Rock-A-Bye IP — A Dangerous Bargain for Inventors
Rock-a-bye IP, in the treetop,
When the cash flows, your cradle will rock!
When the dream breaks, the cradle will fall,
Then kiss goodbye your IP, cars, farm and all.
When an entrepreneur is also the inventor, or owner or originator of the technology underlying an innovative product or service, the penalties of failure carry double jeopardy. How is this possible?
The rewards for success are (theoretically) equivalent for everyone in any given circumstance. But the consequences of failure are not at all the same for those who have ample assets to invest compared to those whose investment in a new venture includes the assignment of their main, perhaps only, ticket to financial independence — their intellectual property (IP); it’s their ‘baby.’
The difference lies in the dangerous bargain that the cash-strapped inventor/founder may have had to agree to when raising seed capital to start or promote his or her new company.
Simply put, most entrepreneurs seek capital because they don’t want to work for somebody else. However, most inventors as well as entrepreneurs have modest personal means. They invest their own money and borrow on credit cards to establish their “lifestyle company” or to buy a franchise. Entrepreneurs often view the IP they control as their ticket to self-employment. Where does this leave the inventor/entrepreneur and friends who are “thinking big” yet are among the 90% who lack the personal resources necessary to conduct market research, produce and test prototypes, and obtain patent protection, much less achieve significant market share.
President Obama views innovation as one of America’s great economic engines. MIT Sloan Prof. Ed Roberts wrote, “Estimates based on 2006 data revealed that living MIT alumni have founded or cofounded 25,800 companies that today employ 3.3 million people worldwide. The annual sales of these companies add up to about $2 trillion–the equivalent of the 11th-largest economy in the world.”
THE PRIVATE EQUITY OPTION
When Business Angels or private Venture Capital Fund Managers want in on an “unfair competitive advantage” from brilliant IP, expect terms requiring that the IP be assigned to the venture/ company. Unless the IP is coming from a university’s Technology Licensing Department, the inventor, a “Common” stock owner, will be required by holders of “Preferred” stock to sign that IP baby over to the new venture. Investors insist on the new entity per se having the IP upon which they base their participation. This is especially so for many of the thousands of Venture Capital funds who, because they frequently invest in a syndicate along with other VC funds, demonstrate a high degree of conformity from one VC to the next when it comes to the bargaining terms. i Although most individual ‘Business Angel’ investments ii are in the $10,000 range, both the organized Angel Networks and the sophisticated backers (LPs) of “Super Angel” funds and VC funds seek merchant-banker-like privileges such as “Preferred” stock having a liquidation preference, anti-dilution and participation rights and a spot on the Board or one per syndicate member.
‘Accredited (wealthy) Business Angels’ may settle for a venture that could only scale to sales of $10 to $30 million and may not spend much to check out each opportunity. However, VC Funds spend six figures on due diligence iii as they seek a “big hit,” a potential NASDAQ IPO and a market capitalization high enough to attract market analysts by clearing the U.S. “small cap” threshold of $300 million.
With these private investors, there are no statutes or SEC regulations governing proxy votes or other rights of shareholders vs. founders. There are no VC or Angel Codes of Ethics or securities regulations. iv Whatever the fiduciary responsibilities of VC fund managers, the entrepreneur and his or her intellectual property are mainly protected by an ability to pay hard charging lawyers to draft comprehensive contracts and to defend in the event of prolonged litigation.v In thousands of cases, if the enterprise fizzled for lack a merger or IPO“exit,” even if as a result of changing VC industry conditions entirely outside the control of the new venture’s management team,vi the inventor/entrepreneur lost control of the intellectual property in either “down round”vii dilution or a bankruptcy liquidation.
Venture capital is a long-term asset class whereby Limited Partner investors’ funds are locked in for 10-years. That’s supposed to be one of its best selling points (and is what the industry uses on Capitol Hill to fight against SEC registration or increased taxation proposals). VC clients (inventors and entrepreneurs) are locked in by a battery of covenants – dependent upon VC Fund partners until a suitable “exit,”i.e., a merger or IPO becomes available or until liquidation as the 10-year old VC fund is liquidated.
Inventors and entrepreneurs have understood that they would need to consistently make agreed-upon performance milestones or face a“down round.” Understandably, preferred investors neither foresaw nor made accommodations for changing VC market conditions triggered by a toxic investment banking scandal. New conditions have invalidated the conventional, long term, VC model to the utter detriment of all concerned.
Seeing almost no alternative, viii inventors and entrepreneurs continue to apply for financing from VC funds, but Limited Partners are reluctant to be locked in again for ten years. The median net return to these VC fund investors has not been positive for any vintage year since 1998 and Cambridge Associates reported that 10-year VC funds’ median net returns fell further from a minus 4.2% in 2Q 2010 to a negative 4.64 percent (-4.64% IRR) in 3Q 2010. The fault lies principally with Investment Banks’ toxic paper asset crash and not with a surge in toxic new ventures. Most US VC funds are finding themselves unable to sustain their level of operations beyond the 10-year life of their 1999 and 2000 funds. Recent Venture Source reports reveal that LPs are not investing in (US-based) VC funds at even one-seventh the rate they were in 2000 (see endnote chart). Most Silicon Valley Funds are being forced to let great talent go.
