VENTURE CAPITAL READING CLIPPINGS CONTENTS VC TRENDS VC WORKINGS ECONOMICS LAW VC TRENDS Financing in Purgatory Venture Capital Journal May 01, 1999 Michael Gannon Pre-venture capital investing has long been - like the venture industry itself originally was - an informal process. But as VC vehicles and average deal sizes grow larger, so too does the seed capital requirement angels and other pre-VC investors must be able to finance. As a result, individual investors have devised a slew of ways to put their money to work, including more formalized investment clubs and small venture funds that cater to individual investor limited partners - all of which can often bridge the gap between angel money and a traditional institutional round of venture capital.. According to Venture Economics Information Services, a data company affiliated with Venture Capital Journal, limited partners invested a record $24.34 billion in venture capital funds in 1998 (VCJ, March, page 44). The figure, 90% of which comes from institutional investors, represents the latest coordinate on a hyperbolic rise that began in 1991..entrepreneurs and high-level executives - the very individuals who comprise the angel investor class - have benefited from venture capital's growth. VCs invested a record $16.02 billion in 2,692 companies last year (VCJ, March, page 39).. Professor Jeffrey Sohl of the Center for Venture Research at the University of New Hampshire - the organization where the term "business angel" was coined around 1980 - says that research conducted in the past 18 months indicates conservative estimates of as much as $20 billion of available angel money.. Joanna Rees Gallanter, founder and managing director of Venture Strategy Group in San Francisco, was working as a merchant banker in 1995 when she began to sense an opportunity for seed-stage investing. Venture vehicles, she noticed, were getting larger and increasingly focused on later-stage investing, in part due to an influx of fund managers with investment banking backgrounds who were more comfortable with more mature investments. Ms. Gallanter believed a pre-venture fund that coupled investors with entrepreneurial know-how with emerging technology companies could fill the emerging early-stage financing void. She launched Venture Strategy Group in July 1996, first concentrating on strategic consulting and traditional private placements for technology companies reliant on a strong brand or "the nexus of brand and technology," she explains. In March, the firm closed its first fund, Venture Strategy Partners, a $25 million vehicle primarily raised among executive officers and individual investors who can provide a specific set of entrepreneurial and management skills to start-up companies (story page 18). The vehicle, whose limited partners must invest a minimum of $100,000, will finance deals ranging from $500,000 to $2.5 million, primarily on the West Coast.. While Venture Strategy Group's investors are primarily individuals, several venture firms, such as Brentwood Venture Capital, JW Childs Associates and Catterton Partners, as well as individual partners from Benchmark Venture Partners and US Venture Partners have invested in the fund as L.P.s. These firms see Venture Strategy as a sort of "farm league" for their much larger vehicles.. "We're delighted to have any new entrant to join us in the seed-stage part of the market," says Gordon Baty, a general partner of Zero Stage Capital in Boston. Zero Stage closed its sixth fund in October on $125 million, 150% larger than its previous effort. The firm still does some fairly small deals, but Mr. Baty concedes that it has become more difficult with the larger vehicle. "There's more deals ... than we can fund ourselves," he says Financial Times Mandate August 11, 2003 .."As the baby boom generation ages, the demand for healthcare products will only increase and the cost of those products is rising," said Roger Savell, Metropolitan New York venture capital advisory group leader at Ernst & Young.. "The percentage of seed and first-round healthcare deals - roughly 31 per cent of the total - should ensure healthy future deal flow." Investment in first round deals is only 27 per cent for venture-backed companies as a whole, as there is a greater focus on companies being restarted. According to the survey, investments in restarts comprised 7 per cent of overall funding compared to less than 1 per cent historically.. "Every year we survey more than 1700 US pension funds with $5 trillion in total assets," said Mr Smith. "In 1999, 28 per cent of funds said they invested in venture capital, 31 per cent in 2000, 32 per cent in 2001 and 33 per cent in 2002. "It is a long-term aim of US pension funds to increase their allocations to alternative investments, which includes venture capital as well as hedge funds, real estate and international equities.".. Greenwich Associates, pension funds have increased allocations to private equity and hedge funds from 2.7 per cent a year ago to 3.7 per cent. Among US pension funds, allocation has increased from 2.9 per cent to 3.6 per cent, Canada has gone from 2.1 per cent to 3.1 per cent, Continental Europe from 1 per cent to 2 per cent and the UK from 0.9 per cent to 1.1 per cent.. "Anecdotal evidence suggests that institutions are thinking more seriously about investing in venture capital than at any point over the past three years.".. "In the early 1990s, about 25 per cent of venture capital investment went into life sciences with about 75 per cent in IT," said Mr Daniel.. Venture Capital Journal Securities Data Publishing April 1, 2004 Tom Stein ..real VCs were chagrinned by the carnival atmosphere. After all, these novice angels were driving valuations to ridiculously high levels. They were giving amateurish advice that often steered companies in the wrong direction. Term sheets, meanwhile, were littered with errors and egregious anti-dilution clauses that were at best laughable, and at worst a major headache to undo. Perhaps most galling to the VCs was that many of these nouveau angels didn't even economically qualify to invest in private companies. According to the U.S. Securities and Exchange Commission's standards, only people with a net worth of at least $1 million or an annual income of at least $200,000 can participate in private equity rounds. When the market turned south, the vast majority of the angels bolted, leaving the professional VCs to clean up the mess and pick up the pieces of a thousand broken companies. "Some friends of mine who are senior VCs simply won't touch a deal if angels are involved," says Bob Pavey, a general partner with Morgenthaler Ventures in Menlo Park.. angel investors operate more like mom and pops. Most everyone agrees there is a real need to make the business more professional.. "But they see the angel money as basically free money because it does not come with the bells and whistles and fine print of a typical VC term sheet.".. Prof. Jeffery Sohl, director of the Center for Venture Research in Durham, N.H.. bigger these groups get, he says, the less chance the guy in the garage with a great idea - but not much else - will get any angel funding. "The last thing we want to see is angels moving out of the seed market,".. [angelcapitalassociation.org hcangels.com angelsforum.com commonangles.com keiretsuforum.com vc-angelroundtable.com] eFinancialNews.com January 28, 2005 Apax Partners, Europe's first seed capital firm, has succumbed to pressure from investors to turn its back on the small start-up investments with which it made its name in favour of bigger deals. George Jenkins [Patricof] HBR 11/89 p117 we are trying to invest in increments of no less than $5 million and have become much more selective regading the startups we will fund: startups are huge time-sinks and generally require modest amounts of money in early phases. THey are however, still the source of greatest investment return for us. Moreover, the venture capital industry is now almost entirely dependant on institutionalized sources of funds.. removal of capital gains incentive has seriously eroded the availability of early stage, high-risk capital The Boston Herald November 19, 2001 FINANCE; Pg. 029 ERIC CONVEY Following the crash of the new economy, traditional venture capital may be taking something of a back seat to one of the oldest investment mechanisms: big placements by successful entrepreneurs. These wealthy investors, commonly called "angels," are playing an increasingly important role.. "Various features in the current market have driven most venture capital into the higher range of deals," said Steve Honig, head of the business practice in the Boston office of the law firm Schnader Harrison Segal & Lewis.. What's more, he said, "the large funds have raised so much money that they can't, with economic efficiency, make small investments." European Venture Capital Journal Securities Data Publishing September 01, 2001 Michael Murphy Entrepreneurs throughout Europe often complain of the difficulty of finding early stage funding to get an idea off the drawing board, into production, then into the market. Incubator arrangements, seed and early stage funds private or government sponsored are available but are so thin on the ground and often administer such limited funds that in many cases their resources are hard put to support an ever rising tide of potential revenue-earning innovations. VCJ Matthew.Sheahan@Thomson.com 7/05 Why can't Angels and VCs just get along? [p10] Tony Stanco, chairman of the group that conducted the survey, George Washington University's Council on Entrepreneurial Tech Transfer and Commercialization.. 