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WSGR Entrepreneurs Report Summer 2009
WSGR Entrepreneurs Report Summer 2009
Many companies in search of a cash infusion The Market for Patents In the last decade, the growth of this market
are not aware that they might be sitting on an has been remarkable. In 1998, only a few
asset that can be monetized to help meet their We estimate that approximately $1 billion a large companies, such as Intel, Broadcom, and
liquidity needs. Whether you are an early- or year changes hands buying and selling bare IBM, were buying or selling patents. Today,
late-stage company in need of cash, if you patents. These patent sales occur almost there is a robust market of buyers and sellers,
have a patent portfolio, you might consider exclusively in the information technology along with a developing community of patent
selling some of those patents, particularly sector, including such fields as wireless brokers and finders. With the growth of this
those that you do not need today. Indeed, the communications, Web 2.0, SaaS, and LCD emerging market also come the challenges of
cash generated from any such sale may TVs. Prices can range from a few thousand volatile pricing, deal transparency, lack of
reduce the impact of, or eliminate the need dollars to more than $10 million per patent. standard terms and conditions, and lack of
for, a dilutive down-round financing. standard processes.
The first quarter of 2009 saw a very sharp Q1 08 - Q1 09 Amount Raised - By Quarter
decline from previous quarters in both the
$2,500 183 200
number of equity financings that were
completed as well as dollars invested. The 162
155 151
acceleration of the decline from the fourth $2,000
quarter of 2008 to the first quarter of 2009 150
$1,616
Amount Invested ($M)
was steep in comparison to the decline from
Number of Deals
$1,500 $1,478 $1,485
the third to fourth quarter of 2008. This 101
$1,245 $1,245 $1,294
accelerated decline in the first-quarter private $1,178 100
equity financing market trails by roughly a $1,000 $920
quarter the steep decline in the public equity
markets beginning in September 2008. $606 $606
50
$500
The backdrop for venture financing in the first
quarter continued to be challenging:
$0 0
1Q08 2Q08 3Q08 4Q08 1Q09
• The decline in venture capital
financings in the first quarter of 2009 Total Amt. Invested Amt. Invested w ithout Megadeals Total # of Deals
that we saw in our database was
consistent with the declines reported two venture-backed IPOs that priced in fourth quarter of 2008 to 101 transactions in
by VentureSource and MoneyTree. May 2009. While it is too early to tell the first quarter of 2009, a decline of
These declines were experienced what this portends for future periods, it approximately 33%. This decline is even
across all sectors and across all stages is safe to assume that a high level of steeper when compared to the financing
of venture capital rounds of financing. venture-backed IPOs is not likely to transaction activity in the third quarter of
return immediately. 2008, during which 183 transactions were
• There were no venture-backed IPOs in completed. The number of transactions
the first quarter of 2009, and only one • According to VentureSource, the completed in the first quarter of 2009 was
venture-backed IPO since the first number of exits in the first quarter of significantly lower than the number of
quarter of 2008. However, there were 2009 through merger and acquisition transactions completed in any recent quarter.
transactions deceased in comparison to
the fourth quarter of 2008, continuing a There was also a steep decline in the
For purposes of the statistics and downward trend that began in the first aggregate dollars invested in the first quarter
charts in this report, our database quarter of 2008. The average valuations of 2009. The $606 million aggregate
includes venture financing of merger and acquisition exits also investment amount was nearly 60% less than
transactions in which Wilson decreased significantly from prior the $1,485 million aggregate investment
Sonsini Goodrich & Rosati periods. amount in the fourth quarter of 2008. The first
represented either the company quarter saw no megadeals, i.e., single
or one or more of the investors These and other factors have had a significant financing transactions involving an amount in
(although we do not include negative impact on venture capital investing excess of $100 million. The absence of
venture debt or venture leasing in recent periods, which is borne out by the megadeals in the first quarter of 2009 had
transactions, or financings data from the financing transactions captured a significant impact on the aggregate
involving venture debt firms). This in our database. These trends continue to investment amount (three such megadeals
data consists of more than 600 impact the rate of return for the venture accounted for approximately $550 million in
financings in each of 2005, 2006, capital asset class. investment amount in the fourth quarter of
2007, and 2008, as well as more 2008). However, even after eliminating the
than 100 transactions in Q1 2009. The number of financing transactions of all megadeals from the fourth quarter 2008 data,
types decreased from 151 transactions in the the decline in investment dollars from
2
THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
3
THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
$15.0 $12.1 $12.4 *To see how the terms tracked in this chart might be used
in the context of a financing, you can construct a draft
$9.2
$10.0 $8.0 term sheet using the automated term sheet generator
$6.1 available on wsgr.com.
