altgate

Law Firm Wilson Sonsini Now Preparing Term Sheets For Free

No, this isn't a recessionary move to give away unbilled lawyer time nor is it some sort of shift to being a pro-bono only firm.  Today, Wilson Sonsini announced the launch of a "term sheet generator."  It's basically a web tool that creates draft preferred financing term sheets for startups.  I got a preview of it a couple of weeks ago and my review is that it is really impressive!

The way the tool works is that you answer a bunch of questions (north of 100) and then when you are complete it gives you a perfectly formatted Word file term sheet.  Most of the questions are structured as "select from" several options often with an optional to "write your own."  The beauty of having the option to select from "standard" options is that WSGR has included some market data, e.g. what percent of term sheets in up rounds in 2008 included this term.  Last year, I spent a lot of time attempting to reverse engineer this data based on a small personal sample size.  Obviously, WSGR has a much larger sample size and the fact that they make it public (in aggregate) is impressive.

Publish at Scribd or explore others: Business & Law financing Term Sheet

The Term Sheet Generator originated as an internal tool for WSGR attorneys to rapidly generate draft term sheets which they would polish up and then deliver to their clients.  Not surprisingly, WSGR Partner Yokum Taku, who I've previously written about, is the key co-conspirator behind making this tool public.  I exchanged email with Yokum about this tool and I wanted to excerpt a few take aways from that conversation:

• Apparently this is the first of many online document generator tools that WSGR intends to make publicly available on the web.  There are three categories (startup, equity financing and bridge loans) so we can expect more to come.
   
• I would have thought that internally there would have been a debate about giving away for free what they used to charge for, but Yokum insists this did not come up.
   
• The biggest challenge in building this tool is that each branch in the question tree is associated with unique verbiage.  Building that must have been crazy.

So I think this is a brilliant step toward "open source law" which I've been advocating for a while.  I am certain there will be hundreds (ne thousands) of lawyers who will use the WSGR Term Sheet Generator to create draft term sheets for use with their clients.  In fact, I bet Google Analytics will quickly show Yokum and his colleagues at WSGR that his real userbase for this tool will be other attorneys both at firms and inhouse.  What this tool really wants to evolve to is having an open, wiki-style back end where practitioners can change and comment on the myriad of options and verbiage which would keep the tool evergreen based on the best crowdsourced legal opinions.

In the meantime, I wouldn't be surprised to see some sort of watermarking of term sheets created by the tool that would allow WSGR to offer discounted legal fees if they created the draft term sheet using the tool.  It would certainly reduce WSGR's time/costs as they would know the underlying terms

Extraordinary Popular Delusions & the Madness of Crowds

Extraordinary Popular Delusions & the Madness of Crowds is one of my favorite books and included in it is one of my all time favorite quotes:

Men, it has been well said, think in herds ; it will be seen that they go mad in herds , while they only recover their senses slowly, and one by one! - Charles MacKay, from EPD&MC

That's as true now as it was in 1841 when Charles MacKay published his tome.

The book is written as a series of stories in three categories: "National Delusions," "Peculiar Follies" and "Philosophical Delusions."  Each little story is 10-50 pages in length and the entire book is nearly 3 inches thick.  I confess that when I first bought the book in 1999, it took me a full year to read it as it sat in my "reading rack" in my bathroom.

The three stories that the book is most famous for are the "economic bubbles" specifically, tulip-mania, the South Sea Company bubble and the Mississippi Company bubble. 

Each of these bubbles was based on irrational exuberance driven by "new rules" and innovation in the absence of any oversight or regulation.  And, of course, each bubble crashed leaving most people disillusioned and poor.

The true moral of the story is that if you don't know history you are doomed to repeat it. 

But even that doesn't go far enough. 

I read this book in 1999 at the height of the internet bubble and still wasn't smart enough to short the market in time.  And then 5 years later, I bought a house at the height of the real estate bubble!  I hear that I'm not alone.  I guess some people never learn...   