It’s not only at VC funds where the finance of innovation has faded. Most companies are now able to commercialize less than one in five promising idea and even the most innovative companies commercialize only 60% of their most promising ideas.x
If an IPO opportunity were somehow to arise, would Common shareholders have their say at the bargaining table?xi Would those early risk takers have also received “Equal Opportunity IPO” (EOIPO) warrants exercisable right along with favored IB clients’ allocations the day before the S-1 IPO trades?
99.9% of the 29.6 million businesses in the U.S. in 2008, were “small.” Suppose inventor / entrepreneur and friends seek to raise $5 million “publicly” – such as from small business owners. In most U.S. states, that approach lacks “merit” unless those founders have already put ten percent at risk (the IP plus five-hundred-thousand dollars cash) into a $5 million offering to the general public under Regulation A. Also, the exemptions to US securities regulations (except for Reg. A in “full disclosure” states) limit solicitations to 35 or fewer members of the public (‘non-accredited’ investors‘. Such ‘Blue Sky’ barriers shut local community participation out and thereby stop all but wealthy inventor-entrepreneurs cold.
As a rule, for the “small cap” ($300 million market capitalization IPO) opportunity, contacting 35 hard-working peers won’t raise “enough.” As a practical matter, the inventor / entrepreneur really has just three options:
- Opt out – filing a “provisional” patent would trigger a 12 month countdown so, being unsure that financing would turn up in time, quietly lock the idea and business plans in a drawer, or
- Ask the accountants or lawyers for personal introductions to Angels or to Private Equity (PE), that is, new Venture Capital funds, those within the first year of the target VC fund’s 10 year life, or
- Prepare for Public Equity. Start with a Self Screen at Beacon or a site like SCORES’ Self Evaluation for Going into Business – then tap mentors and Business Angels at BEST – then consult Beacon Investment Partners LLC resources about public/private funding.
Public/private finance resources and methods are novel. Because the inventor / entrepreneur’s new venture will typically be listed and trading in a matter of months, the inter-relationships, roles/ responsibilities and control of operations and of the IP assigned to the venture all become well defined as between any public corporation and Common shareholders. However, these public/private resources are unknown to most founders. More likely, an inventor/entrepreneur hears about option #2, a private Venture Capital road. Can the founding team maintain IP control and still team up with a VC fund? xiii
Venture Capital funds and their limited partners are looking for “big hits.” Past successes like Apple, Fed Ex., or eBay were made possible by the “ÍPO window” being open. In the past, the average VC-backed firm was more successful than the non-VC backed entrepreneurial firm. With the IPO window closed, but with even the largest fund managers still constrained by lack of fund permanency, that traditional VC formula has (on average) failed investors in nineteen out of every twenty VC funds launched since 1998.
The 2007 Edition of Pratt’s Guide to Private Equity Sources described over five thousand VC firms and their investment preferences on 1,634 pages. Newly entrant private equity VC fund managers generally strive to syndicate with established firms because deal flow and promising intellectual property may very well be revealed to every member of such a syndicate.
It is not good form for an entrepreneur to address multiple members of that unpublished syndicate, the local community development commission plays no role whatsoever, so it’s up to savvy lawyers to guide entrepreneurs through the thickets. However, entrepreneurs say they have lost their assets after hiring lawyers whose best clients have been VC firms — See: DOUBLE-CROSSED: Silicon Valley entrepreneurs say they have been betrayed by venture capitalists and lawyers, the very people they asked for help.
The investors’ valuation of the founder’s IP contribution is seldom rigorous and is generous only by accident. Year after year, the average seed stage product venture was valued at about $6 million dollars pre-money according to VentureOne regardless of the management, market, pre-sales contracts and founder’s cash, IP and kind. In Series/Stage A, the VC funds usually have invested $2 million for 33% or more of the new venture. For 33%, a software application that runs on various smartphones may fetch only $.5 million at Stage A.xv That $500,000 may get the app taking orders online and into the handset of at least one claim jumper who, in view of the cash-starved new venture’s paltry IP defense war chest, could establish an attractive clone. Conversely, the entrepreneur may be sued for infringement. It costs an average of $5 million per incident to defend a patent. xvi
Founders armed with exceptionally promising Intellectual Property to back their Common shares, could manage to control the VC-backed company throughout the first stage of venture financing so long as they are able to pay over $30,000 to a lawyer dedicated to representing only entrepreneurs. But that ‘A’ round of the series of financings is a mere drop — hopefully enough to make it to the first milestone on the path to becoming an “early-stage” venture, often not. Just four months after they received a multimillion-dollar Series A investment from Bessemer Venture Partners, Go Fig.Inc. filed for Chapter 11 bankruptcy; go figure.