78% of VCs cited "unrealistic company valuation" as a reason that a company with angel involvement would be unattractive.. If Fact, a higher percentage of venture capitalists than angels (94% to 72%) surveyed said angel investors are beneficial [p11] When doing follow-on investments, venture capitalists frequently don't appear to act very nice to one another.. Bill Payne, an angel investor.. "Angels make 50,000 investments per year; VCs make 1,500 new ones per year. There's a huge discrepancy in the two groups".. To the delight of VCs and angels alike, the less responsible and more troublesom angel investors were the first to get their wings clipped.. "Sophisticated angels and sophisticated VCs work very well together," says Payne.. "Many VCs really appreciate the level of due dilligence that angels do, which was not the case 10 years ago" PR Newswire October 25, 2005 Tuesday 10:00 AM GMT Venture capitalists invested $5.3 billion in 714 companies in the third quarter of 2005, according to the MoneyTree Survey by PricewaterhouseCoopers, Thomson Venture Economics and the National Venture Capital Association. Venture investment decreased from Q2 2005 of $6.1 billion, but surpassed Q1 2005 of $5.0 billion and Q3 2004 of $4.6 billion. For the first nine months of 2005, investing totaled $16.3 billion compared to $15.9 billion for the first nine months of 2004. Total venture capital investing in calendar 2005 could meet or exceed 2002's $21.7 billion which is the highest level in the prior three years.. average post-money valuation rose to $78.9 million for the 12 months ending Q2 2005 compared to $63.2 million for the Q1 2005 period. (Note that valuation data lags investment data by one quarter.) Funding for Start-Up and Early stage companies fell back in Q3 to $1.0 billion in 216 companies, but still above the first quarter.. Life Sciences accounted for $4.2 billion or 26% of all venture investing. At the current rate, Life Sciences will meet or exceed 2004's total of $5.8 billion.. Venture capitalists continued to make new investments at a steady clip in the third quarter. A total of 215 companies got their first-ever round of institutional venture capital which amounted to $1.1 billion. Year-to-date, 653 companies received their first venture capital for a total of $4.0 billion. Full-year 2004 figures of 854 companies and $4.6 billion were both three-year highs, putting 2005 on track to a four-year high. Year-to-date, the most first-time financings, 69%, went to Start-Up and Early stage companies. Expansion stage companies were 26% and Later stage 5%.. first-time deals. Life Sciences followed closely with 120, or 18% CONTACT: Emily Mendell of National Venture Capital Association, +1-610-565-3904, emendell@nvca.org ; or Lisa Peterson of Porter Novelli for PricewaterhouseCoopers, +1-512-241-2233, lisa.peterson@porternovelli.com ; or Mary Macdonald of Thomson Financial, +1-416-964-1265, mary.macdonald@thomson.com Web site: http://www.ventureeconomics.com/ http://www.pwc.com/ http://www.nvca.org/ http://www.pwcmoneytree.com/ PR Newswire July 14, 2005 Thursday 7:33 PM GMT Data released by Irving Levin Associates, Inc. confirms that venture funding to the pharmaceutical sector is in a downswing, and the type of acquisitions in demand is changing. During the first half of the year ended June 30, 2005, the pharmaceutical sector captured far less of the total venture capital committed to health care than during the first six months of last year.. Fewer large venture financings are being recorded in the pharmaceutical sector. This year, 15 pharmas have announced venture rounds of $25 million or more, totaling almost $580 million, but during the first half of 2004, 23 had announced venture rounds of $25 million or more, totaling more than $876 million.. Approximately $80 billion was committed to fund pharmaceutical M&A during the first half of last year; during the first six months of 2005, only about $23 billion has been committed.. Irving Levin Associates, Inc., a leading health care financial publisher established in 1948, is based in Norwalk, CT and is online at http://www.levinassociates.com.. Stephen M. Monroe, Partner, or Gretchen S. Swanson, Associate Editor, both of Irving Levin Associates, Inc., 1-800-248-1668, or Fax: +1-203-846-8300 Business Wire Oct. 6, 2003 VentureWire, published by Dow Jones Newsletters, today announced that preliminary totals of venture capital investment in the U.S. was $3.6 billion for the third-quarter of 2003. The biotech and software sectors continue to receive the most private capital than any other business segments.. A total of 326 private venture capital financings, based in the U.S., have awarded a preliminary $3.6 billion over the past three months. In the second quarter of 2003, venture-backed companies raised $4.0 billion through 502 financings. In the third quarter period, one-year ago, 476 companies raised $4.1 billion.. Following the pattern of the last three quarters, biotechnology attracted significantly more venture capital investment than any other sector, with 39 companies raising $911.5 million.. VentureWire (www.venturewire.com), a service of Dow Jones Newsletters (www.djnewsletters.com).. Robert H. Christie, 609-520-5051 Business Wire November 3, 2000 Venture Capitalists Continue to Fund Companies At Near Record Levels    Venture Economics (VE) and the National Venture Capital Association (NVCA) announced today that the venture capital industry continues to invest in innovative companies at an extremely healthy rate. During the third quarter of 2000, $25.9 billion was invested in 1,774 companies. VE and NVCA also restated their previous findings higher for the first and second quarter of 2000 to $26.3 billion and $27.8 billion respectively. These new totals bring the total venture capital investment in 2000 to $79.9 billion, representing a 137% increase over venture capital investments made in the first three quarters of 1999. www.tfsd.com, www.ventureeconomics.com Monica McGlinchey (TFSD) 617. 856-1355 or National Venture Capital Association www.nvca.org John Taylor (ext. 17) or Jeanne Metzger (ext. 16) 703.524.2549 Investment Dealers Digest October 17, 2005 Best of Times For Healthcare M&A; Sandra Lea Abrams (sandra.abrams@sourcemedia.com) A lot of pharma companies have products coming off patent protection in 2008-2012, and to maintain sales and earnings growth, they need to acquire biotechs or partner up for new products, according to Sage Kelly, a biotech banker at UBS in New York. "I think there will be public-to-public transactions where biotechs in the $500 million to $3 billion market-cap range will continue to get acquired by pharmaceutical companies, because those biotechnology companies have later-stage products than the private companies that have phase I and phase II products," Kelly says. Other bankers see more private biotechs forgoing the IPO process and heading straight into the arms of an acquirer, driven in part by venture capitalists that have found public equity markets a difficult exit. Says Cowen's Quirke: "The VC guys have gotten religion; they have figured out that they can get better returns from a value-and-timing perspective by selling.".. healthcare represents 18% of the US gross domestic product. Financial sponsors' level of activity in the sector has been dwarfed by that of corporations, and the former want to catch up. "Most sponsors are underinvested in healthcare and would like to have a larger percentage of their portfolios in it," says Greg Sorensen, head of healthcare M&A at Deutsche Bank. "Now financial sponsors can be competitive with strategic buyers in this robust financing market." He adds that the financing markets are open to leverage as high as 7-8 times Ebitda. http://www.iddmagazine.com http://www.sourcemedia.com Daily Deal November 21, 2005 Venture firms turn to M&A George White Over the first three quarters of 2005, there were 230 buyouts of VC-backed portfolio companies, according to statistics from Thomson Venture Economics and the National Venture Capital Association. Although only 110 of those deals disclosed a value, M&A has still accounted for $11.7 billion, compared with only $2.89 billion raised from IPOs in the first three quarters of 2005.. M&A for tech companies has averaged more than $3 billion a quarter this year.. So far this quarter, VCs continue to prefer the M&A exit especially for tech companies as IPO filings have been lackluster. Investment Dealers Digest May 21, 2001 M&A as exit path is on the upswing for VC-backed deals Barbara Etzel (barbara.etzel@tfn.com) Nearly 37% more mergers involving venture-backed companies were completed in the first quarter versus the fourth quarter of 2000, indicating that venture capitalists are quicker than ever these days to pull the trigger on a merger as an exit