"Venture Capital: A Practical Guidebook for Business Owners, Managers and Advisors" by

90 Pages·2011·2.1 MB·English

Venture Capital
A P r a c t i c a l G u i d e b o o k f o r B u s i n e s s O w n e r s ,
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Venture Capital
A Practical Guidebook for
Business Owners, Managers
and Advisors
(Fifth Edition)
by
Daniel H. Aronson
RR DONNELLEY
Copyright © Daniel H. Aronson 2011. All rights reserved.
All or part of this book has been or may be used in other articles, presentations, outlines and/or
programs published, prepared, delivered or made available by the author. No part of this book may
be reproduced or transmitted in any form or by any means, electronic or mechanical, including
photocopying, recording, or by any information storage, retrieval, or transmission-system process,
without the author’s prior written permission.
Daniel H. Aronson is a Shareholder, and Group Leader of the Corporate and Securities Practice,
of Berger Singerman, P.A. The views expressed herein are solely those of the author. This is the
5th edition of this treatment and work. The author wishes to extend special thanks to partners
and associates at his current and former law firms (including Berger Singerman colleague
Iryna Ivashchuk) for their contributions, support, guidance and assistance with respect to
various portions of this GUIDEBOOK. This GUIDEBOOK is intended solely as an educational
introduction to, and not an exhaustive treatment or analysis of, the topics and matters
addressed. It is not designed to provide, and does not constitute or include, legal, accounting,
tax, or professional opinions or advice on any topic or matter, and should not be relied upon
for that purpose.
V C
ENTURE APITAL:
A PRACTICAL GUIDEBOOK FOR
BUSINESS OWNERS, MANAGERS
AND ADVISORS
BY DANIEL H. ARONSON
TABLE OF CONTENTS
Foreword. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi
About the Author. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
SECTION I: SOURCES OF CAPITAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Owners; Friends and Family . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Earnings (Company-Generated Funding) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Commercial and Bank Loans; Government Loans and Aid . . . . . . . . . . . . . . . . . . . . . . 4
Strategic Alliances; Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Private Placements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
FIG. 1—Securities Law Considerations for Private Offerings:
What You Need to Know . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Venture Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
Going Public—The IPO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Practical Tip. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
SECTION II: VENTURE CAPITAL INVESTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Pursuing Venture Capital: Opportunities & Challenges . . . . . . . . . . . . . . . . . . . . . . . . 16
Choosing and Making the Most of a VC Partner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Practical Tip. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
iiiiii
Venture Capital Fundamentals: Understanding Venture Capitalists
and the Investment Process; Planning and Preparing for a VC Transaction . . . . 20
1) Understand the business model and goals of VC investors . . . . . . . . . . . . . . . . 20
2) Understand and be prepared for the investment process—from
initial contact through funding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Figure:Common Mistakes in Pursuing Venture Capital . . . . . . . . . . . . . . . . . . . . . 24
Practical Tip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
3) Assemble and build a strong management and advisory team . . . . . . . . . . . . . 28
4) Present a clear, compelling opportunity via the business plan . . . . . . . . . . . . . 29
Practical Tip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
5) Be prepared—get and keep your house in order . . . . . . . . . . . . . . . . . . . . . . . . 32
Practical Tip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
FIG. 2—Early Planning Considerations: Entity Selection & Structural
Considerations in Organizing a BusinessVenture . . . . . . . . . . . . . . . . . . . . 33
Key Objectives of VC Investors—What Makes Venture Capitalists “Tick”? . . . . . . . 35
1) Maximizing the Upside . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Figure:Life Cycle of a Venture Capital Fund. . . . . . . . . . . . . . . . . . . . . . . . 37
2) Protecting the Downside . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
3) Monitoring and Influencing Progress and Development . . . . . . . . . . . . . . . . . . 43
4) Pursuing and Effecting “Exit” Strategies and Liquidity . . . . . . . . . . . . . . . . . . . 46
Practical Tip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Practical Tip . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Considerations in Obtaining Venture Funding and Negotiating
Terms in Distressed Markets and “Down Rounds” . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
Understanding the challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Approaching the (limited) opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