Covenants xvii , if triggered, could cede substantial control of the new enterprise (IP included) over to the preferred-share-owning and preferred-debenture-owning accredited, limited investors in the VC fund. If, for whatever reason the venture becomes “financially distressed,” there is the probability of IP control changing hands in either a “work out” or an auction. xviii
THE TEN-YEAR VC FUND HAZARD
Unlike permanent (publicly traded) Business Development Companies (BDCs), the private VC funds lack permanency. Driving thousands of bankruptcies this year is time — the fact that huge private VC funds who raised hundreds of billions together back in 1998, 1999 and 2000 are about ten years old and so they must liquidate, even if at an auction block. xix
Compounding VC funds’ lack of permanency, the IPO exit window has, for all but the largest offerings, remained stuck shut ever since the NASDAQ plunged to just 1140 from a high of 5049 a decade ago. Many clients of these VC funds have waited eight years. Time’s up. Ten-year-old private VC funds are liquidating.
Absent an exit by shotgun marriage, client venture’s assets, including IP and management’s still-illiquid option pool, ends up on the auction block. Last and least to lose are the limited partners; covenants cede those preferred investors 2X, 3X or even greater “preference over Common stakeholders in liquidation.”
Some VC-seeded ventures survive to spend yet another $30,000 or more for founders’ counsel to engage in “Stage B,” alias “First Round” or “Series B,” negotiations that will hopefully conclude with a drizzle of cash, typically about $6 million and not just a $500,000 to $3 million drop as in the “seed stage.” With the drizzle of cash comes more dilution of the founders’ equity and debt and the tougher new covenants that limited partners insist upon now after they lost trillions ten years ago in the “dot bomb” bubble that has polluted the well for IPO exits ever since.
At Stage B, if not before, the founders’ control of the new enterprise and its intellectual property is usually xx seriously jeopardized. However, the consequences of this shift between classes of ownership do not play out in an evenhanded way as between the possible outcomes of either the success or the failure of the company. The privileged class have further distinguished themselves from the Common shareholding founders. Like bankers, those privileged cash investors become “creditors” and their covenants give their class powerful privileges in the event the enterprise is dissolved for whatever reason, or for no reason at all other than that the fund is no longer willing to spend its scarce resources to support the particular venture’s needs when it has a few *star* clients that it favors instead. To the credit of some VC funds, not all are disposed to allow a client venture to twist and perish on the vine if it isn’t meeting its milestones or showing signs of not being a “big hit.” Some go to great lengths to protect or salvage clients – especially when the VC firm has been through a long period of coaching the company’s management. “Stage C” negotiations concern the much larger dollop of cash to help, but not necessarily sufficient to see through to commercialization. Where there are needs to finance production tooling, soaring raw material and finished goods inventories, regulatory compliance, long sales cycles, training, ads and more, whatever VC funds remain uncommitted are likely to be insufficient without a corporate partner, or debt and public equity.
Entrepreneurs whose projects may have these needs in the offing could become mired in today’s touch-and-go corporate finance environment’s “Valley of Death,”Figure 2. xxi
These entrepreneurs would do well to plan ahead and to chose a VC source whose Limited Partners or, in the case of a BDC, whose public stakeholders include major international banks and Sovereign Wealth Funds. US-based VC funding collapsed as the 10-year funds’ returned an average of –4.2% (negative) for the decade from 2000 to 2009.
Even if the company eventually exits from the venture capital cocoon successfully, ownership and control of the company will have shifted further away from the inventor-entrepreneur with each successive capital infusion of VC cash. The founders’ shrinking share of the growing pie up to and including exiting a VC, is depicted in Figure 3, Business Ownership Interest Over Time.
GOING PUBLIC IN THE USA — FORM S-1 “FULLBLOWN” IPO
There was a time when most of the shares in public companies were owned by individual investors whose broker would call with an allocation of shares in an IPO being offered to John Q. Public. That distribution channel for corporate finance is drying up.
Now, institutional investors snap up the entire IPO at a discount they get for purchasing analysts’ reports and other services from bulge bracket investment banks. That trend, plus discount trading, mutual funds and index funds have exacerbated the public’s move away from buying and holding shares of individual growth stocks.
What limited retail distribution of offering shares to the public that may still be available from regional and local brokerages now is of marginal assistance relative to the United States’ critical need for capital formation to commercialize today’s global torrent of brilliant innovations. xxiii
Anyway, the IPO window went the way of the “new economy.” Most projects being backed by VC funds today are software applications, especially “apps” that run on smartphones. As of July 2009, there were already over 65 thousand such apps able to execute on smart phones. Investors simply can’t keep up. xxiv The chances of a VC fund financing an app that can break away and achieve the recognition needed prior to an investment bank agreeing to underwrite an IPO are slim to none. xxv Business Angels and VCs who are seeding these and Internet software ventures, typically for half a million each, don’t provide the inventor-entrepreneur enough for even one $5 million IP infringement contest.