strategy. Mergers have always played a large role for such concerns, but their prominence diminished during the initial public offering boom.. For anyone on the fence about whether an acquisition is the right move, the $7 billion earned through acquisitions in the first quarter has far outpaced the $930 million that venture-backed concerns raised through IPOs in the same period. Trickle down trouble in the venture world: a backlash by frustrated limited partners could keep VC funding conservative for years to come Electronic Business, 29(7): 42, May 15, 2003 Universities, pension funds, foundations and private individuals that fund venture capital (a.k.a. limited partners) are venting their frustration on their general partners at VC firms.. Limited partners are pressuring the funds to return committed capital that seems unlikely to find profitable investment. They are negotiating for better terms when they pledge new monies. In some cases, they are taking venture firms to court. And they hold the ultimate trump card: a clawback obligation that may force individual VC firms to return tens of millions of dollars they've already taken as profit. This could limit the amount of VC funds available for investment for at least a decade.. Total investment by the venture capital industry last year shriveled to $19.4 billion, all the way down from the peak of nearly $94 billion expended in 2000, according to VentureOne.. 2000, 243 venture rounds raised capital for chip firms, according to VentureOne. Last year saw just 117.. In 1999, according to Thomson Venture Economics, the ratio of follow-on investments to early-round investment was 2.5:1. Last year, it swelled to 4:1.. Whereas venture capital produced remarkable returns, exceeding 18% a year, during the 1980s and 1990s, venture funds went into the red in 2001 and produced a negative return of 22% for the year ending last September, according to Thomson Venture Economics.. not a dearth of capital but an overwhelming surplus that has inflamed the venture crisis. VCs continue to sit on mountains of cash--as much as $80 billion, according to Venture Economics. That's more than total venture investment in the entire pre-bubble period of 1990 to 1998.. A large firm sitting on a billion-dollar fund will spread itself too thin if its deal size is too small. Indeed, insufficient management attention is one of the unforeseen consequences of the flood of venture capital in the late 1990s. "There's ten times the capital per partner that there was ten years ago," notes Marks.. Venture firms typically cloak their dealings with limited partners in secrecy, and the limited partners are often contractually bound to silence.. But that's simply somebody else's money the VCs won't have. They now have to worry about their own personal bank accounts, too. This is the threat of the clawback, a delayed-release kick in the teeth likely to menace venture capital for many years. Here's why: Venture firms, as we've seen, collect annual management fees on their funds, typically 2% to 3% of committed capital. But that's not their only source of wealth. They also generally receive 20% to 25% of all profits--a rake-off known as a "carry"--on the fund. Contractually, they are entitled to this 20% only after the original investments of the limited partners have been returned. But in the late 1990s, as IPOs became a personal mint for the VC industry, many began taking their cuts early in the fund, before the limited partners had gotten back their invested capital, according to Dagres.. Clawback provisions don't kick in until the end of the fund's life, normally 10 to 12 years. So potential clawbacks will shadow the venture capital firms for much of the decade. VC WORKINGS Arthur Rock [Fairchild, Apple] HBR 11/87 Strategy vs Tactics from a venture capitalist p63 Frankly, how anyone can figure out what sales and earnings and returns are going to be five years from now is beyond me. The first place I look is the resumes.. especially interest in what kind of financial people they intend to recruit. So many entrepreneurial companies make mistakes in the accounting end of the business. Many start shipping products before they confirm orders are good, or that customers will take the product, or that accounts are collectible [p65] After being honest with yourself, the nest most important characteristic for the entrepreneur is to know whom to listen to and when to listen, and then which questions to ask.. thin line between refusing to accept criticism and sticking to your guns [p66] aware of their own limitations.. "entrepreneurial personality." I suppose there are certain common qualities - a high energy level, strong commitment.. just overpowering.. Good entrepreneurs are tough-minded with themselves and with their teams. They can make hard decisions Top Ten Lies of Entrepreneurs HBR 1/01 Guy Kawasaki Garage.com p22 Nobody believes the financial forecasts - investors simply want to see that the entrepreneur understands the industry, the logic involved in putting together a reasonable financial model, and how companies grow.. Instead of trying to prove that the market will be big, enable investors to fantasize about its size. GIve them the facts and the context [p23] Few new economy companies ever definitievley say no to any alliance, partnership, or offer. They're all afraid of missing the Next Big Thing. Instead, everyone says, "You have an interesting idea. We'll get back to you about it," and then they don't.. one of the litmus tests of fundability and entrepreneurial skill is the ability to attract talent without money.. If an idea is great, ten companies are working on it.. Investors won't sign your nondisclosure agreement because they usually see several similar plans: what if they sign one company's nondisclosure agreement and fund another? In reality, the ability to implement an idea, not the ability to keep it a secret, is the key to a sucessful start-up.. Show a healthy respect for the incumbents while demonstrating a compelling and believable way to compete with them.. investors believe that what makes a company defensible is the ability to out-implement, not out-litigate.. Shooting for the top-dog position is much more attractive to an investor than claiming it will take only a miniscule market share to succeed How venture capital works Zider 11/98 HBR p132 PROFILE OF THE IDEAL ENTREPRENEUR. From the venture capitalis's perspective, the ideal entrepreneur: is qualified in a "hot" area of interest; delivers sales or technical advances such as FDA approval with reasonable probability; tells a compelling story and is presentable to outside investors; recognizes the need for an IPO for liquidity [really? in good times there are 15x M&A:IPO and in bad times 30x]; has a good reputation and can provide references that show competence and skill; understands the needs for a team with a variety of skills and therefore sees why equity has to be allocated to other people; works diligently toward a goal but maintains flexibility; gets along witht he investor group; understands the cost of capital and typical deal structures and is not offended by them; is sought after bymany VCs; has realistic expectations about process and outcome [p137] HOW VENTURE CAPITALISTS SPEND THEIR TIME Soliciting business 10% Selecting opportunities 5% Analyzing busines splans 5% Negotiating investments 5% Serving as directors and monitors 25% Acting as consultants 15% Recruiting management 20% Assisting outside relationships 10% Exiting 5% VCJ 4/03 p31 krassen@netagesolutions.com offers a $10k-100k software that "include deal and contract menegement, employee portal, investor portal and portfolito company portal" ditto relevantequitysystems.com $20-300k "front-office tasks (fund-raising, deal management, investor relations and contract management) and back-office tasks (fund administration, portfolio management, and quarterly reporting)" Kaplan & Stromberg J_Finance LIX 5 10/04 p2194 VENTURE CAPITALIST ACTIONS [% of companies].. VC Active in recruiting or changing management team before investing.. 16%.. VC expects to be active in recruiting or changing management team after investing.. 43%.. Any of the above.. 51%.. VC explicitly active in shaping strategy/busines smodel befor einvesting.. 9%.. VC explicitly expects to be active in shaping strategy/business model after investing.. 30%.. Any of the above.. 