So as penance I'm going back and re-reading this great book and as part of my public service I want to ask you to also read this book.  Recovery from a bubble is a very individual task (as opposed to the very public mania of how we got into this).  Take this opportunity to reach out to someone you know who got caught up in the credit bubble and recommend this book.

Top 10 Posts From 2008

As ranked by traffic to website during the year (as opposed to when it was written):

1. The Science & Art Of Term Sheet Negotiation
2. 5 Reasons Convertible Debt Sucks  
3. Venture Debt For Startups  
4. Due Diligence - What To Expect  
5. How To Blog Like A Pro  
6. How Liquidation Preferences Work  
7. 2008 Startup Compensation Survey  
8. 10 Tips On Negotiating With VCs  
9. 10 Web 2.0 Tips: $75  
10. Killver VC Pitch Deck

Not much to learn here.  That's actually about what I would have guessed had I not seen the Google Analytics numbers.  Although in 2008 I did learn that this is called a "sneeze page."   Who knew?

A Squeeze On Boston Venture Valuations

Today there was a front page story in the Boston Business Journal about how the market's downturn is putting a squeeze on local venture valuations.  The story is similar to two posts I wrote here; one on the hit to valuations and the other on how VC firms are responding.

The reason I mention this is because someone in their infinite wisdom decided to quote me and to put my mug shot on the front page (the decision was probably made before they knew the subject!).

I think it's interesting how this blog has turned me into some sort of quotable source on startups, venture capital and the like. 

Long live blogging!

A-Round Valuations Down 25-50% While B- And C-Rounds Non-Existent

So says venture capitalist Bob Ackerman, co-founder of Allegis Capital according to this article in PEHUB.  Ackerman points out that in 2001-2002 valuations fell this amount over 15 months but have collapsed to this level in as few as 6 weeks!

I think he's talking about "new" rounds.  Obviously many startups with their A- and B-rounds behind them will see some inside follow-on funding.  From what I've seen, those valuations will be put off for another day as insiders fund with bridge loans.  Why a bridge loan?  Essentially it's just kicking the ball down field in terms of valuation, but more importantly (for investors) it keeps the new cash well in front of all other equity capital in the event of a liquidation (and in a down round, it has a better chance of converting at the lower valuation than doing an equity round now).

If you're an entrepreneur, you should fight like hell to avoid bridge loans, venture debt, convertible debt or any other form of leverage.  Instead seek to raise equity capital.  This is no time to be levering up...instead, you should be de-levering!  If you have outstanding venture debt or bridge loans, prioritize figuring out how to raise equity capital to replace it.  As almost every other market has shown, debt is toxic right now and should be avoided at all cost.

UK Government To Launch VC Fund To Rescue Startups

No, I'm not making this up.  According to this article in the Guardian, the UK government is putting £1 billion into a fund that will invest in startups.  The idea is that it's some sort of rescue plan.

This is not going to end well.

How are they going to allocate the money?  How will they track it?  Are they going to sit on boards?

Market Timing Is A Skill Not Luck

Selecting the ideal time to start a company is a skill, not just dumb luck.  This is one of the striking conclusions of a newly released working paper by Harvard Business School entrepreneurial finance professor Paul Gompers, et al.  Think about that.  It means that guys like Mark Cuban were not simply lucky for starting a streaming video company in 1995 and selling it to Yahoo for $6 billion in 1998. 

Did you know that Cuban's first startup was a computer systems integration company he founded in 1983 and sold to CompuServe for $6 million (pocketing $2 million after tax in the deal)?  Gompers points out in the working paper that 1983 was the best year ever to start a computer company (52% of them eventually went public).  Using a large set of data, Gompers' paper, Performance Persistence in Entrepreneurship, supports a few really interesting conclusions, including:

• Entrepreneurs who have previously been successful, are significantly more likely to succeed in subsequent ventures (as compared to first time entrepreneurs or entrepreneurs with previous failures).


• Entrepreneurial "skill" comes in two forms: market timing skill and management skill.  Everyone, including VCs, tend to focus on managerial skill.  For example, in the hundreds of VC pitches I've given, not once was I asked questions about my (relatively poor) market timing skill.  The paper doesn't address the issue of whether market timing or managerial skill is more valuable, but my guess is the former.