For the rare venture that goes on to succeed with an initial public offering (IPO) and exit the valley of death, all turns out well, both for founders who invest the IP and for limited partners who invest only cash.
This begs the question that every entrepreneur must carefully ponder — will my venture become a *shining star* in Beacon’s book or will I end up negotiating with private investors who will, sooner or later, get control only to orphan my venture and let it twist on the vine for years. How dangerous a bargain is that now when the average time from ‘Stage A’ VC funding to VC exit has doubled to nearly eight years?
Figure 4 below lays out the inventor / entrepreneur team’s gamble. Five ventures at the high end, just 20 percent of the twenty five clients in this VC fund’s representative portfolio, returned 240% of the funds deployed back in the days when the ‘IPO window’ would open. That came to six times more than portfolio venture numbers one through twenty. Given that big hits attract resources, then even in the good old days, most inventors / entrepreneurs who competed for VC funds were at considerable risk of becoming “orphans” xxvi and at great risk of having the IP they had contributed be either sold off or liquidated at auction. CEOs rate/rank VCs on theFunded.com. There are some VC funds, typically ones independent of syndicate influence, who do stay with every viable client to fullest extent practicable.
VENTURE FINANCE IS ALL ABOUT ‘GROWTH’
By definition a ‘glamour’ or ‘growth’ stock is a company whose future earnings are expected to grow at an above-average rate relative to the market.
The more a company has already grown the less likely its chances of continuing to be a glamour stock. In The Search for Organic Growth, Professor Rita McGrath discussed a 2004 study of public companies with a market capitalization of over $1 billion which looked for continuous growth of at least 5% over three or four or five years. McGrath found that only 427 of these companies were able to grow their revenue/sales by 5% each year for at least four years and that 97% of those who had succeeded in meeting that modest test of 5% continuously, managed to achieve that growth thanks to acquisitions (as opposed to having core or organic growth).
Purchasing shares at Par helps to optimize investors’ Risk/Reward ratio. The greatest rate of earnings growth and thus the greatest return on investment (ROI) for investors from owning an individual ‘growth stock’ can be achieved by investing in shares at ‘par value’ (known as ‘cheap stock’) the day the new company is chartered and holding those shares until the company has steep earnings growth and the founders’ cheap stock is no longer ‘locked up’ and the shares can then trade on a public stock exchange along with Equal Opportunity IPO (EO-IPO) warrants and the (debt-free) venture’s other Common Stock.
A MIDDLE GROUND TO PATENT SAFETY — EXEMPT OFFERINGS TO THE PUBLIC
In today’s climate, an entrepreneur’s best approach to raising capital is a combination of private and public offerings under Reg. A in the US with ‘EOIPO’ warrants and ‘free trading’ shares quoted soon after on the “Pinks” soon followed by listing and global public trading on the Toronto Stock Exchange – Venture (TSX-V).
A good start is for entrepreneurs to pre-screen themselves at Applicant Self Screening and at SCORE, then seek to avail themselves of a resource which can help them communicate directly with a receptive general public, with local Community Development Financial Institutions (CDFI) and with ‘Business Angels’ about investing first privately, then in a ‘Reg. A’ exempt offering to the public. xxvi
The SEC’s Regulation A, with its Testing the Waters (general advertising exemption) provision, affords an ideal avenue for the lucky few who know Reg A’s ropes to conduct a “Direct Public Offering” – DPO xxviii for up to $5 million per year using radio ads to prospective investors (not 35, but 3.5 million male commuters age 35 – 65 and more). Radio ads would encourage listeners to learn much more by browsing SEC-accepted, illustrated sales information on an interactive Test The Waters website on the Internet and then leaving feedback for use in ‘book-building’. xxix
Taken together, the Beacon Investment Partners, LLC, and BEST (BrightChange Executive Service Taskforce) array of resources for the entrepreneur include: public and private corporate finance, angel gathering, seed capital, standby underwriting, public governance / board members, mentoring, strategic/growth planning, Deming-Shewhart cycle of continual improvement, business development, securities law, operational management, manufacturing, research and development, market research, PR, marketing and sales, merger & acquisition services, due diligence, insurance, IP licensing, distribution, accounting (US, Canada and UK) and both public and private financial valuations and capital.
BOTTOM LINE — SECURE IP BY MAINTAINING FINANCIAL FREEDOM
Assuming that IP will be assigned to the venture, patenting one’s technology is only the beginning. What is essential for true IP safety is to create and maintain a zone of financial independence.
This strategic financial independence zone rests on three legs – 1) a public listing on the TSX-V that facilitates repeated forays into the capital market directly or via Reg. A 2) the freedom from potential private investor neglect that an inventor / entrepreneur’s public finance options provide, and 3) commitment to standby underwriting from a substantial resource like the Beacon BDC.