$5.0
$0.0
Q1 08 Q2 08 Q3 08 Q4 08 Q1 09
$70.0
$61.0
$58.0
$60.0
$50.9
$50.0
$40.0
$40.0
$M
$30.0 $24.5
$20.0
$12.0 $12.0 $10.8 $10.0 $9.0
$10.0
$0.0
Q1 08 Q2 08 Q3 08 Q4 08 Q1 09
4
THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
Anti-dilution Provisions
Weighted Average - Broad 88% 92% 91% 91% 100% 77% 80%
Weighted Average - Narrow 3% 2% 3% 3% 0% 4% 4%
Ratchet 4% 5% 4% 3% 0% 9% 8%
Other (Including Blend) 5% 1% 1% 3% 0% 10% 8%
Redemption
Investor Option 32% 31% 39% 32% 36% 32% 36%
Mandatory 3% 3% 3% 3% 7% 4% 0%
No 65% 66% 58% 65% 57% 64% 64%
1
Numbers do not always add up to 100% due to rounding
2
Includes Series A rounds unless otherwise indicated
3
Includes flat rounds and, unless otherwise indicated, Series A rounds
4
These columns include only Series B and later rounds. Note that because the numbers in the All Rounds columns include Series A and flat rounds, they are in some cases outside the ranges
bounded by the Up Rounds and Down Rounds columns.
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
Last year’s financial market collapse has made September 2010. Given the state of the Therefore, determining which solicitations
for tough times for technology companies that financial markets and the large amounts of might be useful should start with an
traditionally have looked to venture capitalists, government funding now available, technology assessment of your business and needs. Are
venture lenders, or the public markets for companies, particularly those in the clean you an early-stage R&D company in need of
financing. Venture capital investment in the technology and renewable energy industry, funds to get to proof-of-concept? A later-stage
first quarter of this year was down 47% in should consider applying for some form of company in need of funds to put up a
terms of dollars and 37% in deals from the government funding. manufacturing or production plant? Isolate
fourth quarter of 2008.1 After a banner year, what you want to
capital investment in clean technology For venture-backed accomplish, the
companies was down 63% in dollars and companies, applying for anticipated timing of your
48% in deals compared with the same period government funding may With the government's project, and your funding
in 2008.2 With potential customers cutting be a foreign concept, new focus, tens of needs, and then assess
back on purchase commitments, companies approached only with which funding programs
have struggled to find sources of funding, and great trepidation.
billions of dollars best map to those of your
in many cases, to survive. However, in our firm’s already have been company’s business and
experience with directed into programs scale of financial need.
Government funding long has been available emerging technology Federal agencies’
to technology companies in the form of grants, companies and the administered by funding opportunity
loans, loan guarantees, tax incentives, tax government, we have federal, state, and announcements are listed
credits, and cooperative research and found that the at www.fedconnect.org.
development arrangements that are cost- government and venture
local agencies. State and local funding
shared with the government. With the new capitalists are not so opportunities are more
Administration’s and Congress’s focus on dissimilar. difficult to track because
mainstreaming renewable energy, ensuring of the sheer number of opportunities available
energy security and energy independence for How do I decide which government and the fact that a number of programs are
the United States, creating American jobs, and funding opportunities to pursue? starting up with federal funds allocated to
reducing greenhouse gas emissions, the states for various projects. A database of
American Recovery and Reinvestment Act In the same way that certain venture state renewable energy opportunities is
(ARRA) and 2009 federal budget capitalists are known for their focus on certain available at www.dsireusa.org.
appropriations process already have directed industries or on companies at a particular
tens of billions of dollars into programs stage of development, each government Given the number of applicants for each
administered by federal, state, and local funding opportunity has a specific focus. For funding opportunity and the amount of
agencies to provide an immediate and example, the DOE’s Advanced Research management time (and in some cases, non-
substantial boost to the renewable energy Projects Agency-Energy (ARPA-E) funding trivial sums of money) that can be expended
industry. opportunity is targeted toward R&D-stage on a funding application, companies would be
companies with “transformational” well advised to make a very clear-eyed,
We expect this trend to continue in 2010 and technology, while the Advanced Battery upfront assessment of which opportunities to
beyond. For example, the entire budget for the Manufacturing funding opportunity focuses on pursue.
Department of Energy’s (DOE’s) Office of shovel-ready projects for companies to create
Energy Efficiency and Renewable Energy for a domestic battery manufacturing industry for
the 2008 fiscal year was $1.7 billion, but the electric vehicles, and specifically excludes
ARRA alone provided the same office with an R&D-stage companies.
additional $16.8 billion to commit by
1
MoneyTree Report by PriceWaterhouseCoopers with the National Venture Capital Association and Thomson Reuters.
2
Ernst &Young Cleantech Investment Group with Dow Jones VentureSource
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
How do government agencies decide gas emissions, and create jobs; programs good use. This is particularly important with
which companies to support? within the federal agencies have more specific respect to funding obtained through ARRA
objectives, such as developing the electric programs; the intense focus on weeding out
Government agencies make decisions about vehicle industry or encouraging partnerships waste, fraud, or abuse of taxpayer funds
which companies to back in much the same between academia and industry to collaborate distributed through these programs puts
way that venture capitalists do. Just as on wind-energy technology research. additional pressure on the government to pick
venture capitalists do not give handouts to Companies that are able to make the case likely winners who will run their companies in
companies based on financial need, neither that their project will help the applicable a trustworthy and ethical manner that will
does the government. Each agency will make agency achieve these goals quickly and with achieve success.
