Wednesday, November 29, 2006

Outsourcing: Don't Make Me Ralph

If a business outsources its core functions, is it still a business? This is what I pondered after spending time today on Ralph Lauren's site. You can now either buy clothes that Ralph actually designed or click through to "Create your Own Gift Collection", where you can design your own versions. Simply: (a) select the clothing item (shirt! tie! hoodie!), (b) choose your colours (Chatham Blue! Vermont Brown! Newport Navy!), (c) choose your pony or monogram, and (d) "make it your own"(add a vintage year!) Why pay a premium for the design vision of Ralph Lauren when you can pay the same premium for the design vision of, well, you?

Outsourcing design seems like an odd choice for a designer to make. I can't get my husband to select socks that match his suits; why on earth would I let him choose what horse galloped across his pectoral muscles? And why is displaying the year on a piece of clothing significant for men's fashion? Do we have to cellar some shirts for a few years before wearing them? Will they be collected like baseball cards at some point? I'm very confused....

Venture Capital and Music

Two of the most interesting VC plays in digital music right now : Pandora, through its Music Genome Project, is aiming to become the definitive music recommendation engine. Countless hours, dollars and music geek effort has been spent trying to map the unique properties of each song. The theory is that if you can track commonalities between songs, you can provide customers with a stream of genetically identical songs.

Can you predict musical taste, and also make money from it? And how do you provide for the quirkiness of individual taste? Some folks generally like jazz, for example, but may nonetheless be mesmerized by certain songs by, say, the Bay City Rollers (I don't care what you say, they were musical prophets).

This is a "swing for the fences" kind of investment, and you have to applaud the investors behind this venture for taking the risk.

LyricFind is, at this stage, a full lyric search engine. This is an important missing piece in the world of digital music search. LyricFind has managed to both obtain the necessary licenses and to also hit the market at a time when publishers are moving to actively enforce and protect these rights.

What I love about this company is the multiple points of pain it can alleviate. Full lyric search is not just a nice added feature to any digital music service or online store. It could be an important tool for parental monitoring and control of children's music downloads. At a recent gathering in D.C., I listened as a number of parents discussed using online lyric search to vet their children's downloads on a song by song basis. There's an immediate natural audience for the business while the company builds out the rest of its business. Best of all, it's Canadian. Go team!

Tuesday, November 28, 2006

Startup Fashion: Holiday Don'ts



You may find yourself wondering what to wear to that holiday mixer your investors have invited you to. I went to Ralph Lauren's site today. After all, as the International Herald Tribune noted, Ralph's latest menswear collection embraces " the dapper masculine elegance that has recently come back into style." Look to your left and right: THESE are Ralph's choices for holiday wear. ?!?!?!? Consider both of these options as the fashion equivalent of IRAQ. There can be no phased retreat from either choice, so just don't go there.

How has it come to this? Ralph used to be my "go to" guy for my husband's clothes. Safe, solid and assured. But now, he's only good if we want to play naughty boudoir games like "Prussian army officer returns from the front" or "Brideshead Revisited...Uncut"(P.S., we don't.)

If you want to avoid the horrors of the current fashion war of aggression go here and click on "What Would Cary Do?" a style section that helps you think like the original dapper guy, Cary Grant. Don't let Ralph put your weapon of mass destruction in terrycloth.

Monday, November 27, 2006

Startup Sales Incentive Plans

I spoke at a local session for entrepreneurs last week, alongside a sales performance consultant. I found his insights fascinating, particularly his observation that, in many high growth companies, the sales force does not always have an accurate understanding of their sales incentive plan or the metrics by which their company measures sales performance.

This surprised me. My experience has been that the sales incentive plan is the ONLY document that sales people pay any attention to. It is studied and marked like a bookie's sheet. The rest of their employment documents - policies, option plans - are regarded as just so much paper from HR (or, as one of my sales clients calls them, the "Human Remains" group).