The inventor-entrepreneur’s best tactics for IP success are to minimize dilution, skip “preferred” shares, skip OTC BB Reverse Merger xxxyet offer both growth and ‘liquid’ Common equity soon enough to assure maneuverability among financing options. Money talks but the inventor-entrepreneur dials the volume. How? By creating liquidity on the TSX-V xxxi so that opportunities for raising capital become dramatically easier. xxxii In the final analysis, the value to founders of their IP investment hinges upon sustained financial maneuverability. Freedom lasts while John Q. Public’s desire for Common Share equity lasts.
© 2010 – 2011
About the Authors
Vincent A. Fulmer is a co-founder of the M.I.T. Enterprise Forum and a member of its Executive Board. He is a nationally recognized advocate of entrepreneurship.
George W. Beard is Managing Member of Beacon Investment Partners, LLC (Delaware, USA) and founder and CEO of KeepTrack USA. KeepTrack is a development-stage physical cargo security and supply chain IT firm. KeepTrack features a portable Katie Bar® internal locking platform for containers which securely incorporates patented sensing and imaging while offering every innovator an “open” standard, “plug-and-play” bus and an open application programming interface (API).
i Amar Bhide studied successful founders: just six percent came from affluent backgrounds while 26% described their backgrounds
as “working” class, 63% came from the “middle” class and 5% were “poor.” Only 15% had an MBA.
“VCs in seed clothing”: Chris Dixon, Mark Suster, and Naval Ravikant … http://venturehacks.com/articles/vc-seed
Also, Term Sheets & Valuations by Alex Wilmerding, 2006, ISBN 1-58762-068-5 and Alex Wilmerding’s Deal Terms, 2005, ISBN 1-5-208-48762 w. Sample Term Sheet, p. 186-199.
ii Typical Business Angel: Sex: 90% male. Age: 40 – 60 Income: $250,000 to $1 million. Frequency: average 2.5 investments/yr. Amt: $10k to $50k per deal. ROI: 20%+ per yr. Roles: Advisor &/or Board – tech or manufacturing startups. Source: Web-Based Money by John K. Romano, page 191.
Ref: “Venture Capital Due Diligence: A Guide to Making Smart Investment Choices and Increasing Your Portfolio Returns”
by Justin J. Camp, ISBN-10: 0471126500
Ref: “Due Diligence Defense Under Section 11 of the Securities Act of 1933” – SSRN-id864584.pdf retrieved 8-10 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=864584
iv By requiring each Limited Partner (LP) to risk at least $1 million, VC funds avoid SEC regulation, unlike Business Development Companies (BDC) which are regulated and have Common shares trading on a US exchange.
v Learning from others can help founders to be prepared: Nishan founder Aamer Latif’s suit of ComVentures and Lightspeed, see http://www.sagylaw.com/pdf/fourth-ammended-complaint.pdf also http://www.networkcomputing.com/document.asp?doc_id=43685
also, Nishan Founder: VCs Screwed Me http://www.networkcomputing.com/document.asp?doc_id=43685
also, What to Do When Founder’s Equity is Wiped Out?, TheFunded.com Discussion, 27-Dec-2010
vi Examples of “changing VC industry conditions” on exits from VC control in the last decade include:
withering of the “exit by merger” option due to the Sarbanes-Oxley fear stemming from collapsing bank credit, closing of the IPO window after the “new economy” bubble.
vii The Fenwick & West Venture Capital Barometer showed that, in the third quarter of 2010, 30% of VC financing rounds completed were “down rounds.” If Stage B is not a down round, there is the possibility that some later stage will be down unless VC industry conditions change for the better.
http://www.businessweek.com/print/smallbiz/content/jan2009/sb20090123_008974.htm describes how liquidation preference, anti-dilution, drag-along rights and tranche investing mean that entrepreneurs considering a down round need to retain experienced counsel and even a third-party valuation firm. In his article, Down Round’ Considerations: Venture Capital Financing in Challenging Markets, Geoffrey R. Starr points out that “The apparent conflicts of interest that arise in connection with down round financings often subject the transaction to a higher standard of review known as the“entire fairness test Unlike the business judgment rule, which presumes a board’s decisions to be fair, the entire fairness test shifts the burden to the board to prove that a transaction is entirely “fair” to the company’s stockholders, including with respect to price and process.