34% What do Venture Capitalists do? Gorman & Sahlman, HBS 9-288-015 1987 p5 Table 2 Mean Std Dev High Low # of Active Partners per Firm 5.1 3.8 25.0 1.0 # of Investments Managed per Partner 8.8 3.5 20.0 4.0 # of Seats on Boards per Partner 5.1 3.0 21.0 0.0 p8 Table 4 Form of Assistance Rank Frequency 1. Help obtaining additional financing 1.9 75.0 2. Strategic planning 2.4 67.5 3. Management recruitment 2.6 62.5 4. Operational planning 4.1 55.0 5. Introduction to potential customers and suppliers 4.6 52.5 6. Resolve compensation issues 5.6 55.0 p11 Table 5 [worst problems] Frequency Rank Std Dev.. (1) Inneffective Senior Management (SMAN) 95% 1.6 1.0 (2) Innefective Functional Management (FMAN) 50 2.5 1.1 .. (3) En user market failed to develop as (MKT) 43 2.7 1.9 .. (4) Poor channel selection/ (DIST) 35 3.3 1.5 .. (5) Competition (COMP) 34 3.0 1.3 (6) Poor product/market fit (FIT) 28 3.5 1.7 .. (7) Devlopment delayed or unsuccessful (DEVT) 51 2.4 1.4 (8) Manufacturing failure (MFG) 11 2.9 1.4 (9) Poor product performance (PROD) 18 4.2 1.4 (10) Inadequate quality control (QUAL) 13 4.7 2.4 Financial Contracting: "DEALS" HBS 9-288-014 6/89 p43 deals that have proved successful over a long period of time: they are simple; they are robust (they do not fall apart when there are minor deviations from projections); they are organic (they are not immutable); they take into account the incentives of each party to the deal under a variety of circumstances; they provide mechanisms for communications and interpretation; they are based primarily on trust rather than on legalese; they are not patently unfair; they do not make it too difficult to raise additional capital; they match the needs of the user of capital with the needs of the supplier; they reveal information about each party (eg, their faith in their ability to deliver on the promises); they allow for arrival of new information before financing is required; they do not have perverse discontinuities (eg, boundary conditions that will evoke dysfunctional behavior on the part of the agents of principals); they take into account the fact that it takes time to raise money; and, they improve the chances of success for the venture. Amis & Stevenson, Winning Angels, FT/PH/Pearson 2001 ISBN 0-273-64916-7 p86 [Landrum Profiles of Genius 1993 Prometheus p232] 1. Promethean (Carl Jung and MBTI) - INTJ, ENTJ, ENTP Intuitive - Perception of world (forest vs trees / macro vs micro) 2 Competttive to a fault Aggressive behavior where winning is more important than playing 3. Innovator operating style (Kirton's style inventory) Preference for "doing things differently" vs "doing things excellently" 4. Self-employed father - Early vision fo achievement outside establishment Fathers made their own way in the world as dentist,truck driver,or lawyer 5. Big "T" personalities (high in testosterone, thrill seeking - enormous risk takers): Big Ts - High in risk taking. Preference for uncertainty, unpredictability, variety, intensity, novelty; Little Ts - Low in risk taking. Preference for certainty, predicatbility, simplicity, low intensity, familiarity. 7. "Type A" behavior (Meyer Friedman and Ray Rossenman) - Impatient and impulsive. Impatient to a fault, obsession with winning, short attention span, multitasking personality types 8. Charismatic - The consumate salesman. Enthusiastic, passionate and inspirational leadership qualities. 9. Right-brain, qualitative "gut" decision makers - qualitative vs quantitative. They utilize macro vs micro, long term vs short term, qualitative vs quantitative, analogue vs digital, indutive vs deductive, and subjective vs objective operating styles. 10.Psychosexually driven - Sublimated libidinal drives of insecurity and inferiority. Intensely driven individuals with high sex drive and /or need to overcome innate fears of failure. Consumate overachievers. 11.First-born males (Adler and Kevin Leman) - Morber the major influence. Perfectionism, stiving for superiority, and need to achieve, Natural leaders (12 of 13 innovative geniuses studied were first-born males, as were all seven of the Mercury austronauts) 12.Personality focused and goal oriented - Edison's aphorism "persistence vs inspiration". Persevering prevails in entrepreneurship. Individuals who never give up never lose! 13.Transient childhoods - Leading to consummate self-sufficiency. Ability to cope in foreign environments learned early in life. p123 looks for in a start-up opportunity: 1. Quality dedicated management that is passionate for what they are doing with industry experience and a willingness to test new ideas. If I walk away everything continues to move forward!!! 2. A business that is simple and has a clearly defined product and revenue model with clear customer benefits. 3. A reasonable time to market advantage, channel control, or technology advantage that creates some barrier to entry 4. A scalable business that creates long-term customers and or a product that when generated can be sold in perpetuity to become marginally more profitable over time. p125 REDFLAGS 1 Salary is utmost on their mind (they should be thinking about creating share value) 2 The business plan claims 10 revenue sources or products (ealry stage companies need to focus on one or two and make them work) 3 They say or do anything that is dishonest. (If they do not have a strong moral code, your money is history) 4 They are not realistic about their own abilities (eg, lacking any financial knowledge, the entrepreneur does not have "financial guy" on his list of to-dos) 5 They only "need 1% of the market" 6 They have not identified the first customer p127 Top 10 things Manny Villafana [MN] looks for in a medical start-up.. 1 Is there a technical need for the device? 2 Is the technology readily available for the manufacturing of the device? 3 The management; composition of the team; previous experience.. 4 Capital requirements. Is the capital going to be raised in stages? 5 The make-up of the scientific advisory board 6 The capitalization of the company. Is there fairness to the incoming investor? Is the valuation correct? Does the CEO have a meaningful investment in the company? 7 Does the CEO and do the members of the management team have a proper proportion of the ownership to make it worthwhile to invest their time and effort into this project? 8 The quality of the regulatory officer as a medical device company needs to have a top person in that field 9 Are there any possible litigation factors? 10 What does my gut tell me? p129 Must have Match of interest and experience Management team A+++ Big market opportunity, rapid growth to $1bn+ Compelling business model Concise and convincing differentiation Ought to have 2 customers already identified Draft business plan Demo version of product 2-4 people already involved Entrepreneurs that know how to use advisors Nice to have Revenue Track record in this kind of deal Good advisors Must avoid Dishonest entrepreneur Self-destructive ego Lifestyle entrepreneur Ought ot avoid Empire builders Nice to avoid Inexperienced CEO p150 David Berkus created his own methodology for investing in early-stage deals. Typically he invests $200k and values the deal based on the simple formula: For a sound idea $1m [million]; For a prototype +$1m; For a quality management team +1-2m; For a quality board +$1m; For any roll-out, sales +$1m p152 [Multiplier Method, eg D&B Std Biz Ratios] Mutiply a key number in th ebusiness plan times an industry standard, eg, a nursing home start-up might project 2,000 beds and if $60k per bed is an industry standard for valuing a nursing home, the company couls be worth $120 when it attains its target p153 Venture capital method.. 1. Determine the future value of a company using the multiplier [industry ratios] in a given year, say $25m in year 5. 2. Decide what ROI you need on your investment and calculate the future value to the same year. So if you are investing $100k and need a 50% return, in year 5, your investment should be worth $759,375 at that time. 3. Now sipmly divde the value you need ($759k) by the future value of the company ($25m) and that will tell you the percentage of the compnay you need to own $759k/$25m=3% p196 [STRUCT] Inpact on Exit Downside Protection Upside Potential Coomon stock/ None, expect it gives None Limited to initial units no rights the entrepreneur shares/units maximum freedom ownsership, no rights to invest additional capital Common with None None 1 Investor is given pre-emptive and the chance to invest tag-along rights additional capital - to avoid dilution 2 Entrepreneur cannot sell his shares without also offering the investor a similar exit Preferred Depends on additional 1 In the event Depends on the terms convertible with terms. Complicated of liuidation, but is generally the various terms or irregular terms the investor best structure for reduce the likelihood is ahead of capturing upside of second-round the common financings and shareholders some exit events 2 Additonal terms may provide further protection, eg buy-out clauses or board seats Convertible note Facilitates a VC Loan note provides Yes, if the with various terms round, and VCs are best leverage in conversion terms the exit pros the event of are favorable or liquidation or if investors get work-out the same terms as the VC p214 Capitalyst [author Amis] Preferred Deal Terms Common share structure Preferred share structure Convertible note Must have Must have Must have Pre-emtive right Pre-emtive right Set conversion price Tag-along right Tag-along right or discount Registration right Registration right Cumulative interest Reasonable price Reasonable price (deferrable) Anti-dilution Ought to have Ought to have Ought to have Entrepreurial compensation Visitation rights Convertible into preferred limit (not necessarily Redemption rights contractual) Warranties and representations Anti-dilution Cumulative dividend (although deferrable) Board representation (far all preferreds) Nice to have Nice to have Nice to have Warranties and repr.. Put Potential payback with Put warrants to provide upside Board representation (for