I had never thought about the importance of sales training or sales coaching before (I always assumed that software sales guys sort of sprang abundantly coiffed from their mother's wombs, ready to close the quarter), but now I'm a believer. Sourcing prospects, qualifying potential customers, shepherding them through the process and managing their account are things that can vary in some fundamental ways from company to company, depending on stage of growth. Company-specific training makes sense to me.

A Sales VP once tried to sell me (and the rest of theboard of directors) on a sales forecast built on a pipeline of "qualified" prospects. When we questioned him further, it turned out that he'd built his list of prospects from the business cards some trade show attendees had submitted for a prize draw. Now, I may only be a lawyer, but even I know that "I want to win a free tee shirt" is not the same as "I would like to buy a service provisioning tool, and some support and maintenance sometime within the next quarter."

Thursday, November 23, 2006

Software Trials: Beta Watch Out

Lately, I find myself spending more and more time negotiating the terms of what should be relatively simple affairs - software evaluation agreements. To me, this is like debating the terms of a coupon or gift certificate. How does this stimulate sales? I have no answers, but it seems to me that reviewing how these deals can unfold might provide some insights.

Here's how evaluation licenses more or less work for most software solutions:
  • Customers who wish to try before they buy receive a limited term license to trial the software, free of charge, without any warranty or other protection from the vendor.
  • The evaluation, or "eval", license is a quick way to get the product in the hands of the CTO/IT group without having to first agree to price or other terms.
  • The customer may also agree to make a deposit that will be applied to any professional or technical services it may ask the vendor to perform to assist in the evaluation.

The theory is that: (a) both parties are mutually incented to get to a final license in place before the trial runs out if the software turns out to be useful, and (b) since the value of the software has already been proven, the vendor has better leverage in negotiating price and support following the trial.

That's the theory. Here's what often happens when the vendor is a startup looking for its first sales:

  • The customer insists on running the software on production servers, instead of in a controlled, or lab-like environment. This means, should anything go wrong, the vendor is exposed for business interruption, lost data or other damages to the customer's business that may result from running the trial. All before the vendor has received a cent.
  • Because the software is now in a live environment, the customer insists that the eval license contain protections and indemnities that will compensate the customer if there is a problem.
  • To mitigate the chance that a problem will occur, the startup then goes for the full court press, providing whatever installation, training and other support is necessary to secure a deal. It attempts to expand its eval agreement to specify the precise services and the value being provided, and (in anticipation of future price discussions) to make clear what is included in standard support and what would be an additional charge if a sale results.
  • The customer's lawyer then wants to make sure that it will own any improvements or know how resulting from these services that the vendor has agreed to provide. (Even if they don't buy your application, they sure as heck want to own the interface between their system and yours.) Further debate ensues.
  • The startup waives any deposit, or reduces it to a token amount (within the signing authority of the person trialing the product). To avoid any suggestion that installation was free, further clarifications are made.

You get the picture. Soon, the legal fees for a free license rise and I'm finally buying the Sub Zero fridge everybody's bugging me about.

Sometimes, the value of simple concepts is lost through too much elaboration. Offering evaluation copies to some customer is one instance. Here's another: personal care products for men. It's one thing to sell cleanser and toner to men, but quite another to provide holiday dazzler makeup kits. I need to wake up knowing there's a fighting chance I might be the prettiest one at my next board meeting. I don't want to live in a world where men have equal access to bronzer, eyeliner and body glitter.

Tuesday, November 21, 2006

Startup Strategy: Sometimes, There's No Right Angle Turn


The fall has been kind to many startups and with the Thanksgiving Day Sales around the corner, you may be thinking it's time to upgrade your wardrobe. Think carefully when you see these things in your shoe department.

I'm all for man comfort, but a sweater is a sweater. It cannot be a shoe. As the holiday shopping scene comes upon you, resist the urge to buy things like these. The salesman who shows you these will probably try and sell you a cravat, too.