funding awards to companies that it believes greater success are more likely to receive a
can best use its available funds (i.e., our tax government funding award. Do you have good references?
dollars) to advance the agency’s strategic
goals in particular target industries. Across Is your project plan financially feasible? When your funding application goes into the
the board, we have found that government hopper at a particular agency, it is likely to be
agencies ask the same basic set of questions In most cases, a separate financial review competing with many (possibly hundreds of)
of applicants: of your application will be conducted by other applicants for the attention of the
people who are agency’s reviewers. How will you differentiate
Is your project sophisticated in such yourself?
technically sound? matters, including
Just as venture major consulting firms One way is to try to get to know key people
When funding capitalists do not give and accounting firms within the relevant departments or programs
applications are reviewed, handouts to companies who are retained to and introduce your technology to those
the bulk of the applicant’s assist the applicable individuals well before your application is
“score” in most cases will based on financial agency in application submitted. If you are able to meet with these
be based on the results of need, neither does the review. Are your key individuals, you should treat that
the agency’s technical spending plans and opportunity as you would an opportunity to
review, which is to be government. revenue projections present to a venture capitalist. Prepare well,
conducted by reviewers realistic? Is the timing use your time wisely, and have a succinct,
schooled in the art of your you propose for the high-impact presentation that will leave a
technology. Do you have good research commencement and completion of positive and lasting impression of you and
conducted by reputable scientists backing up your project supported by reasonable your company that will give you name
your claims? Do you have positive results from assumptions? Overly optimistic projections are recognition when applications are reviewed.
small- or large-scale demonstrations of your likely to be viewed as just that, and may
technology? Does your manufacturing process detract from the credibility of an otherwise In addition, try to make yourself known at
work? Can you point to previous success in strong application. industry conferences and through positive
this field to bolster your case? Applicants who media coverage. The program managers and
inspire the confidence of the government in Do you have an experienced application reviewers are going to the same
their companies’ technology are those most management team that inspires conferences and reading the same press
likely to obtain funding. confidence that the project can be that you are; become a familiar face whose
completed as planned? presence in the application pool will be
Will funding your business help the expected and sought out by the granting
government achieve its policy objectives Just like venture capitalists, the government agency.
and programmatic priorities? wants to bet on horses that have won in the
past and are likely to win again. An Do your traditional investors have skin in
The Obama Administration has high-level experienced management team with past the game?
policy objectives to mainstream renewable successes in a similar industry gives the
energy technology, enhance energy security government confidence that it is backing a Most funding opportunities have a cost-
and energy independence, reduce greenhouse company that will put taxpayers’ money to sharing requirement (or equity investment
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
requirement in the case of loans and loan traditional equity investors will have far government contracting accountants and
guarantees) typically mandating that 20 to greater control from a stock ownership attorneys so that you understand and are
50% of the proposed project cost be borne by perspective relative to the percentage of prepared to meet these requirements.
the applicant company. One of the goals of the capital they have invested. Particularly if an
ARRA is to bring skittish investors off the equity investment is contingent upon receipt Intellectual property rights of the
sidelines, and requiring cost-sharing or an of a government funding award, you must government should be understood and
equity investment alongside debt financing consider the effect of this dynamic on the negotiated wherever possible. Each
provided or guaranteed by the government is company’s valuation when negotiating funding program will have intellectual property
one way to accomplish that goal. The investment terms with those investors. rights provisions in the relevant funding
government also has found that the higher the opportunity announcement that should be
proportion of project cost borne by the More process, a different kind of control. considered when formulating an application
applicant, the higher the likelihood of success The Energy Secretary is not going to come to and in negotiating a funding award. The
of the project, because the applicant is your board meetings if you receive funding from government may have certain rights in
literally more invested in the project. Note the DOE. However, starting with the application technology created using a funding award
that cost overruns will not be cost-shared by process itself, you will be subject to strict by statute, or there may be flexibility to
the government, but borne by the applicant. procedural requirements, and if you receive an negotiate those terms. Questions for an
Yet more reason to make sure that your cost award, you will be subject to government applicant company to ask include: Does the
projections are as realistic as they can be. contracting regulations that sometimes can be Bayh-Dole Act apply to me? If so, what does
quite onerous, especially compared to the that mean? What position is the applicable
How is the government different from a information rights that are granted to board agency likely to take when they are
traditional venture capital investor? members and key investors in a venture-backed negotiating intellectual property rights under a
company. Government funds come with Technology Investment Agreement? Will I be
There are a few key differences, including: restrictions regarding the manner in which they able to commercialize my technology as
may be spent, and may require that an planned, domestically and overseas, if I use
No equity investment. The government’s awardee company institute new accounting government funding? Companies should
investment is not an equity investment procedures to ensure that the necessary consult with experienced government
(though there has been some discussion about tracking and reporting can be done accurately contracting and intellectual property attorneys
whether this should continue to be the case). and on a timely basis. If you are selected to to structure the award to preserve maximum
So long as government funding is in the form negotiate a funding award with a government flexibility to commercialize technology
of grants, loans, or loan guarantees, your agency, please consult with experienced developed using government funding.