all current-round investors) Must avoid Must avoid Must avoid A call Anything too complicated Forced conversion by Anything that will turn entrepreneur without a off next investors trigger event related to significant progress p264 [Benefits from angel] INDUSTRY: Strategic advice; product development advice; Introducion to industry players. FUNCTIONAL: Management advice; Assitance in interviewing job candidates; Hands-on assistance. NETWORK: Opens doors: New partners, New team members, New capital providers, Other professionals. ANGEL EXPERIENCE: Raise more angel capital; Raise venture capital; Allround advice on dealing with financial or growth issues. ENTREPRENUER EXPERIENCE: High-impact general advice and support on a variety of growth and management issues; Hands-on assistance Corp Cult Deal & Kennedy AW 1982 0-201-10277-3 p107-111 tough-guy macho culture.. take high risks and get quick feedback Police.. surgeons.. consulting.. venture.. entertainment.. speed, not endurance.. best the[ir] most senior.. tolerate all-or-nothing.. wax poetic.. rituals become superstitions VCJ 10/03 p50 Top 10 Tips for New VCs from an Old Hand Dotzler Generate deal flow.. former work associates, law firms, patent attorneys, consultants.. Keep an open mind.. "What if it works?".. Follwo the money.. sold to customers who are making a profit and have discretionary spending.. Learn how to identify great people.. Ask questions that focus on past behavior and results..thorough reference checking.. review a candidate's work product - patents, marketing plans, sales reports.. Be rational in terms of investment.. Be patient with startups.. strategies of many companies evolve over time.. Keep track of cash balances.. how many months of cash burn remains.. Know what milestones the company must achieve to enhance its chances of raising money with favorable terms.. Spend time every week working with all your portfolio companies.. avoinf getting on too many boards. I have found it valuable to ask CEOs the follwoing question: "How can I help you?".. Don't get too high on good news. Likewise, don't get too low on bad news.. Treat everyone with fairness and dignity VCJ 4/05 Latta An LPs 10 Tips For Emerging Managers [p40] Emerging managers must be able to convincingly demonstrate why their investent strategy will be successful and how it is ifferentiated from other funds in the market.. Demonstrate Relevant Expertise.. Prove You Are A "Dream Team" [p41] The ages, outside interests and personal wealth of the current partners will be scrutinized. LPs would prefer to invest in a multi-generational firm in which partners are motivated and the issue of succession has already been addressed.. Show a Track Record.. key word is "transarency".. The most successful venture capitalists are those that can identify new and developing markets, business models and technologies; assemble management teams to exploit these opportunities, manage a successful investment to exit.. partners contribute a meaningful portion of their net worth to the fund - having "skin in the game".. Offer Reasonable Terms.. y on LPs.. understaffed and the decision to invest or not may boil down to whether the merging manager provided all of the requested information.. Don't Neglect Marketing.. Make sure that each partner can deliver the presntation and answer all questions by themselves.. Be Honest and Up Front.. turn weaknesses into strengths.. Be Persistent.. keep the process moving forward.. follow-up is critical L.P. Confidential [Venture Capital Journal August 1, 2002] We convinced four top LPs to spill their guts about hot-button topics. The only hitch was that we had to keep their names confidential.. Not only are they holding the purse strings tighter, they are far more willing to press for their own practical and philosophical interpretations of how venture funds should operate.. foursome has a combined 55 years of private equity experience. The participants' firms manage a combined $20 billion spread over more than 500 private equity funds.. When we came out of Sept. 11, the public market was very low, and I think a lot of the private investments got written off. The magnitude of the write-downs in the third quarter of 2001 was equal to what we saw in the first two quarters. So you were starting to feel like maybe we were beginning to see the bottom. But we haven't.. Are we in a technology depression, and how long will it last?.. They got back and raised a huge fund in 2000, because the 1997 fund was clearly a huge winner. Then they suddenly look back, and the pace has gone down. The 1999 fund is a disaster, and the early deals in the 2000 fund are a disaster before they settled down.. In some respects, we previously had been kind of oblivious to the effect of management fees on our returns because there has been such a discrepancy between the rate of deployment and the rate of appreciation of the assets that were mark-ups, and, all of a sudden, you don't have that.. If we put pressure on the GPs, the risk you're taking is that they'll just speed up their investment pace. And you don't want that.. Unless you have a no-fault divorce escape clause and can convince some super majority of the people who signed one of these agreements that they need to suspend this fund or somehow terminate this fund, it's the deal that you signed up for. That's why you should do your due diligence, because it's a 10-year partnership.. Some firms, like Kleiner Perkins, have told LPs that they "most likely" won't call down a certain percentage of committed capital. Does there come a point when you need it to be official?.. If you are paying management fees on a portion of capital that never gets managed, it seems as though that is somewhat inefficient for the return on the fund. You could fix that fund size and let the fund manager redeploy the capital.. There were funds that had 30% carries before 1999, so some will possibly still have it. Carry is a sticky term that moves up quickly but not necessarily down so quickly. Again, investors will have to decide whether or not to go into funds with so-called premium terms.. A bunch of people come together to start a firm, generate a great track record and are able to raise $1 billion based on that track record. Now they step back to just work 35 hours per week. Maybe the last couple of great deals were done by the younger generation, but the issue is still, "Who gets what?".. If you look at the overhang of what's been committed to funds and what's been dispersed by funds, there's a big gap there. The big issue is finding the equilibrium. It used to be that a couple of billion dollars was in the pipeline, and now all of a sudden we've got maybe a couple hundred billion dollars in the pipeline.. If I look at our 2000 funds' weighted average, right now they're 23% drawn down. It's the first time in the history of venture capital when there's been a lot of money in the hands of the venture industry and it hasn't let it burn a hole in its pocket. For 25 years, they've never done it. Every single time the industry has had too much money, they've let it flow out.. suggested that the VC overhang is anywhere from $30 billion to $100 billion.. It used to be that valuations were generally financing-event driven, and only in rare instances was there a subjective write-down. Today, though, in the last several quarters, we've been in kind of a new environment in which there have been many more subjective valuations and revaluations of companies.. As far as I can tell, I've only heard one announcement so far of anybody pulling back on the endowment/pension side. Moreover, I can think of at least five or six states and four or five major international players that are either increasing their allocations or coming into venture capital for the first time.. It's one of the ways the private market is different that the public markets. The public markets are there every day, so you can pick what stock you want to be in. The private markets aren't. It's only what's in the market at that point in time that you can choose from.. We've done our best to pre-wire the clients. What we're telling our clients right now is if we have a three-year fund horizon, we're not going to invest it 30%/30%/40%. It's going to be more like 20%/20%/60%.. Entrepreneurs Sound Off On Perils of Fund-Raising Venture Capital Journal January 01, 2002 Carolyn Chin: Just as we thought it was safe to get back into the water again, and the VC was thinking about coming back, we had September 11th.. The world stopped for a while. You just couldn't get a deal going. So, I think this has been the worst environment I've ever seen to get funding.. Damir Perge: Right now there's this huge gap between angel investing and VC investing. It's like the value chain for investing has been broken. And it's going to take time for it to repair. And so, you've got very few people right now that are actually interested in their early stage investing and some of the deals that we've seen would blow you away.. Joseph Dooley: I can no longer just present a business plan and it will be funded.. Kenneth Bob: one type of investment that hasn't been touched upon is corporate investment, which became extremely popular, especially when the technology