Venture capital and ip strategy in silicon valley 2013

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Venture capital and ip strategy in silicon valley 2013

  1. 1. Venture Capital: Fundraising, Founders and IP Strategy in Silicon Valley Richard Horton Silicon Valley – Sydney richard.horton@squiresanders.com37 Offices in 18 Countries
  2. 2. Squire Sanders • Dual qualified US – AU attorney • 13 years in Silicon Valley • Squire Sanders1,300 lawyers globally  39 offices in 19 countries  2 in Silicon Valley (Palo Alto, San Francisco)  Top-20 global legal practice  Practicing law in more than 140 jurisdictions, in more than 40 languages  United States/Latin America: 16 offices, ~540 lawyers • Represent many major SV funds and numerous startups • Global venture capital and M&A expertise2
  3. 3. US Venture Capital industry • About 30 billion dollars invested in 2011 (about 4,000 deals in US) vs. 120 billion 1999 – 45% SV • Internet and Software are leaders (nearly 50% in 2011) – ultimate start up business • Cleantech – capital inefficiency issues • Second coming of internet due to new infrastructure • Return to fundamentals: capital efficiency3
  4. 4. Investments by Industry Q4 2011 – PWC/NVCA MoneyTree Report4
  5. 5. Australian Explosion and Silicon Valley • Explosion of AU incubators, accelerators, co-working spaces etc  Replicate Y Combinator • Huge number AU IT/software graduates • Many AU gov’t grants (CA, R&D tax credit etc) • Silicon Valley ex-pats (Aussie Mafia too) • Relevance of Silicon Valley?  AU VC and Angel community very small  AU vs. global opportunity  US Parochialism  Flip?5
  6. 6. Australian Explosion and Silicon Valley • US-centric approach • Australian American Free Trade Agreement • The Future in Australia?  More to remain HQ’d in Australia as venture and entrepreneurial community grows  Several new VC funds in Australia online soon (Australian and offshore)  Too many first time entrepreneurs currently6
  7. 7. US Venture Capital industry7
  8. 8. Plan for Success • Venture capital is a mature industry  Well known set of deal terms and variations  Need a lawyer with experience • Most VCs hate legal complexity • Standardization • Expensive mistakes  LLC (unless very simple and conversion path to C corporation) – Angel may require  Nevada incorporation • Question mark re Australian startup reputation for corporate compliance8
  9. 9. Sources of Capital for Startup Business • Self Funding  “Bootstrapping” and “Organic Growth”  Smart money is good money • Angel/Super Angel  Many sophisticated Angels in SV from dot com era and subsequently  Higher risk, pre-VC money  Can be good and bad • Traditional VCs  Specialize in subject-matter (semi-conductors; cleantech; life sciences)  Pressure to perform for LPs  Homerun game  Looking for exit9
  10. 10. Sources of Capital for Startup Business • Confidential information • Don’t “shop” the deal too broadly • Be prepared: you never know who you will meet when  Have an “elevator” pitch  Have a powerpoint of Business Plan • Understand the fund’s decision process  Keep competitive till the end if possible • Corporate Investment/Strategic Investment  Usually equity investment by large corporation and significant grant of rights  Strategic’s key motivation10
  11. 11. Process to Signing a Deal – The Term Sheet • Term Sheet  Non-binding  But must have legal advice • Legal Documents  Based on term sheet  Usually 2-4 weeks, depending on due diligence findings and any “clean up”11
  12. 12. Due Diligence • Initial due diligence • Continues in earnest after signing of term sheet • DD process (approx 1 to 2 months) • Due diligence • May have a material impact on valuation12
  13. 13. Key Terms - Valuation • Primary issue in fundraising • Too low • Too high no good either • Pre-money vs. Post-money? • Convertible notes and bridge financings13
  14. 14. Key Terms - Valuation • AcmeCo example  Pre-money valuation $8,000,000 – Founders – 3,000,000 shares of common stock – 75% » Consideration? – Drug and software IP/technology? – Earnout (repurchase) – Share option pool – 1,000,000 common stock – 25%  Amount to be raised – $4,000,000 => Post-money valuation of 12m – 2,000,000 Convertible Preference Shares @ $2 each14
  15. 15. Key Terms – Valuation (example) Capitalization (Cap table) Capitalization Pre-Money % Post-Money % Founder’s Common Stock 3,000,000 shares 75.00% 3,000,000 shares 50.0% Outstanding Preferred Stock 0 shares -- 2,000,000 shares 33.33% Outstanding Stock Options 200,000 shares 5.00% 200,000 shares 3.33% Reserved Options 13.33% 800,000 shares 20.00% 800,000 shares 100.00% 100.00% 4,000,000 shares 6,000,000 shares Valuation: (Series A Preferred Purchase Price = $2.00 per share) $8.0 million $12.0 million15