perceived value they believe will be created 1. Access to new markets via partner their customers through their massive
by virtue of them doing business with you. If distribution. In this instance, the investor sales force. They guaranteed a certain
this is the case, your partnering deal is likely agrees to distribute your product to level of revenue and the product was tied
to include a purchase option for your company. markets that they dominate; ideally, these to their operating system. It worked
markets are both large and cleanly incredibly well for both parties, and we
Common Ground separated from your existing distribution were able to go public largely on the back
channels. This kind of operating leverage of our mutual success. At a different
I now have the benefit of having raised money makes it worth taking on a corporate company, we took on a strategic
or otherwise partnered with seven strategic investor along with the potential pitfalls investment from Cisco in return for a large
investors over the course of five start-ups during that accompany this type of relationship. internal software license plus a
the past two decades. With significant hindsight Early on in my career, my company sold distribution agreement that brought our
as my guide, I now believe that there are IBM 10% of its stock in return for IBM technology to their sizable customer base
primarily two scenarios where it is beneficial distributing a version of our software to in Japan. It allowed us to safely and
to take money from a corporate investor:
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
quickly enter a new market and rack up first casualties. It is fairly routine to see stage companies will want to avoid this deal
millions of dollars in revenue with little corporate VC funds turned into caretakers, feature, but if you are pressed on the matter,
operating risk. sold off at a steep discount, or entirely try to negotiate a time constraint so that
shuttered. Unfortunately, this usually occurs you’re freed up if they don’t move within the
2. Access to proprietary technology. In exactly when the entrepreneur needs an first year of the arrangement. In the one case
this case, you take the investment engaged and supportive investor team. If you where we were stuck with an unbounded
because it is coupled with a license to are hitting the road for a challenging follow-on RoFR, it nearly derailed an acquisition. The
critical (and potentially patented) round, you can’t afford to also be scrambling prospective acquirer refused to negotiate a
technology that you would otherwise find to explain and fill in a new hole in your deal price unless the strategic investor agreed
challenging or impossible to develop on capitalization table. to waive their RoFR. There was little incentive
your own. If the technology is clearly for our investor to waive the right to acquire
game-changing and you can box out Polarity. The presence of a well-known us, but after numerous very intensive
potential competitors from also gaining strategic investor on your capitalization table discussions, we ultimately convinced them
access to it, a strategic investment easily (and perhaps on your board) can present that they should. Of course, this did little to
can make sense. I had a positive problems later in life when you’re trying to then help us maximize price—our suitor had
experience with Intel many years ago, enter into a strategic relationship with one of flushed our greatest leverage point completely
where they spent tens of millions of that investor’s major competitors. out of the picture.
dollars developing a technology but were Downstream deal-making can be very
challenged with bringing it to market. My challenging when the prospective partner is Conclusion
company exclusively licensed the concerned about information being shared
technology from them, packaged it for upstream, or when deal champions worry Every deal is different, but the patterns and
sale to our customers, and quickly built it about losing points internally for doing pitfalls associated with strategic investors are
into a multimillion-dollar revenue stream. anything that can be perceived by their peers now well chronicled and understood. They
They invested in our company and as aiding and abetting the balance sheet of have repeated themselves through multiple
ultimately profited from both the license the enemy. Why should they help their economic cycles and across virtually all
fees associated with the technology and competitor when they can build a similar technology sectors. As a start-up company
the sale of our company two years later. relationship with your competitor? executive, it’s your duty to distance yourself
from the emotional and qualitative arguments
Taking an investment from a corporate partner Absenteeism. This pitfall falls into the associated with taking capital from a strategic
simply because they are a very large customer “frustrating but not fatal” category. Unlike investor. Instead, you must relentlessly insist
(or plan to be) is typically not a good reason to traditional venture capital and private equity that any investment be associated with real
do this kind of deal. You have all the potential investors, the individuals behind a corporate operating leverage and without the
issues mentioned below, without adding any investment often have a different day job. entanglements that can sub-optimize a
significant leverage to your business. They are being paid to run their businesses, liquidation event. Follow these rules and you
Similarly, raising money from a strategic not yours. Despite their best intentions, I found can land a strategic investor deal that strongly
partner as a means of “getting closer”—i.e., that getting operating executives to burn road positions your company for growth, without
in hopes of some future operating agreement— time on your behalf is nearly impossible. misdirecting your energy or sub-optimizing the
is generally not a sufficient rationale. final outcome.