company has their own funds. And even though we were successful in getting strategic money, the fact is that I went to a number of those groups where we had great synergy. And one that will remain nameless, the head of corporate development said to me, "we're not smart enough to invest in early-stage companies.".. Chin: A lot of the problem is that there's a lemming effect. But the truth is that investors have tended to go in crowds. A lot of them got burnt, but this is a time for some leadership and there are great opportunities for those that are willing to show some leadership.. Perge: In the old days you could go in as a 25-year-old kid and you could get funded five million bucks or more. Not anymore. The gray hairs are definitely back.. Perge: Absolutely. Despite all the conditions, the recession in Japan, Germany, United States, the world economy, the September 11th tragedy and so on, it's still mind-boggling to me. People with salaries like $200,000 and they're in Series A. It's really hard to talk to me like this because the first 20 months I never got paid. My recommendation to entrepreneurs who want to get funded? It's really simple. You have to think in terms of the investor. So, don 't come to him with a $15 million, $20 million pre-valuation right now. Because you know what? Those billion-dollar-plays, they're not going to happen. Put yourself in the investor's shoes. I know that's such a simple basic statement, but I can tell you, 95% of the entrepreneurs don't do it. Even today, despite the hard conditions.. Perge: Well, investors are very skeptical. You come to them with these five-year hundred-million-dollar projections, please. Advice to entrepreneurs: Don't put down $100 million revenue projections in five years. You will be laughed out of the office. And this thing about having beta customers. Guess what? They're not interested. They want paying customers. Anybody can get beta. How do you convert a beta into a paying customer? If you can't convert that, you don't have business.. Chin: It's always a problem with founders. Founders, particularly with this last bubble, always think they should get more and that they should get a lot. The problem is founders always have to get diluted because you need the money. I think one of the ways we dealt with it is to be pretty simplistic. To say, listen: either we get diluted or we die. It's just a realty.. Hurley: I have a friend who is a venture capitalist. He had worked for First Chicago, Bridges. He was very instrumental in some start-ups that made lots of money. So, I went to him for some advice before I really got involved with Specdex and his advice to me when approaching venture capitalists is this: VCs are normally very nervous about the deals because even though they may look good on the surface, you have to make sure you understand the management team completely, because that's really what you're investing in. And the other thing is that valuations are really what two people agree on. What he told me was having been with a major bank and their investment division for several years is that in these start-ups, about seven out of the 10 deals go bad. So, I'm looking for the one that pays off those seven and hopefully I pick up another one somewhere along the line. But if you have a good idea, if you have a good management team, then valuations can be whatever you agree to.. Nesmith: Everybody's looking for something when you make an investment and it's not living with a company for 15 years. If you're running a portfolio, you have to show a gain somewhere and you have to show your investors some kind of return. If you're running funds and you're running other people's money, you're at the mercy of how you do at year-end. Your P&L is always scrutinized by your performance and people will throw money at you to invest at the end of the year if you've done well. So, some people have to cash in on their investment once in a while, which is what makes Wall Street such a wonderful place. ECONOMICS Financial Times April 24, 1999 Quarterly Personal Finance Survey p3 Where does all the money come from? One theory is that it relates to the ageing of the populations in key areas of the global economy. Much publicity has been given to the "baby boomers" of the US who are entering their fifties and have been shovelling their savings into mutual fund-based investment plans. But they may be less important than the more dramatically ageing population of Japan, and to some extent Germany too. Japanese short-term interest rates were reduced effectively to zero during the first quarter, and ever-rising Japanese trade surpluses are being recycled into markets elsewhere. Flood of Cash to Mutual Funds Helped to Fuel '95 Bull Market FLOYD NORRIS 26Jan96 NYT p A1 Lured by an unprecedented bull market, and with aging baby boomers growing more concerned about retirement, stock mutual funds are taking in more money than ever before. And that money in turn is driving up stock prices, helping to bring in more money for the funds.. With the first of the baby boomers turning 50 this year, more and more of them have begun to worry about retirement. With interest rates relatively low, and real estate prices quiet at best in most areas, stocks and mutual funds that invest in stocks have become the asset of choice for more investors. In the last five years, assets of mutual funds specializing in domestic stocks have nearly quintupled. Flood of New Money Makes '92 a Vintage Year for Mutual Funds p FF3 WP 16Dec92 Stan Hinden Even after the yield fever cools, industry analysts say, mutual funds will benefit from the pressure on aging baby boomers to save for retirement.. Crain Investment News May 9, 2005 Pg. 3 Rick Miller CHICAGO - William F. Sharpe, the Nobel laureate in economics whose capital asset pricing model set the framework for optimizing investment portfolios, is researching how baby boomers can optimize their income streams in retirement.. How should retirees invest, and how should it change over time? To what extent should retirees use annuities and other insurance products? How can retirees efficiently spend down their limited assets?.. ``What is telling about the fact that Bill Sharpe is working on this is that he is essentially saying that the tools that have been developed over the last 30 years - that he had a major part in developing, that are applicable to the savings side of the life cycle - are not applicable to the dis-savings side of the life cycle,'' said Moshe Milevsky, an associate professor of finance at the Schulich School of Business at York University in Toronto. CNNMoney.com April 1, 2005 Friday 3:07 PM EST Walter Updegrave ..Even before the president called for making private investment accounts part of the Social Security system, many people were concerned about what you might call the Bad News Boomers effect -- namely, that the very same baby boomers who helped drive the bull market skyward in the '80s and '90s with their saving and investing would send it spiraling downward once they began unloading their investments for retirement income. In fact, some economic observers see the boomers' influence stretching even wider, sending the economy itself into a tailspin as retiring boomers trigger a slowdown in productivity growth and the growth of the work force itself.. transition of the huge baby boomer generation from workers to retirees and from accumulators of wealth to spenders of assets is going to have some profound effects on the economy and the market National Post's Financial Post & FP Investing (Canada) February 21, 2005 Monday FINANCIAL POST; Pg. FP7 Peter Francese, Barron's Watch out for ageing Boomers: They might bite you.. The danger to the economy is that a significant portion will start to do what any sensible person facing leaner times would do: cut expenditures and sell some assets. The hit to the two-thirds of the economy that's consumer spending [never mind the stock market] would not be a pretty sight.. There is some evidence that Baby Boomers, who delayed getting married and having children, just might delay even thinking about retirement as well.. St. Louis Post-Dispatch January 9, 2005 BUSINESS; Pg. F05 HUMBERTO AND GEORGINA CRUZ The reality, according to a study of recent retirees, is that of a money-worried, cash-strapped group largely dependent on Social Security.. More than one in four would rather be working than retired.. Forty percent are concerned that they'll outlive their money.. LAW Are Finders Also Broker-Dealers?; New Jersey Law Journal April 9, 2004 Those who bring parties to a deal may avail themselves of a registration exemption By Steven M. Hecht, Edward M. Zimmerman and Jason I. Diener In this era of increased regulatory scrutiny and expanded application of investor protection laws, a continually evolving area of broker-dealer law takes on increased importance: Whether a so-called finder, who introduces potential investors or merger partners to each other, can avail himself of the exemption from the registration requirements applicable to broker-dealers. A finder might bring interested parties to a transaction, but may threaten the viability of that deal if he or she cannot meet the exemption from registration, and thus improperly