• For subsequent ventures, successful entrepreneurs raise venture capital earlier than do first time entrepreneurs.  I wouldn't have expected this.  I would have thought the entrepreneurs would have used their own capital to delay dilution.

There are many other pearls in this 33 page paper, so I definitely encourage you to read it.  For instance, one of my favorite conclusions that Gompers compellingly makes is that venture capitalists do not add value to the companies they invest in.  How does he know this?  Not surprisingly, the top-tier VC firms are better at picking unknown "star entrepreneurs" but once they've been successful in their first ventures (i.e. their "star" qualities are now public information) then the success of subsequent ventures is unaffected by whether the venture backer is a top-tier firm or a bottom-tier one.  Ouch!

So the obvious question is, how do you improve your market timing skills?  A good question...  More on that soon.

Popular Posts

Once again, here is a list of some of the more popular posts on this blog.  The two most popular posts are relatively recent ones: this one on term sheet negotiation and this one on venture debt.  I'd like to take this opportunity to thank all of my readers, particularly those who have voted, commented or contacted me about this blog...your interest is my motivation!

Raising Capital:

• 5 Reasons Convertible Debt Sucks HOT
• 10 Tips On Negotiating With VCs NEW
• Dating...er...Fundraising Etiquette
• The Science & Art of Term Sheet Negotiation HOT
• How Liquidation Preferences Work HOT
• How Much Money Should I Raise? NEW
• How To Get Introduced to VCs
• How To Pitch To VCs
• Killer VC Pitch Deck NEW
• Top 10 Tips For Entrepreneurs Pitching VCs
• Top 10 VC Objections (And How To Overcome Them) NEW
• Triage NEW
• Venture Debt For Startups HOT
• What To Expect In Due Diligence HOT
• Why Dividends Matter HOT

Startups:

• 'Tis The Season To Change The CEO
• 10 Things To Consider Before Joining a Startup
• 10 Web 2.0 Tips: $75 HOT
• All-Hands Team Meeting NEW
• Board Management Tips For Startup CEOs
• Customer Support 2.0
• Financial Modeling Tips For Early-Stage Startups NEW
• Hiring Your First Salesperson
• How To Demo Your Startup NEW
• How To Pitch The Press
• Interview with Professor Noam Wasserman
• Sales Learning Curve
• Startup Compensation HOT
• Startup Entertainment
• Strategies For Two-Sided Markets
• What To Include In A Board Package

Triage

Right now in board rooms across the country, nay around the world, the equivalent of battlefield triage is being conducted.

Venture capitalists are going through their portfolios and categorizing their investments into three buckets:

1. Expectant: So badly wounded that it is not worth expending resources to attempt to save them.  On the battlefield, these casualties get morphine.
2. Priority: Badly injured but rapid and focused attention can save them.  These casualties get almost all of the scarce time and medical resources.
3. Routine: Walking wounded.  These casualties are lightly wounded and there is little cost in delaying treatment until after the battle is over.  On the battlefield, these casualties get left alone in a position of cover.

So which category is your company in?  If you're in the "routine" bucket you probably know it.  But if you've got little or no revenue, your monthly burn is $400K, $500K or even $1MM or more and you have just a few million in the bank, then it's probably not clear if you're "expectant" or "priority" from your venture investors' point of view.  And knowing the difference has big implications (morphine or a lifeline).

For venture investors, the first (and probably most important) filter is "runway" (i.e. amount of time existing cash will last assuming conservative revenue projections).  If runway is more than 12 months, for the time being you're in the "routine" bucket (although make sure you are really conservative on your revenue projections).

If your runway is less than 3 months and you don't have other factors in your favor then you could be in the "expectant" category.  My view is that companies with real promise and runway between 3-12 months will get the "priority" classification.

There are obviously a lot of other factors that get considered...I'll try to address those next.

Canary In The Mine?