Entanglement. Finally, the more your
Common Pitfalls strategic partner puts into the operating Dave Panos is the CEO and co-founder
agreement portion of the deal, the greater the of Pluck Corporation, a social media
The following are the more frequent common chance that your investment will come with software pioneer that successfully sold
pitfalls associated with raising money from significant strings attached. If the strategic to Demand Media in early 2008. An
strategic partners: investor is helping to make you an important executive in five early-stage software
player in your shared industry, they will want companies, Dave also spent two years
Stamina. Corporate venture investors to be sure your company isn’t easily snatched as a venture partner with Austin
generally have a reputation for being up by somebody else. This concern typically Ventures. Dave can be reached at
interested in strategic investing when markets manifests itself in some form of Right of First dave.panos@pluck.com.
are good. But when economic times are tough, Refusal (RoFR) or Right of First Offer (RoFO) as
the corporate VC group is often among the part of the investment agreement. Many early-
9
THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
When entering into commercial contracts and post-bankruptcy periods (also called pre- party can mitigate payment risk by requiring
during uncertain economic times, it is petition and post-petition periods). The pre-payment, or including a right in the
important for a company to contemplate the automatic stay severely limits the ability of contract to suspend performance of services
consequences of a counterparty becoming aggrieved counterparties to take any action or shipment of goods following nonpayment. If
insolvent or otherwise failing to perform. against the failing party without the approval a contract does not have these protections at
While such considerations are prudent for all of the bankruptcy court, even if there is an the outset, it might be possible, when a
companies, they can be particularly critical for explicit contract provision to the contrary. counterparty begins to fall behind on its
early-stage companies, which inherently tend payment obligations, to amend the contract to
to have fewer contracts and less Payment Issues put such protections in place or to otherwise
diversification and, consequently, may be reduce the counterparty’s credit and payment
disproportionately harmed by the failure of A primary purpose of bankruptcy law is to period. But due to the limitations imposed by
one or more commercial relationships. ensure that when debt claims are too much the automatic stay and other aspects of
for the failing party to handle, those claims bankruptcy law, timing is important and can
When a counterparty to a commercial contract are processed in an affect the validity of any
fails, there are a variety of potential orderly manner. Thus, such amendment; thus, it
consequences for the other company. The claims for payment is important to closely
specific consequences depend on the nature on amounts that relate
In most cases, a party monitor payments.
of the relationship, the type of failure, and to pre-petition can mitigate the risks
whether or not the failing party files for, or is performance must be of a worst-case Termination Rights
involuntarily forced into, bankruptcy brought before the
protection. In most cases, a party can mitigate bankruptcy court. If the outcome by negotiating Many contracts contain
the risks of a worst-case outcome by claim is unsecured— protective provisions at express rights to terminate
negotiating protective provisions at the outset meaning there is not a in the event the other
of the relationship, by paying attention to the lien or other security
the outset of the party is subject to a
counterparty’s performance, and by taking interest that serves as relationship. bankruptcy filing. But
action before a bankruptcy petition is filed. collateral for the debt— because of the automatic
then the party owed stay, that right cannot be
Bankruptcy Law payment under that claim will stand at the exercised without the approval of the court,
back of the line, behind aggrieved parties that which in the absence of extraordinary
To understand the risks, one has to know have secured collateral or that are otherwise circumstances, is unlikely to be granted. In
some basics about the overlay of bankruptcy given priority status, and fight to collect many cases, being held in a contractual
law. First, because bankruptcy law is a body of pennies on arrangement while the bankruptcy process
federal law, it takes precedence over (or the dollar. plays itself out may be perfectly acceptable,
preempts) commercial arrangements, which but often this can leave parties in limbo while
are governed by state law. In other words, if A party can mitigate payment risk by getting waiting to find out whether the agreement
bankruptcy law requires one outcome and a and perfecting a security interest in collateral, ultimately will survive.
contract provides for a different outcome, the or something that approximates this kind of
outcome dictated by bankruptcy will prevail. protection, e.g., a performance guaranty from If it is important to be able to exit a
One of the more important provisions of a credit-worthy third party, such as a parent relationship upon signs of instability, then the
bankruptcy law (and an illustration of the company, or a letter of credit from a bank that termination rights need to be carefully
consequences of preemption) is the can be drawn upon to make payment. Getting structured so that the right to terminate arises
imposition, effective immediately upon the these protections is easier said than done, prior to the actual filing for bankruptcy. This
filing of a bankruptcy petition, of an automatic however, and in many cases these are not means identifying events that are common
stay, which is in essence a wall that divides practical options. But even where these precursors to a bankruptcy filing (such as
the failing party’s world into pre-bankruptcy protections are not possible or practical, a making a public statement regarding financial
10
THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
difficulty or amending a credit facility) or right. If the failing party exercises its right to by rejecting the license agreement. If the
providing a more general right to terminate reject a contract, the other party will be left contract is rejected and the license grant is
upon a material change in financial condition. with an unsecured claim for damages. not broad enough to enable the aggrieved
Additionally, a company procuring goods or licensee to support the intellectual property,
services can mitigate risk due to the failure of Integrity of Inbound Licenses to the licensee may not have very useful rights.
a vendor by insisting upon termination rights Intellectual Property And even with broad use rights, if the licensee
in the event of an uncured material breach or does not have access to the source materials
a number of immaterial breaches, because As an exception to the bankrupt party’s (e.g., source code, blueprints, and technical
such breaches may indicate that the general right to elect to terminate a contract, instructions) or personnel with know-how, the
counterparty does not have the resources parties holding a license to the bankrupt use rights may be significantly handicapped.