performs the functions of a broker-dealer.. Securities brokers are required to register with the SEC pursuant to Ss 15 of the Securities Exchange Act of 1934, which broadly defines "any person engaged in the business of effecting transactions in securities for the account of others" to be within the scope of the registration mandate.. A significant exemption to the registration requirement has emerged for "finders," a term that has been defined mainly by the SEC's unofficial pronouncements in no-action letters. Sometimes referred to as interpretive letters, no-action letters are written guidance from the SEC staff in response to inquiries concerning the application of the securities laws to a proposed transaction or particular set of facts. These informal opinions may provide assurances that the staff will recommend that the SEC refrain from pursuing any enforcement action in response to the described transaction or conduct. The SEC examines numerous factors to determine the applicability of the finder's exemption. While the general rule is that the exemption applies when the finder does not "effect securities transactions," that statement serves merely as the jumping-off point for dozens of very fact-sensitive SEC no-action letters that, in aggregate, yield a somewhat cryptic message. The effect is as if the SEC were saying, "the test is very dependent on the facts but the SEC will look at the level of involvement in negotiating and structuring the deal and valuing and endorsing the securities; the extent to which the compensation is based on the sale of securities; and whether the broker or finder is generally engaged in the business of brokering these transactions, among other aspects of each specific transaction.".. When finders facilitate the introduction of buyers and sellers of businesses, the factors most relevant to the SEC's determination of whether the exemption is met are well described in Int'l Business Exchange Corp., SEC No-Action Letter, 1986 SEC No-Act Lexis 3065 [Dec. 12, 1986]. In that matter, the finder provided a listing service to businesses interested in transferring ownership primarily by way of asset sales.. finder did not advise the parties whether to issue securities or assess the value of the securities to be sold. The SEC took a no-action position, based in part on the nature of the deal as a sale of a business rather than a transfer of securities. When a finder will be paid only if the transaction is completed successfully, the SEC is less likely to apply the exemption. Some of the more common forms of transaction-based compensation [also known as success fees] described in the no-action releases consist of commissions linked to the volumes of securities sold, although success fees can take a variety of forms. Thus, in many no-action letters involving transaction-based compensation -- whether in the form of a fee, commission, concession or other compensation that is paid only upon a successfully consummated deal -- the SEC would not agree to forbear from an enforcement action.. while it may be form over substance, when a sale of the company is structured as an asset sale rather than a sale of securities -- and assuming that the seller's assets consist largely of hard assets and goodwill, not simply the securities of other companies -- the transaction does not generally implicate the securities laws and therefore should almost always be exempt from the broker-dealer registration requirements of the 1934 securities act.. SEC identified the following criteria as influencing its decision in Victoria Bancroft not to recommend enforcement action: [i] the business represented by the finder is a going concern and not a "shell" organization; [ii] the sale conveys all of the business's equity securities to a single purchaser or group of purchasers; and [iii] the finder refrains from advising as to whether to issue securities and from assessing the value of any securities sold.. The SEC has adopted a much stricter attitude toward the exemption when finders act as intermediaries in the sales of new issues of securities, in which cases the SEC has severely limited the availability of the exception. In particular, when the finder in such a sale stands to earn his or her payment from such introductions by transaction-based compensation, that factor alone can disqualify the finder from the exemption.. when the finder does nothing more than merely refer potential investors to an issuer -- that is, the finder is completely isolated from the ensuing negotiations and provides no investment or related advice or input, and is otherwise totally disassociated from the securities sales and transfer of funds -- the SEC does not generally take exception with transaction-based compensation.. thrust of the exemption: To permit businesses to pay those who make successful introductions when that is incidental to, and not the sine qua non of, the relationship between the finder and the company, or at least when that is not the means through which the finder generally makes a living.. finder was strictly prohibited under the agreement from mentioning any of the advantages or disadvantages of any particular investment; providing any recommendation, analysis or advice related to any investment; participating in any negotiations; and receiving or handling any of the investors' funds.. finder's fees could not fluctuate with the outcome of the investment transactions, and could only be modified once annually on a prospective basis.. difficult to fault a finder for failing to divine clear guidance from the fact-sensitive and broad spectrum of the relevant SEC no-action guidance.. strictly prohibited by contract from explaining or advising about the investment, expressing any belief about the advisability of the investment, or receiving or handling any securities or funds utilized in the investment. The finders were responsible solely for providing marketing data and criteria for identifying interested investors possessing the necessary financial resources, and the finders' agreement was terminable if the finders were found to have exceeded that limited scope. The agreement also called for the finder to review a synopsis of the statutory and regulatory provisions governing brokerage activities, including the registration requirements and the anti-fraud provisions, and to acknowledge their understanding of such provisions. To register or not: a finder's big dilemma Securities Law; Pg. B9 The National Law Journal January 22, 2001 VICTOR L. ZIMMERMANN JR., SPECIAL TO THE NATIONAL LAW JOURNAL Those who assist emerging companies in getting investors could be subject to certain federal and state securities laws. WITH THE dramatic increase in private equity investing during the last few years, an old issue seems to have made its way back to the forefront. So-called finders, who assist emerging companies in identifying potential investors, may be subject to the requirements of federal and state securities laws regulating the activities of broker-dealers. [See e.g., Securities Exchange Act of 1934, Pub. L. No. 73-291, § 15, 48 Stat. 881 (1934); 15 U.S.C. 78c(a)(4).] Finders who are found to be acting as unregistered broker-dealers could face significant penalties and sanctions under both federal and state securities laws. Perhaps even more important, the issuing company may have its financing effectively nullified as a result of being required to provide rescission to the affected investors, and the company may be tainted by the prior violations, making future financing more difficult and expensive.. In fact, angel investors -- wealthy, accredited investors who often provide the seed financing to start-up companies -- now provide 30 to 40 times more financing each year than their more famous counterparts, the venture capitalists.. Finders are often paid substantial fees when introductions to investors prove successful. These fees can approach 10% of the cash invested, in addition to warrants granting the finders the right to purchase shares equal to up to 10% of the value of the transaction at any time over five or more years.. A "broker" under the Securities and Exchange Act of 1934 is "any person engaged in the business of effecting transactions in securities for the account of others." [15 U.S.C. 78c(a)(4)] Sec. 15 of the Exchange Act makes it unlawful for any broker or dealer to use "the mails or any means or instrumentality" of interstate commerce "to effect any transactions in, or to induce or attempt to induce the purchase or sale of," any security, other than exempted securities, commercial paper, banker's acceptances and commercial bills, unless the broker or dealer is registered with the SEC [15 U.S.C. 78o (a)(1)].. Finders historically have maintained that they are not subject to the broker-dealer registration requirements. They have argued that they are not engaged in the business of "effecting" securities transactions because they merely "find" and place in contact with each other, for a fee, potential buyers and sellers of securities, which will then complete any resulting transactions. However the meaning of "effecting" under the Exchange Act is not clearly established, either by regulation or by consistent interpretation, resulting