Down Round Financing — Practical Realities / Legal Considerations and Protections
By Shannon Zollo, December 2008 http://www.mbbp.com/resources/business/down-round.html: Zolo warns inventors and entrepreneurs that: “The most evident and economically painful consequence of a down round is the dilution experienced by existing investors/stockholders … Most down rounds involve an interested director transaction. This generally means that one or more directors has a material financial interest in the outcome of the deal that isn’t shared by the company, the other directors, or the shareholders generally (such as a VC director). This potential conflict is exacerbated when such directors constitute a majority of the board and/or exercise material control over the board’s actions Zollo goes on to explain that the inventor/entrepreneur who find themselves locked into a conventional VC fund have, other than a shotgun merger, little choice other than to accept the new, harsh terms proposed by new shareholders in a down round investment. He didn’t mention waiting for the liquidation.
viii Those Business Development Companies (BDCs) investing in early stage ventures offer the advantage of “permanency” in contrast to the 10-year life constraints typical of conventional VC funds.
x Good Ideas Are Not Enough – Adding Execution Muscle to Innovation Engines by Ajit Kambil, Accenture, also: Investing Like It’s 1999 by Evelyn Rusli and Vern G. Kopytoff, The New York Times, March 27, 2011
xi A few Business Development Companies invest in early stage ventures. BDC funds’ shares trade on the New York and NASDAQ stock exchanges so BDC funds provide venture clients the advantages of “persistency” in sharp contrast to the arbitrary, liquidation-prone 10-year life of conventional VC funds.
xi “The March 1999 IPO for Priceline.com (PCLN) – the Internet retailer that lets shoppers bid for plane tickets, hotel rooms, and other goods – had an offering price of $16 a share. The stock opened at $81, leaving $650 million on the table “In all, companies that went public in 1999 priced their shares so low that more than $36 billion in first-day trading profits were there for the big investors’ taking,” according to Ritter of the University of Florida. He based his estimate on the high price each IPO reached on its first trading day. “More money was left on the table in 1999 thanduring the first nine years of the decade combined,” says Ritter. Note: By “big investors,” Ritter is not referring to the early-risk-taking Common-share-holding founders. Ritter is referring to PCLN IPO underwriter Morgan Stanley’s ‘best’ clients, i.e. money managers trading shares of multibillion dollar portfolios who each benefit from a Morgan Stanley allocation of hundreds of thousands of IPO shares at the ($16) offering price (not the $81 opening price of the following day’s public trading).
The Star-Ledger, April 26, 2000, “IPOs are a sure-thing investment — but only for Wall Street’s elite http://kmslaw.com/press/pub24.html see also suit in US District Court, Southern District of NY, IN RE PRICELINE.COM INITIAL PUBLIC OFFERING SECURTITIES LITIGATION 01 Civ. 2261 (SAS) (LTS)http://www.coursehero.com/external.php?db_filename=2890781&url=http%3A%2F%2Fsecurities.stanford.edu%2F1024%2FPCLN01-01%2F20020419_r01c_012261.pdf see also Equal Opportunity IPO Brings Innovation Back to Main Street by Amy Bauman http://beaconinvestmentpartners.homestead.com/A-Bauman.htmland also Equal Opportunity Initial Public Offering (EOIPO) – Leveling the Playing Field for Early Stage Investors By Vincent A. Fulmer http://www.bbdc.usclick the EOIPO tab.
xii For “world changing” ventures, investments totaling $25 million have often been required in order to garner general market acceptance, i.e. to build the team, trust, acceptance and track record needed for a venture to cross the chasm from when sales can be made only to visionary early-adopters (the left tail or market’s third deviation) and when moving “up the hockey stick” of the first-selected market’s curve – on track to a $300 million market cap (“small cap” status). The iBeer app for iPhone needs far less capital, of course, and sometimes VC’s call for well over $25 million. In July 1999 Petopia.com raised $66 million funding and in Sept 1999 Petsmart.com raised $66 million funding. Then in Nov. 1999 Pets.com raised $35 million funding. Being “On The Bubble,” petstore.com raised $97 million funding and in Feb. 2000. New economy Pets.com raised $82.5 million more in IPO. In Nov. 2000 Petsmart.com raised $30 million more funding just before going out of business Dec. 2000. Petco bought Petopia.com’s assets and Petsmart.com bought the domain name from Merrill Lynch underwritten Pets.com. An online grocer, Webvan raised nearly $1 billion in start-up capital from institutions like Softbank of Japan, Sequoia Capital and Goldman Sachs, its lead underwriter, which invested about $100 million. On its first day, Webvan’s market rose 65 percent to about $8 billion at the close.
Less than two years later, Webvan was bankrupt. In 1999, the underwriting industry made $1.3 billion in underwriting fees, according to data from Thomson Reuters.
xiii Investment Banks hired experts out of the three rating agencies to discover the criteria that garnered ‘Triple A’ ratings on derivatives backed by sub-prime trailer home mortgages. Entrepreneurs can discover the selection criteria employed by the syndicates of VC funds by reading “Do Venture Capitalists’ Implicit Theories on New Business Success/Failure have Empirical Validity?” by Hernan Riquelme. For that study, http://isb.sagepub.com/content/20/4/395.short, 147 questionnaires were returned by respondents representing 65% of the UK’s leading venture capital firms. Participants were asked to express their level of agreement with each of 73 selection decision rules using a four point scale ranging from ‘strongly agree’ to ‘strongly disagree’. This study, and the self-screening resources and the benefits listed on Beacon’s home page at http://www.bbdc.us are “must reads” as entrepreneurs prepare to approach venture capital funds. For further insight, we suggest: “Venture Capital Investing” (2004) by BDC founders David and Laura Gladstone, ISBN10: 013101885X, and also “Venture Capital Due Diligence” (2002) by Justin J. Camp, ISBN10: 0471126500 – both found 8-10 at Amazon.com.