needed to support its business. Further, party’s intellectual property, including patents,
deeming the non-payment of any amount to be copyrights, mask works, and trade secrets (but Consequently, if an inbound license to
a material breach and providing for a shorter not trademarks), are afforded special intellectual property is of vital importance and
cure period for non-payment than for other protections under Section 365(n) of the U.S. mere use rights are not in and of themselves
material breaches can further mitigate Bankruptcy Code. In short, a license within the sufficiently protective, it can be critically
exposure. But these rights only help if used meaning of Section 365(n) will be preserved important to require that relevant supporting
before the bankruptcy filing, and so it is irrespective of whether the contract granting materials be placed into a third-party escrow
important to promptly send notices of default, that license is rejected by the bankrupt party. account, to carefully define the release triggers
and to be diligent and precise in complying In other words, the right to use intellectual (e.g., material breaches of performance
with notice provisions, in order to start the property within the scope of the license obligations, insolvency, and termination of the
cure-period clock running and reduce or granted by a licensor that subsequently fails contract by licensee for cause) and, if
preclude arguments that rights of termination will be unaffected by a bankruptcy filing. That applicable, provide for expanded use rights
have not arisen. is good news for the licensee and underscores upon release, so that the licensee can access
the importance of being explicit that a license the materials and use them to support its
Conversely, as part of the bankruptcy process, is intended to fall under Section 365(n). license. Here again, monitoring performance
the bankrupt party can reject, and thereby can help to mitigate risk. If a licensee who
terminate, certain types of contracts— The bad news is that, while the license is negotiated for source materials to be placed in
generally, any contract that has unperformed preserved, the license agreement itself can be an escrow account never bothered to verify
material obligations of both parties. This right rejected. Accordingly, if a failed licensor has delivery or periodic updates, it may be left
is provided by federal bankruptcy law and, ongoing performance obligations (e.g., without access to those source materials post-
thus, is available to the failing party even if development work, maintenance, and support petition and left at the back of a line with an
the contract does not expressly provide such a obligations), it can get out of those obligations unsecured breach-of-contract claim.
Tools
WSGR TERM SHEET GENERATOR
Always looking for ways to better serve the entrepreneurial community, Wilson Sonsini Goodrich & Rosati is pleased to offer the WSGR
Term Sheet Generator, an online tool that allows entrepreneurs and investors to generate an initial draft of a term sheet for a preferred
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included. After answering as many questions as desired, users can generate, print, and save a Word version of the term sheet, which is
intended to be useful in deal discussions between entrepreneurs and investors and in crafting a final, customized term sheet with the
help of attorneys. Please go to http://Display.aspx?SectionName=practice/termsheet.htm to learn more.
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
In recognition of these principles, courts have Directors are subject to the duty of care, the Certain steps can be taken to minimize a
provided certain protections for the benefit of duty of loyalty, and the duty of good faith, as board’s exposure to liability from stockholder
directors and the decisions they make where described below: claims in connection with the fundraising
minimum standards of board conduct are met. process, particularly where one or more
For example, the business-judgment rule Duty of Care. Directors must inform themselves directors or funds affiliated with them are
generally provides that if directors comply of all material information reasonably available participating as investors in the financing. A
with their fiduciary duties of due care, loyalty, (which includes seeking input from relevant number of these are practical and easy to
and good faith (further discussed below), most members of management); engage in a implement, and often make good business
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
sense from the standpoint of maximizing board should be prepared to show that it have day-to-day visibility into the process
stockholder value. Others are more formalistic made an informed decision in approving a involved and apprised. If the board is called
process protections that have proven to be financing. Having as many data points as upon to defend the fairness of an interested-
beneficial under scrutiny by trial courts. possible demonstrates that the board was director financing transaction in the face of a
adequately informed. stockholder challenge, it may be helpful to
It is important to be mindful of best practices demonstrate consideration of minority
from the very onset of the fundraising process. Keep Detailed Records stockholder interests and solicitation of
While there usually will be a sense of urgency their feedback during the transaction
to close a venture financing once a term sheet When your company does receive a financing negotiation process.
is signed, often six months or more will have term sheet, whether from an outsider or for an
passed from when a company identifies the inside-led round, the company is likely to From a practical perspective, stockholders who
need to raise money to when it finally signs a have pressing short-term cash needs and are kept informed or consulted during the
term sheet and advances to a closing. may want to close quickly. A displeased fundraising process may be less likely to
Therefore, it is critical to contemporaneously stockholder may seize on this as evidence instigate a stockholder lawsuit; they also may
consider these best practices throughout that the board did not carefully consider the be more cooperative during the closing process
this entire process to create a clear record terms, did not actively weigh the financing (e.g., submitting signatures required of them
evidencing the company’s deliberations alternatives, or that the transaction was not on a timely basis). For example, if initial
and discussions. fair to the stockholders. In order to dispel any investor feedback indicates that the company
such perception, the officers and directors is likely to receive a low valuation or that a
Cast a Wide Net principally involved in the fundraising recapitalization may be necessary as a
process should carefully document each step condition to their investment, you may not
Make your company’s fundraising pitch to as of the process. want to surprise your stockholder base with
many potential investors as possible. Reach this information late in the fundraising process.