in a continuing uncertainty as to whether one is acting as a finder or as a broker.. Although most courts have not implied a private right of action under Ss 15(a) and 29(b) of the Exchange Act, these provisions, with certain exceptions, render void "[every] contract made in violation of any provision of [the Act]," and have been interpreted to allow the rescission of transactions in securities with unregistered broker-dealers.. The definition of "broker" in § 3(a)(4) of the Exchange Act appears to include finders because they initiate securities transactions between buyers and sellers and because the SEC has broadly interpreted the phrase "effecting transactions." [Exchange Act Release No. 605 (April 17, 1936) (defining "effecting transactions" in connection with § 11 (d)(2) of the Exchange Act, 15 U.S.C. 78k (d)(2))] However a de facto exception appears to have emerged from court rulings and no-action letters exempting finders of capital from broker-dealer registration requirements if the finder does little more than introduce the issuer to the prospective investor[See Couldock & Bohan Inc., v. Societe Gen. Sec. Corp., 93 F. Supp.2d 220, 229 (D. Conn. 2000); SEC v. Margolin, No. 92 Civ. 6307, 1992 Lexis 14872 at * 15 (S.D.N.Y. Sept. 30, 1992)] Probably more people attempt to rely on the finder's exception than on any other provision in the 1934 Act [John Polanin, Jr., 40 Cath. U.L. Rev. 787 (Summer 1991)] The strict definition of a finder, however, is relatively narrow, and most who claim the exemption are likely excluded. In determining whether the finder's exemption is available, courts and the SEC normally look at the degree of the finder's involvement in negotiations, the extent to which they have made recommendations regarding the investment, the extent to which their compensation is success-based and their prior involvement in the sale of securities. Success-based compensation, although not determinative, has been a significant factor in determining whether the individual or entity is a broker since it provides an incentive to engage in selling practices. [See Carl L. Feinstock, Fed. Sec. L. Rep. (CCH) 82,067 (March 2, 1979); Russell R. Miller and Co. Inc. Fed. Sec. L. Rep. (CCH) 81,324 (July 14, 1977)].. Start-up companies, often short of cash, are themselves loath to pay retainer-based compensation; thus, start-ups encourage and even insist that the finder be compensated, for the most part, with a success-based fee.. In 1990, the National Association of Securities Dealers (NASD) attempted to make broker-dealer registration easier for finders and other smaller firms that do not engage in a traditional retail business with customers. The NASD reduced the minimum net capital requirement to $ 5,000 -- which broker-dealers are required to maintain -- for broker-dealers who do not take customer orders, but this alone has not proven to be enough of an incentive for the finder to register if he or she is not otherwise engaged in the kind of activities clearly warranting registration. The Secret World of Finders: Unlicensed dealmakers are suddenly, uncomfortably, in the spotlight. Inc. Magazine, March 2005 Page 23 By: Wendy Fried Simply put, finders are intermediaries who introduce businesses to investors, earning a fee in return. Jeffrey Sohl of the Center for Venture Research at the University of New Hampshire says finders generally operate in "angel territory" of $100,000 to $2 million.. Given the current capital crunch and the consolidation in both retail and investment banking, finders are in demand as never before. But that serves only to focus the spotlight on an inconvenient fact: As the law now stands, nearly all finders, whether they know it or not, should be licensed as securities brokers.. To be sure, some matchmaking is so limited that it doesn't require a broker's license, but it's hard even for legal experts to say when a finder crosses the line. Little case law exists. In the words of Hugh H. Makens, the former chief securities regulator for Michigan who probably has delved deeper into this world than anyone else, the work of finders constitutes "a vast gray market.".. The Securities and Exchange Commission, which is now contemplating the finder problem, has failed to locate hard numbers. State regulators admit that the problem has crept up on them, too, even though they are "closer to the action," in the words of Texas securities commissioner Denise Voigt Crawford. Some states, including Texas, are now trying to track finders' activities.. People who are new to the issue often wonder why finders don't get licenses just to be on the safe side. Here's where the SEC comes in for the most blame. Its rules dictate that a broker is a broker; in other words, smalltime matchmakers fall under the same complex regulatory scheme as Merrill Lynch's stockbrokers. It's one-size-fits-all, and much of what's required, small-business advocates argue, is irrelevant and costly, such as business continuity plans and special financial statements. Most finders simply choose not to go through the hassle.. WHEN FINDERS BRING TROUBLE: AVOIDING PITFALLS OF WORKING WITH UNLICENSED BROKER-DEALERS Virginia K. Kapner Boston Bar Journal January/February, 2003 47 B.B.J. 14 A finder generally is defined as a company or an individual who brings together sources of capital with those who need it for a fee but who has no active role in negotiations and who may not bind either party to a transaction (Alan J. Berkeley and Alissa J. Altongy, Regulation D Offerings and Private Placements, SF 71 ALI-ABA 41 (2001), hereinafter "Berkeley"). A finder should act strictly as an intermediary for the purpose of introducing the parties, and not get involved with negotiating the transaction.. Whether identified as a finder, consultant, investor or employee, persons who are compensated for bringing together buyers and sellers who are not registered broker-dealers must be sure to comply with the applicable state and federal securities laws.. Section 3(a)(4) of the Securities Exchange Act of 1934 (the "1934 Act") defines a broker as "any person engaged in the business of effecting transactions in securities for the account of others." In practical terms, a broker negotiates the terms of securities transactions, gives advice on the value of securities, receives compensation based on the outcome of securities transactions, and provides assistance in financing securities transactions. Section 3(a)(5) of the 1934 Act defines a dealer as "any person engaged in the business of buying and selling securities for his own account . . . but does not include . . . any person insofar as he buys or sells securities . . . not as a part of regular business.".. Upon conviction, a person in violation could be fined up to $ 1,000,000 or imprisoned up to 10 years, or both, and a company could be fined up to $ 2,500,000 (Section 32(a)).. Although the 1934 Act does not provide a statutory exemption for finders from the requirement to register as a broker-dealer, the Securities and Exchange Commission ("SEC") has issued many no-action letters that outline both acceptable and unacceptable conduct for finders in connection with the offer or sale of a security. A finder does not have to register as a broker-dealer if the finder's activities are limited such that the finder is not effecting transactions for others. The SEC considers the following factors in evaluating whether a particular finder needs to register as a broker-dealer: 1. Level of involvement in negotiations. Finders involved in negotiations, as opposed to finders who simply identify and introduce potential purchasers or sellers and let others negotiate the transaction, are more likely to have to register as a broker-dealer. 2. Recommendations. Finders who discuss details of the transaction and make recommendations to either party or take other actions associated with active solicitation are more likely to have to register as a broker-dealer. 3. Compensation. Finders who are compensated on a commission basis linked to the size of the transaction are more likely to have to register as a broker-dealer. 4. Previous involvement in the sale of securities. Finders who were previously involved in the sale of securities for this or another company or who were previously associated with a broker-dealer are more likely to have to register as a broker-dealer. No one single factor determines whether the finder is required to register as a broker-dealer. The greater the number of factors present, the more likely it is that the SEC will believe the finder is indeed acting as a broker-dealer.. The SEC does not always require a finder who receives a commission to register as a broker-dealer, but it serves as a "red flag," especially if the finder has been engaged in other private placements wherein he received commissions as a finder or broker. Similarly, the less involved the person is in the negotiation and structuring of a transaction, the less likely the SEC would require registration as a broker-dealer, even with the person receiving a transaction-based commission.. Any agreement with a finder should define the scope of the finder's work in a manner that is consistent with the current guidance from the SEC and applicable states.