  16. 16. Key Terms – Liquidation Preference • Convertible Preference Shares • Liquidation Preference*** • Non-participating Preferred vs Participating Preferred • Precedential value • Non-participating Preferred (NPP) • Participating Preferred (PP)16
  17. 17. Effect of Liquidation Preference in MergerPreferred Investment Amount $ 5,000,000Percentage purchased 30%Sale Price of Company $ 25,000,000 Non Participating Preferred Participating Preference Only Converted Preferred Sales Price $ 25,000,000 $ 25,000,000 $ 25,000,000 Amount to Preferred Liquidation Pref $ 5,000,000 $ 5,000,000 --------------- --------------- --------------- Amount after Preference $ 20,000,000 $ 25,000,000 $ 20,000,000 Percentage of Balance 30% 30% As Converted $ 7,500,000 $ 6,000,000 --------------- --------------- --------------- Total to Preferred $ 5,000,000 $ 7,500,000 30% $ 11,000,000 44% Common Stock $ 20,000,000 $ 17,500,000 70% $ 14,000,000 56%In this climate Founders may need a massive exit to make any money….17
  18. 18. Key Terms • Drag Along Rights  Investors can force vote for a merger • Dividend Preference  Fundamentally, startups can’t pay dividends  Cumulative dividends • Protective Provisions  Authorize more shares of that series (i.e. authorize future investors)  Authorize series with more senior rights  Change rights of that series  **Merger/sale of assets  Changes to option plan (ESOP)  Limits on changes to number of members of Board of Directors18
  19. 19. Key Terms • Board level protective provisions? • Board of Directors  Observer rights only? • Participation Rights/Pre-emptive Rights** • Right of First Refusal** • Co-Sale (Tag Along) • Anti-dilution protection for Investor  Full Ratchet  Weighted average • “Pay to play” • Exclusions  Option pool of limited size  Mergers/acquisitions  Warrants for banks/leasing companies19
  20. 20. Effect of Anti-Dilution Formulas • Merger Returns Series A % of Company and valuation thereof post-money Assumes 4,000,000 additional shares of Series B Preferred Stock issued at the following per share prices: $1.50 $0.75 Example A: Preferred without antidilution 20.0% ($3.00 MM) 20.0% ($1.50 MM) protection Example B: Weighted average antidilution 21.9% ($3.36 MM) 25.5% ($2.06 MM) formula protection Example C: Full ratchet antidilution protection 25.0% ($4.00 MM) 40.0% ($4.00 MM)20
  21. 21. Calculating Anti-Dilution One, not “the” approach : Application to Issuance of 4,000,000 Shares of X Co + $ = C1 Series B Preferred at $1.50 per share: X+Y (5,200,000  2.00) + $6,000,000 = $1.78 5,200,000 + 4,000,000 Where: X = number of shares of common stock Each share of Series A converts into Common at outstanding or deemed to be outstanding (including ratio of $2.00 or 1 to 1.12. common stock equivalents) prior to new issuance $1.78 Co = old conversion price Post Series B Common Equivalents: C1 = new conversion price % With % Without Weighted Antidilution Average Protection $= aggregate consideration received for Common (including 39.05% 30.0% new shares issued options) Y = number of new shares issued Series A 21.9 20.0 Series B 39.05 . 40.0 100.0 100.0%21
  22. 22. Key Terms • Founder Vesting - Retention and Golden handcuffs  Vesting = 4 years (1 year cliff)  83b election - critical  Accelerated vesting?  “Founders Preferred Stock” • Key Management/Employees: Employee share option pool  Usually options vest as above (25% after year 1; 1/36th per month thereafter) • Redemption – The Living Dead  Forced liquidity when company hasn’t gone public  Amount (all at once or percentage) • Information rights • Registration rights22
  23. 23. Documents for Funding • Preferred Stock Purchase Agreement  Schedule of Exceptions  Due Diligence • Investor Rights Agreement • Co-Sale/ROFR Agreement (sometimes combined with Investor Rights Agreement) • Restated Articles of Incorporation23
  24. 24. Convertible Notes • Convertible notes?  Quicker, cheaper since not shareholder  Avoids valuation discussion/debate? – warrant coverage  Same terms and shares as subsequent funding?  Cap or Discount (priced?)  Problems (multiple liquidation preference)24
  25. 25. IP Strategy • Must have an IP Strategy  US very sophisticated regarding IP  Patents quintessential right (most important)  Infringement searching  Investor understanding of patents very varied, but valued • IP ownership • Patent protection  1 year grace period from first publication • Prior employer rights  S2870 California Labor Code25
  26. 26. IP Due Diligence Issues • Licensing Mistakes • In-Licenses • Out-Licenses • Failure to secure branding rights • Unplanned use of Open Source software • IP rep and warranty issues26
  27. 27. Key to Success • Understand the process and risk • Focus on goals  Timing and appropriateness of investment  Management team • Knowing the limits of negotiations by using experienced counsel27

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