xiv A Wall Street Journal Opinion piece on March 22, 2011 discussed this closed IPO window: “Over the last de-cade, the annual number has never reached 100 and has averaged fewer than 50. Yes, it’s unrealistic to expect a repeat of the late-1990s Internet boom, when annual IPOs twice exceeded 270. But how about the early 1990s, before the dot-com mania skewed the numbers? The U.S. averaged 160 a year from 1990-1994, three times the current rate.
New companies are the lifeblood of a capitalist economy. Every venture-backed start-up that grows into a public company could be the next Google, Intel, Starbucks or Amgen. Venture investment adds up to 0.2% of U.S. GDP, but the revenue of companies created with such investment amounted to 21% of the economy in 2008. The diminished ability of start-ups to hit the long ball with an IPO discourages investments at all the earlier stages…
A 2009 survey from the Securities and Exchange Commission speaks volumes. The SEC asked public companies about Sarbanes-Oxley’s infamous Section 404. 70% of small public companies told the SEC that Section 404 has motivated them to consider going private again, and 77% of small foreign firms said the law has motivated them to consider abandoning their U.S. listings.
xv “The Coming Super-Seed Crash,” Paul Kedrosky, http://paul.kedrosky.com/archives/2010/06/the_coming_supe.html
xvi “Grove Says Patent System May Have Same Flaws as Derivatives … ” May 4, 2009 … It costs an average of $5 million to defend a patent- infringement claim, David Simon, Intel’s chief patent counsel, told Congress … http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aw5EZ9BzrgtU
BCLT – Berkeley Center for Law & Technology, Mar 12, 2008 … Pak said he is advising clients to obtain IP litigation insurance because it costs $4 million to $5 million to defend a patent lawsuit that … http://www.law.berkeley.edu/institutes/bclt/…/about_news_03-12-08.htm Patent reform and venture capital, Posted on June 16, 2005 by Cathy Kirkman: http://www.svmedialaw.com/articles/venture-capital/
xvii Covenants ref.: “Deal Terms That Really Matter,” by John Hession, http://www.massmedic.com/docs/hession07.PPT
xviii “Finding Riches in Entrepreneurs Woes,” by Scott Austin, [VC liquidations, client bankruptcies]
also. Ref. “Formidable Corporations Join Exclusive Patent-Infringement-Defense Clubs,” July 29, 2009 by Laura Peter
RPX Corporation (funded by elite venture capitalists) … and includes amongst its members: Cisco, IBM, Panasonic, Philips, LG Electronics, Samsung, TiVo, Hewlett Packard, Nokia, Sony and Epson. RPX gives all of its members licenses to the all patents it purchases … Again, its mission is to take patents off of the market …
also ref.: Mark Suster: http://www.bothsidesofthetable.com/2010/04/03/understanding-vc-signaling/
xx In the event of a “down roun,” whether or not the fault of the once-independent inventor/entrepreneur, substitute the words “almost certainly” for “usually” loses control over the IP.
xxi “The Start-Up Enterprise Valley of Death,” Capital Formation Institute, CFI Viewpoints, 2006, by Richard T. Meyer, PhD,
xxii Even today, someone could be an exception; reminiscent of some late twentieth century entrepreneur: Jeffrey Bezos, the CEO of Amazon, and the executives and employees of Amazon.com Inc., owned 88.2% just before the IPO on May 15, 1997 and could have (assuming that they would exercise options totaling 30.8% of ownership post IPO) controlled 79.5% following an Initial Public Offering (IPO) of an 8.5% interest in Amazon for $54 million. The IPO opened on 18-May-1997 at $18 per share, 2.9 years after Amazon’s inception.
Executives and employees of DoubleClick Inc. owned 43.3% of the venture before its IPO in February of 1998 and could hold 34.3% years after the IPO, assuming that they would exercise all other options (11.7% post IPO). The 20-Feb-1998 IPO raised $59.5 million at $17 per share, 2.1 years after DoubleClick’s inception.