out to the investors who are known to make Make sure board discussions of fundraising
investments in your company’s space; take a alternatives and status are recorded in Maximize Stockholder Approval
fresh look at whether it makes sense to bring meeting minutes during the months leading up
in strategic investors (see “Cozying Up to to the financing. Save copies of meeting Your company’s charter documents or
Goliath” on page 1); even consider making requests, presentation materials, and other applicable corporate law typically will
overtures to investors who have previously communications with potential investors necessitate obtaining approval from your
passed on making investments in your (including “no, thank you” correspondence). stockholders as a whole before you can close
company. If a board is required to demonstrate Make it a habit to jot down notes after each a financing transaction. There also may be
the fairness of a financing transaction in the investor meeting or telephone conference with separate approval requirements associated
face of a stockholder challenge, showing that a brief explanation of the results. Follow up on with specific series or classes of your
the company canvassed the community of potential leads and inform the board of the company’s stock. However, you also should
potential investors can be strong evidence current status of all discussions. Then, even if consider whether seeking separate approval
that the company tried to obtain the best your company is required to move quickly to from other groups of your stockholders would
terms for its stockholders that it could— close a fundraising, the board still can be beneficial, even where such approvals are
particularly in the case of an inside-led round, demonstrate that the company engaged in a not legally mandated.
where it may be helpful to show a lack of methodical, well-informed negotiation and
interest from outside investors on more approval process. For example, if as part of a financing
favorable terms. transaction current holders of preferred stock
Inform Stockholders are treated more favorably than holders of
Compliance with a board’s fiduciary duties common stock, you should consider obtaining
does not require it to turn down a term sheet Throughout the course of fundraising, consider separate approval from the holders of a
just because the terms are tough. However, a keeping stockholders who may not otherwise majority of the outstanding shares of common
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
stock. You also might consider obtaining least their pro rata ownership in the company bearing the burden of demonstrating the
approval from the holders of a majority of the by investing alongside the lead investors on fairness of the transaction).
shares held by stockholders who are not the same terms.
participating as investors in the financing. While it is not cost effective, a board also may
Obtaining these separate approvals may This can be strong evidence of the fairness of consider engaging an outside financial advisor
provide your board with an advantage in its the financing in the face of a stockholder to render an opinion to the board or special
defense of an interested-director financing challenge. This also may foster goodwill with committee that the transaction is fair to the
transaction. Additionally, actively seeking stockholders who may otherwise feel that stockholders (generally referred to as a
these approvals may help you identify in they are being excluded from the process or fairness opinion). This assists the board in
advance of closing a financing which disadvantaged by the terms of the financing. carrying out its fiduciary duty of care, and
stockholders are likely to object to its terms. helps it defend the fairness of an interested-
Special Committee; Fairness Opinion director financing transaction.
Conduct a Rights Offering
If your financing could be considered an Conclusion
Consider conducting a rights offering in interested-director transaction, your board
connection with your financing. This involves should consider whether it would be Interested-director and fiduciary-duty issues
setting aside a meaningful portion of the beneficial to empower a special committee of can be complex and fact-specific and may vary
shares or debt being sold in the financing and independent directors to negotiate on behalf by jurisdiction, but with the assistance of legal
making them available for purchase by of the company and approve the terms of the counsel, there are steps that companies may
existing stockholders. Generally, a substantial financing. While the use of a special take to maintain a high level of oversight and
majority of the securities being offered in a committee does not in itself insulate a board transparency in a challenging financing
financing are sold to one or a few lead from liability for breach of fiduciary duty in market. Entrepreneurs can help focus the
investors who negotiate the terms of the connection with a financing, in some cases board on potential issues early and implement
financing with the company. However, we the use of a truly independent special procedures that should lead to good decision-
recommend that you offer your other committee can shift the burden of making, disclosure, and, ultimately, a better
stockholders (at least those who are demonstrating that the transaction was not result for all stockholders as a group.
accredited for the purposes of applicable fair to the party challenging an interested-
securities laws) the opportunity to maintain at director transaction (as opposed to the board
The Non-dilutive Cash Injection: Selling Your Patents (Continued from page 1)
Who is buying? Specialized private equity corporations, and from bankrupt companies to How Do We Participate?
funds, specialized start-ups, large and medium universities. Investors, in particular, are finding
corporations, licensing organizations, and that patents are one of the few underexploited For context, here is an example of the kinds of
defensive patent pools. Depending upon the distressed assets that are also uncorrelated transactions we have done at ThinkFire: A
patents in a transaction, there may be more with the broader markets. venture-backed company is running out of
than 50 buyers to contact. The mix of cash. An infusion of a few million dollars
buyers—and their interests—changes often, The patent-transaction market today breaks could bridge them to a crucial partnership or
but it has been, and continues to be, an ever- down into two broad categories: (1) high- financing deal. The company has a few
growing pool. quality patents with high market impact and patents issued and a few more pending. By
(2) everything else. Even during this recession, selling some of their patents, the company
Who is selling? The sellers’ pool is similarly the first category has seen prices increase. raises cash without impacting their product
large and growing—from Fortune 500 The second category, however, has witnessed offering or operations, and without diluting
corporations to individuals and small a steep decline. their shareholders.
