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.