In the case of eBay Inc., again assuming that the officers and executives would eventually exercise all options outstanding and available, they would own 73.6% of eBay after a 23-Sept-1998 IPO that raised $62.8 million at $18 per share just 2.5 years after eBay’s inception. IPO shares diluted eBay’s officers and executives down to that 73.6% from their 79.9% pre-money (pre full-blown S-1 IPO) position
xxiii The retail ‘selling groups’ for distribution of entrepreneurial high-tech IPOs in the 90s sported such lead underwriters as: Deutsche Morgan Grenfell, Alex Brown and Sons, Hambrecht & Quist, Goldman, Sachs & Co., Cohen & Co., Robertson Stephens, Donaldson Lufkin, Montgomery Securities, Merrill Lynch, J.P. Morgan, Morgan Stanley Dean Witter, Credit Suisse First Boston, Dain Rauscher Wessels, Charles Schwab & Co., Bear, Stearns & Co., Rothschild, Lehman Brothers, Shearson, Laidlaw Adams and Peck Inc., D. H. Blair, C.E. Unterberg, Tobin, Allen & Co., Kidder Peabody and Smith Barney. Those were the days when ‘retail distribution’ (sales to the public) ran so deep that John Q. Public could hope to be called on the phone by his local broker and offered allocation to buy a piece of the IPO.
Ranked by Dealogic in descending order by number of IPOs in the first half of 2010: Morgan Stanley, J.P. Morgan, Goldman Sachs, UBS, Bank of America Merrill Lynch, Piper Jaffray, Credit Suisse, RBC Capital Markets, Deutsche Bank, Citigroup, Robert R. Baird, Oppenheimer, Wells Fargo Securities, Barclays Capital and Raymond James.
xxiv “Apple’s 1.5 billion apps and why you should care,” By Jim Dalrymple, July 14, 2009 Apple says it has more than 1.5 billion downloads withmore than 65,000 apps and more than 100,000 registered developers in the iPhone Developer Program. http://www.loopinsight.com/2009/07/14/apples-1-5-billion-apps-and-why-you-should-care
Ref. The Wall Street Journal, September 10, 2010, page A2. There were also 80,000 apps for smart phones running Google’s Android system.
xxv Diana Frazier of FLAG Capital reported: In nine years, 2001–2009, ~ 850 VC funds backed 24,100 ventures. 750 of those ventures (3%) achieved exits of $100+ million.
xxvi Ref. “Start-Ups Grumble about Directors Too Busy to Help,” The Wall Street Journal, July 29, 2010 B1
xxvii Ref. Coalition of Community Development Financial Institutions http://www.CDFI.org
xxviii DPO – Direct Public Offering, optionally employing “general [public] advertising” to “Test the Waters” (TTW) under SEC Regulation A (Reg. A) exemption. Maximum: $5 million USD in any 12 month period.
Ref: “Web-Based Money : How to Use the Internet to Raise Money for Your Business” by John K. Romano, page 107.
Ref: “Implementing a Direct Public Offering (DPO) ” by J.K. Romano, retrieved from website 8-10,
Ref: “Direct Public Offerings – The New Method for Taking Your Company Public” by Drew Field, Reg. A. pages 118-119.
Ref. “Where to Go when the Banks Says No” by David R. Evanson, DPO pages 98 – 106, Reg A pages 261-262.
Ref: “Going Public Through an Internet Public Offering: A Sensible Alternative for Small Companies” by William K. Sjostrom, (2001),
Florida Law Review, retrieved 8-10 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=831906
xxix “Relaxing the Ban: It’s Time to Allow General Solicitation and Advertising in Exempt Offerings” Sjostrom – SSRN-id834244.pdf retrieved 8-10 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=834244
xxx “The Truth About Reverse Mergers,” by William. K. Sjostrom, Jr., retrieved 8-10 from http://ssrn.com/abstract=1028651
Ref: “Reverse Mergers: Taking a Company Public Without an IPO” (2006) by David N. Feldman, ISBN-10: 1576602311
xxxi “Capital Pool Company Program,” TSX Venture Exchange, http://www.tsx.com/en/pdf/CPCBrochure.pdf
Ref: “Sarbanes-Oxley Act of ’02 is killing our economy in ’09” http://blog.nj.com/njv_guest_blog//print.html
xxxii For example, once listed on the TSX-V, the (now-liquid) business can readily provide warrants to a mezzanine lender such as a Business Development Company (BDC). If distressed, take the PIPE (Private Investment in Public Equity). Sell the PIPE to a hedge fund or a BDC. Ref. “PIPEs” by Wm. K. Sjostrom, Jr. retrieved 8-10 from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=992467 Ref. Also, S.J. Chaplinsky at http://ssrn.com/abstract=907676
Note: Had the venture done a ‘Reverse Merger’ with a US-listed “shell,” it could not do more Reg. A offerings.
It could, however, after merging with a TSX-V-listed CPC (Capital Pool Company), however.
Assigning a patent to a new venture in exchange for founders shares is a dangerous bargain for inventors. If the company fails or does not succeed, the inventor stands to lose any benefit whatsoever from the intellectual property. Ownership has already been traded away. Whereas most capital strapped companies are at the mercy of their private investors for startup or growth funds, companies that can gain early access to public capital markets such as the TSX-V or a AIM have a much better chance of survival and success. A public listing allows them wider access to capital and also frees them from the jeopardy of capital rationing or outright neglect that often accompanies private investment. Thus, a public listing can be a dramatic way to reduce risk for the inventor/entrepreneur.