This article, published originally by our partner VC Experts, goes in depth on how to avoid one ugly tax scenario as a founder or early-stage employee.
Entrepreneurs founding startup companies are often unaware of a potentially significant tax liability that can rear its ugly head with respect to stock issued to founders and employees.
Emerging business founders often acquire their stock through a restricted stock purchase arrangement providing for time-based vesting. However, this common structure may set the stage for an unwelcome and unexpected tax bill down the road. An 83(b) election can, in the right circumstances, provide a relatively simple and effective way to avoid the tax. Read More
This article, by James F Coffey, a partner at Nutter McClennen & Fish LLP, discusses the key principles an early-stage startup requires to move from an interesting concept to a company worthy of securing angel funding. Perhaps even more interesting is the overall concept that a company’s value lies not in its idea, but in it’s actual solution, or execution to a given problem. Read More
How do you best evaluate the performance of a private equity fund? Is there one right way? Why is the popular Internal Rate of Return popular and potentially flawed? How do you truly gauge a manger’s performance and compare it to others? How do you select the best PE Fund Manager? The answers to these questions not only take you beyond that IRR but also beyond the spreadsheets and all the numbers. This guest post, originally from Private Equity International and featured in VC Experts’ Guide to Private Equity, investigates how science and art meet in evaluating private equity performance.
A High IRR Gets Attention
“Just look,” smiles the placement agent, “at those IRRs. These guys know how to deliver serious returns.” The head of private equity investment looks at the memorandum on his desk and can’t help but revisit the chart showing annualised IRRs for the private equity firm’s previous funds. The numbers look impressive. And that’s one reason why IRRs matter so much in private equity: a high IRR figure for your fund has been shorthand for saying that you’re very good at making money. When you’re out fund raising, competing for the attention of an investor who is wary of taking a meeting and quick to remind you how busy they are, an eye-catching IRR is a great attention grabber. “Sure you’ll have investors telling you that IRR doesn’t mean anything to them, but you still find them sniffing round the number as soon as the conversation starts,” says one general partner at a UK buyout firm who regularly pitches to investors.
To declare that IRR is an empty formulation would be wrong, but to suggest that it has been significantly compromised in the eyes of many investors is not.