What terms and approaches are important?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Reality check before signing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
Figure:Funding & Liquidity Cycle of a VC-Backed Portfolio Company . . . . . . . . 60
SECTION III: WHAT TO EXPECT IN A VC TRANSACTION:
KEY STRUCTURES, FEATURES, AND ATTRIBUTES (UP CLOSE) . . . . . . . . . . . . . . . . . . . . 61
1) Equity Securities and Economic Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
iv
Convertible Preferred Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Liquidation Preference. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
“Participating” Preferred Stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Conversion (Optional And Mandatory) Features. . . . . . . . . . . . . . . . . . . . . 63
Dividend Features/Accruing Dividends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Anti-Dilution Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Staggered, Tranched And Milestone-Based Financings . . . . . . . . . . . . . . . . . . 64
“Pay-to-Play” Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
Use of Other Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
2) Governance and Control Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Board of Directors Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Management Controls. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
“Veto”, Negative Covenants and Other “Protective Provisions”. . . . . . . . . 67
Founder and Management Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
3) Liquidity Terms & Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Valuation issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
First Refusal and Preemptive Purchase Rights. . . . . . . . . . . . . . . . . . . . . . . 69
Registration Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
1) Demand Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
2) Piggyback Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
3) S-3 Registration Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
“Drag Along” Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Redemption Right (or “Put”). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
Alignment of Founder and Management Incentives . . . . . . . . . . . . . . . . . . 71
4) Protection of Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
Angel Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
1) More money, and more deals (at early stages). . . . . . . . . . . . . . . . . . . . . . . . . . . 73
2) Dynamics, available funding and deal size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
3) Approach varies widely; dictates access and availability . . . . . . . . . . . . . . . . . 74
4) Angel Groups and Clubs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
SUPPLEMENTAL MATERIALS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . following page 76
Annex A: Illustrative Series A Investment Transaction Term Sheet . . . . . . . . . . . . . A-1
Annex B: Glossary of Venture Capital Terms and Jargon . . . . . . . . . . . . . . . . . . . . . . B-1
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . I-1
v
FOREWORD
Danny Aronson’s Venture Capital Guidebookis a “must read” for entrepre-
neurs, emerging business owners and venture capital investors. I have known
Danny for nearly ten years. He has forgotten more than I ever knew about doing
investment deals, from early stage angel and venture capital all the way through
leveraged buyouts and recapitalizations. In his Venture Capital Guidebook,
Danny allows us all to benefit from his considerable experience, with highly
important and relevant content for businesses of all stages pursuing external
funding. Venture capital investment is well suited for a small set of opportuni-
ties and, in this day and age and under current market conditions, is not easy to
secure. The Venture Capital Guidebookprovides practical insight into the ven-
ture fundraising process, as well as useful tips on “dos” and “don’ts” in interact-
ing with venture capitalists. I suggest particularly close attention to “Common
Mistakes in Pursuing Venture Capital” on page 24. To all of you who are reading
this book with the hopes of raising external capital, I wish you the best luck in
doing so. If you are reading Danny’s book before you start (or even during the
fundraising process), you will be light-years ahead of your peers in navigating
the fundraising terrain.
Alan J. Taetle
General Partner
Noro-Moseley Partners
vi
ABOUT THE AUTHOR
DANIELH. ARONSONis a Shareholder of Berger Singerman,
P.A. (www.bergersingerman.com), where he serves as Group
Leader of the firm’s Corporate and Securities Practice. Mr.
Aronson focuses his practice on mergers and acquisitions,
private equity and venture capital transactions, public and
private securities offerings, other sophisticated finance and
capital market transactions and counseling public and private
businesses concerning strategic business, finance, restructur-
ing, governance and transactional matters. His practice
includes assisting clients (whether start-up or Fortune 100
companies)—from initial formation through financing, expan-
sion, alliances, go-public, acquisitions and sale—in structuring,
negotiating, documenting and successfully closing a wide vari-
ety of business transactions.