I just read this article on the WSJ Blog about how 9 of our 10 hedge funds are not performing well enough to collect performance fees and that just 3% of hedge fund-of-funds are above their high water mark.

That's crazy.

There are about 10,000 hedge funds but in the first half of this year about 350 shut down compared to about 500 in all of last year.  This has to mean a lot of hedge funds are going to close down since no one is getting paid.

While there are many fewer venture capital funds in the US (about 800 in the last data I saw), if the performance distribution is similar for them, that means less than 100 VC funds are collecting performance fees.  It'll take longer to feel the pain, but I wouldn't be surprised to see a lot of VC funds close up shop over he next year or two.

Angel Investor Best Practices

I came across this 200-page document today which is a very detailed manual of best practices complete with a glossary written by and for angel investors.  It's not only great reading for those who are new to angel investing, but it's must read for any entrepreneur looking to raise angel money.  Why?  Well it's always helpful to put yourself in other's shoes to see what they're trying to achieve and when it comes to angels, there's no better way to get into their shoes than to read this.

Angel Investor Best Practices

Read this document on Scribd: Angel Investor Best Practices

More On Convertible Debt

My previous post on why convertible debt sucks shouldn't be construed as advising to never use it, but rather to explore your alternatives and avoid it if you can.  For example, Andrew commented that this might be his only option.  Others have pointed out another scenario in the case where there is a major milestone in the near future and you're confident a little cash can get you there.  Okay.  Just remember, it's "easy" to get into, but harder to get out of than straight equity and it creates some screwy incentives.

Also, here are some additional resources with more detail on the mechanics of convertible debt and opinion and analysis from other entrepreneurs, angel investors and VCs:

• Startup Company Lawyer: details on a lot of the legal terms.
• VentureHacks: gives some rules of thumb.
• Bill Payne: an interesting analysis from the angel investor's point of view.
• Redeye VC: from a VC's perspective.

5 Reasons Convertible Debt Sucks

There are two scenarios where convertible debt is typically used: bridge financing and angel financing.  I've raised convertible debt a few times and I have to say that in most angel funding scenarios it sucks as a way to finance a startup (I think it's okay for bridge funding, but I'd avoid that too if possible).  Why?

1. It's complicated.  Many founders think part of the attraction of doing convertible debt is that you get to "punt" on a lot of the key financing decisions until "professional" investors do the real work and put a "real" value on the company.  Unfortunately, doing convertible debt requires making a bunch of decisions that in total are about the same complexity as preferred equity.  For example, you have to write a loan agreement that includes things like default clauses, collateral, interest rates and more.  If the loan is secured (e.g. against the IP) then you have to create a separate lien.  Also, it's typical to include a discount for the lenders in the form of a warrant, however the warrant is on an equity instrument that does not yet exist (e.g. on the Series A Preferred) but you still need to decide the term of the warrant and the strike price.  Also, most founders don't raise all their convertible debt at the same time so they end up with lenders with different warrant coverage (big Excel spreadsheet).  Then, when it comes time to close your Series A, you can have a problem where the cap table changes on a daily basis because the interest that accrues on the principal converts as well and that changes daily.  [By the way, if you do use convertible debt, I recommend you agree to pay the interest in cash after closing Series A to avoid this last problem.]  All of these issues add up and it makes it more complicated to take convertible debt as opposed to equity.
2. It sets a bad precedent (or at least fails to set a good precedent).  Valuation is just one of the key terms of an investment.  I wrote previously on how to evaluate the various terms of an investment.  By punting on negotiating the full suite of terms in a round of preferred equity, you are basically leaving it to the Series A investors to negotiate these.  And some of them make a big difference (like dividends, preferences, etc.).  Most of the time, you're in a much better situation to negotiate favorable (or reasonable) terms with friendly angel investors than you will be with professional VCs  My recommendation is to use the opportunity to negotiate favorable terms with angel investors and these will likely become precedent for future rounds.
3. It doesn't make a big difference in the upside scenario.  If you run a few scenarios (I have), the potential gain for founders is 3-5% ownership after the Series A round and about half that at a successful exit. If you're lucky enough to get a successful exit of, say $75MM, after raising $15MM of VC and you have 2 founders, you're talking about +/- $500K potential gain each.  Now that's a ton of money, but the point here is that in the upside scenario you're looking at a six-figure benefit against which you have to measure and compare the risks.
4. It makes a big difference in the downside scenario.  In a wind-up scenario, the priority of various parties is, from highest to lowest, employees, A/R, secured lenders, preferred equity and common.  Yes, founders are at the back of the line, but the secured lenders are slightly ahead of preferred equity.
5. It creates a perverse incentive.  The biggest problem with convertible debt is that it aligns the interest of your angel investors with future VC investors and against you!  Because the debt converts into equity at a price equal to or slightly discounted from what the VCs pay, the lower the price the more the angel investors will own.  And often times, the angel investors will have the relationships and connections to VCs (and hence know them better than you do) so it is in your interest to get your angels on your side of the table. 