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
The Non-dilutive Cash Injection: Selling Your Patents (Continued from page 14)
Whether you use a broker or not in this same patents. One might assume that the enter the same market. These competitors
process, the first step is developing the sales price range varies due to the different might have patents that are a concern.
package, which typically includes: information possessed by each of the
potential buyers. For example, finding an as But you are prepared to meet these challenges
• Patents—overview and specific patent yet undiscovered problem with the patents because you planned ahead. Your company
numbers can lead to a zero valuation. Similarly, a kept a license back in the patent sale, so you
• Third-party data on the impacted market prospective purchaser may have better know that your former patents will not be
• Important patent claims comparables data. Since there is no multiple used against you. Also, you never stopped
• Seller background listing service (MLS) for patent transactions, innovating and you continued your patent
• Estimated price range only a few large buyers and brokers have program. You've also bought a few companies,
information on enough transactions to really along with their patent portfolios. Now,
The sales package is then distributed to likely help here. But even when all the parties have because of your increased revenue, you can
buyers. Over a period normally ranging from the same market, patent, and pricing data, the participate in the patent market as a buyer to
45 to 90 days, buyers review the materials valuations can vary considerably. purchase patents to address the specific
and ask questions about the market data, the threat posed by your competitors. In other
patents, and the bidding process. Bids are The primary reason for this variation is that words, by selling your patents early, you gave
then accepted and sales are typically closed in patent value is context specific, with the yourself the cash to move the business
the following 45 days. context of the owner dictating the value. For forward, and the time and resources to rebuild
example, a patent held by a licensing company your patent portfolio.
Many sellers use brokers and some buyers can generate multiple royalty streams, while
prefer to buy from qualified brokers, who that same patent held by a start-up is unlikely Other Structures for Monetizing Patents
usually provide the following services: to generate any. That makes the net present
value for each potential owner significantly There are other structures that you can use to
• Creating the sales package, including different. Thinking about who the potential make money from your patents. Licensing,
identifying the important claims buyers are and how they would use the hybrid licensing-brokering, or patent pools
• Contacting the buyers patents is a critical element in pricing and, (depending on your specific market) all can
• Answering buyer questions ultimately, obtaining a higher valuation. yield attractive returns. Licensing your patents
• Running the bidding process can involve planning and execution
• Helping to set price expectations Importantly, keep in mind that, in any context, requirements as complex as product
• Providing sellers with the current state the sales price is also significantly lower than development and launch. As such, it is often
of the patent market the cumulative future royalty stream. Where a too much of a distraction for the patent
• Acting as a sounding board for deal business case exists for $100 million in future owners to pursue as a strategy. However, you
terms royalties, when risk adjusted, the same can spinout the patents to a limited liability
• Helping to close the sale patents likely will sell for $1-10 million. A corporation (LLC) responsible for licensing and
surprisingly large discount, but the patent participate as a limited partner. As a limited
Often, brokers do this work on a contingency- licensing risks are numerous and large, and partner in the LLC, you can receive revenue
fee basis, so there is no cost to the seller if the investment is likely to be slow to yield any from the licensing activities without control of,
the deal does not close. Depending on the financial returns. or direct responsibility for managing, the
complexity and expected price, the range of licensing process. This structure allows
fees is typically 15 to 30% of the sales price. What Happens After You Sell? tremendous flexibility. For example, once set
up, the LLC can pursue hybrid models of
Finding the Right Price After the sale has closed, you now can use licensing some companies and then selling the
the proceeds to move forward. Imagine a few patents to another company or group.
Pricing the patents may be the most difficult years into the future—your company has Transferring the patents or patent rights to a
part of the sales process. Valuations can annual revenues greater than $50 million, for third party in exchange for a portion of future
range from zero to millions of dollars for the instance, and big competitors have begun to licensing fees is a relatively common
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THE ENTREPRENEURS REPORT:
Private Company Financing Trends
Summer 2009
practice (for example, MPEG LA acts as a includes leadership from several of the Erik Oliver is the managing director of the
clearinghouse for MPEG patents). All of these world's most-renowned IP organizations, Silicon Valley office of ThinkFire Services.
options can result in significant revenues; such as Lucent/Bell, IBM, Cisco, and With licensing experience involving
however, the time to money can be too long for a Rambus. Kent advises clients on patent several hundred million dollars of patent
cash-squeezed start-up. strategy, management, and licensing. and technology licenses, Erik advises
He has licensing and marketing patent clients on patent strategy, management,
Kent Richardson is the general manager of portfolio experiences resulting in more and licensing. He can be reached at
the Silicon Valley office of ThinkFire than $600 million of patent license eoliver@thinkfire.com.
Services, a leading patent brokerage, bookings. Kent can be reached at
licensing, and strategy consulting firm that krichardson@thinkfire.com.
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