An active leader and participant in the development and growth of the venture capi-
tal arena inFlorida and a member of the Florida Venture Forum Board of Directors since
1990, Mr.Aronson served as Chairman of the Florida Venture Forum in 1997-98, as Chair
or Co-Chair of the Florida Venture Capital Conference in 1999, 2001 and 2002, and is a
long-standing member of the Forum’s Executive Committee. He was appointed by
Florida’s Governor to the Board of Directors of the State’s Capital Development Advisory
Committee, and has also served as a member of the Board of Directors of a state-spon-
sored venture capital fund of funds. In addition, he serves on the Executive Advisory
Board of the Center for Entrepreneurship and Innovation at the University of Florida’s
Warrington College of Business Administration.
Mr. Aronson is an Adjunct Professor at the University of Florida Levin College of Law
and has served as a visiting lecturer at the Florida International University College of
Business Administration, Nova Southeastern University College of Law, New York
University School of Law, University of Miami School of Law and the University of
Florida Warrington College of Business Administration.
Mr. Aronson received his J.D. degree from New York University School of Law, where
he served as Editor-in-Chief of the Annual Survey of American Law, and his B.A. degree
from Vanderbilt University, where he graduated Phi Beta Kappa, summa cum laude.
Prior to joining Berger Singerman, he was an Equity Partner of Bilzin Sumberg Baena
Price & Axelrod, LLP (Miami, FL –2007-10); Principal Shareholder of Greenberg Traurig,
P.A. (Miami and Ft. Lauderdale, FL – 1992-2007), where he served as co-head of the
National Corporate Practice and the Private Equity & Venture Capital Practice; Partner
of Steel Hector & Davis (Miami, FL - 1989-92); Corporate Associate at Wachtell, Lipton,
Rosen & Katz (New York, NY –1984-89); Law Clerk to U.S. District Judge Morey L. Sear
(New Orleans, LA – 1983-84); and Judicial Intern to the United States Supreme Court
(1981).
vii
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INTRODUCTION
Venture capital: more art than science, more journey than destination, and clearly
much more than merely a financing or capital-raising transaction. There are many defi-
nitions and descriptions of what constitutes venture capital. In its barest terms, perhaps
the essence is best captured by this description: funds invested in growing, innovative
enterprises in which both the potential for great profit and the risk of complete loss are
considerable. Venture capital funding, for many years now, has been the driving force
behind highly innovative people and businesses that couldn’t attract traditional lenders
or investors.
Starting, nurturing, and developing a business, finding and enlisting the right manage-
ment team, partners, and advisors, obtaining stage-appropriate funding, exploiting
alliance and growth opportunities and, ultimately, executing an exit strategy are all parts
of a dynamic and challenging process, which, in many ways, defies common or business
sense and the skill set of many entrepreneurs and business owners. Raising equity capi-
tal at the various stages of a company’s development and during different market cycles
is particularly tricky and troublesome for the uninitiated.
At the time of publication, the venture industry (and entrepreneurial business com-
munity) are in what I would call a state of “cautious optimism”. Since the U.S. real
estate/housing (and related credit markets) bubble burst in late 2007, all of the relevant
data points—fundraising by venture capital funds, investments in portfolio companies,
mean values and investment amounts, and exit/liquidity transactions—have been down
significantly across virtually all sectors and company development stages. While 2010 is
showing signs of promise and recovery, the “proof” remains to be seen—and of course
the venture industry is both dynamic and cyclical. As discussed further below, cycles can
and do influence investment postures, timeframes and terms.
This GUIDEBOOKis intended as an introduction to the process of finding and securing
institutional venture capital funding for an early-stage or emerging business, as well as a
primer and refresher course for more seasoned private companies and managers that
continue to seek equity funding. While not an exhaustive treatment of the subject, it is
designed to provide practical information and helpful pointers to entrepreneurs, busi-
ness owners, managers, and advisors seeking to source, negotiate, document, and close
one or more equity funding rounds with venture capital investors.
In addition to the Text, two ANNEXES serve as resources to aid the capital-seeking
business owner and manager: ANNEX A is an illustrative and annotated (with commen-
tary) Term Sheet for a Series A preferred stock investment financing, suggesting possi-
ble terms (and their implications) from both the investor’s and the company’s position.
ANNEX B sets forth a glossary of venture capital terms, phrases, and jargon, which
should assist in navigating and understanding the many unique (and sometimes bizarre)
words and phrases often used by experienced participants in venture capital negotia-
tions and transactions. Words and phrases in this GUIDEBOOK which are italicized are
1