Bottom line: convertible debt when there is a high likelihood of an equity round happening very soon (i.e. you're bridging a few month gap), but if you are raising angel money and want to use convertible debt to avoid setting a valuation, don't.  Raise equity instead.

Topics Covered On This Blog (So Far)

Once again, here is a list of some of the more popular posts on this blog.  The two most popular posts are relatively recent ones: this one on term sheet negotiation and this one on Web 2.0 tips.  I'd like to take this opportunity to thank all of my readers, particularly those who have voted, commented or contacted me about this blog.

Raising Capital:

The Science & Art of Term Sheet Negotiation
Dating...er...Fundraising Etiquette
How to Get Introduced to VCs
Top 10 Tips For Entrepreneurs Pitching VCs
Venture Debt For Startups
How Not To Select A VC
What To Expect In Due Diligence

On Startups:

10 Web 2.0 Tips: $75
Board Management Tips For Startup CEOs
Customer Support 2.0
How To Pitch The Press
Hiring Your First Salesperson
10 Things To Consider Before Joining a Startup
Interview with Professor Noam Wasserman
Picking A Domain Name
Sales Learning Curve
Startup Compensation
Startup Entertainment
Strategies For Two-Sided Markets
'Tis The Season To Change The CEO
What To Include In A Board Package

Industry Commentary:

Death of Headhunting
I Need a Social Network Aggregator!
Overjustification Effect and Web 2.0
Plaxo 3.0
The Future of Job Recruiting?
MIT $100K Business Plan Contest
On Wikipedia Fraud

Personal Commentary:

U of M Solar Car Team Crashes; Earns Moral Victory
U of M Solar Car Team Unveils New Technology
2007 University of Michigan Solar Car Team
Alternative Energy No Longer Just For Tree Huggers
Just When You Thought You Were A Good Dad
I want That Job!
Why I'm Voting For Obama

Information Asymmetry In Fundraising

One of the challenges entrepreneurs face in raising money is that they typically do it once every couple of years.  The rub is that you're usually raising money from some folks who have done several deals in the last quarter.  TheFunded has been slowly arbitraging this information asymmetry. 

First they did it by creating a list of VC investors (before TheFunded you were forced to pay for expensive lists or limited to the handful of firms you knew personally).  The list by itself was quite useful.  Second, they started letting entrepreneurs comment on and rate funds/partners.  That bit was a little less useful, but still provided some useful feedback.  And most recently they launched a section on the site where entrepreneurs can share specific deal terms from term sheets they have received.  So far there are only 60 term sheets uploaded and you have to contribute one to see the others.  They claim to be getting about 3 per day.  This is a potentially catastrophic event for investors and a potential boon to entrepreneurs as it could lift the veil on the "deal spread." 

There is no doubt that the more deals get published, the more leverage will accrue to entrepreneurs.  That said, I wonder how long before some VC sues TheFunded (every term sheet has a clause that says you can't share the contents).  I suppose if you don't sign the term sheet there's no violation, but if you raised money on the term sheet (i.e. you signed it) then that could be an issue.  It will be interesting to see if any fund goes to bat on this.  In the meantime, I can hear the deal spread tightening!