Sometimes in life, right angle turns can be made. For example, Nortel could turn from telecom to internet, even with John Roth at the helm. Other times, not so much.

You cannot make CLEC service provisoning tools cool, and you can't make a cableknit sweater cool, either. It's a basic tenet of man clothes that your armpits and your feet should not have textiles in common. I'm just saying.

Thanks, Manolo.

Wednesday, November 15, 2006

Quickstart Canada: Reimbursements for Seed Investors

Millions of dollars are spent each day on R&D in Ontario's universities and research centres. The University of Toronto alone boasts of $2 million dollars a day spent on R&D in life sciences, IT and communications. Now, investors wishing to dabble in investing in university spinoffs will be able to take advantage of a one-time reimbursement program which will allow you to recoup 30% of seed investments. Here's how:

The Ontario Commercialization Investment Fund will reimburse 30% to any eligible investor who makes 3 investments in university spinoffs, up to a maximum of $750,000 invested (for a total $225,000 reimbursement). To become eligible, investors simply have to incorporate or form a partnership with at least one high net worth individual (more investors can be added later). That entity then needs to get one university to sponsor it (again, more universities and research institutions such as hospitals may be added later as sponsors).

Once you have your sponsorship letter, send it with a two page application and a brief "investment plan" indicating your proposed investment focus to the government. You will then have until 2010 to make three eligible investments. Upon the third investment, you will receive the 30% credit on all three. There are no limitations on what your investment vehicle may do, or who may participate - only on what credits it may claim.

This is an interesting way of dabbling in seed stage investments across optical sciences, e-helath, biotech, photonics....and a great chance to get closer to the work at world leaders like the University of Waterloo, Toronto, etc. Here's the catch: only investors who have gone through the process BY DEC 31 will be eligible. Only a handful of investors have filed, which means at a minimum any vehicle you create may be desirable to resell down the road.

Any takers? We'll set one up for you for a flat fee - just email us.

Paul Kedrosky: Waterblogged

Paul Kedrosky loves too much, and too often. There isn't a graph, podcast or Google development that escapes his attention or, as it turns out, his comment. Even the VC feeds I subscribe to contain 80% Kedrosky posts. I am beginning to feel the same way about Paul that I do about Donald Trump (whose prolific real estate ventures led to a friend's child saying that in New York, buildings are called Trumps). If he keeps this up, Paul Kedrosky is on his way to becoming a verb. ("They want to Kedrosky $3 million in a Series A round.")

It's not that I don't value what Paul writes - I do. As a venture partner with one of Canada's leading venture capital funds, he (along with Rick Segal) is an important voice for my people, the Canadian high tech community. But blogging is about discourse, and Pauls' prolific tendencies may have a chilling effect on that. When I ventured into blogdom, I figured, a meaningful post every day or so would be all right. Apparently, that's SOOOO Blog 1.0. Now, thanks to Paul, to be considered a real blogger, I need to generate rich media, graph-laden hourly updates and/or wide ranging commentary and also link to regular podcasts that I create. Crikey!

Friday, November 10, 2006

American Jobs Creation Act: You're Welcome

I was reviewing the 10-K for Zale Corp. when I came across this interesting note:

"We have a Canadian subsidiary for which we elected to apply [the provisions of the American Jobs Creation Act] to qualifying earnings repatriations in fiscal year 2006. In January 2006, we executed a Domestic Repatriation Plan under the provision and repatriated $47.6 million, ......the net income tax benefit realized was $6.8 million, or $0.14 per diluted share for the fiscal year ended July 31, 2006."

I had forgotten about this tax loophole, which was created in Oct. 2004 when the American Jobs Creation Act, or AJCA, was signed into law. The loophole gives US companies a one-time 85 percent deduction on foreign earnings that are returned - or "repatriated" - to the US (through a dividend or otherwise). This translates into a 5.25 percent effective tax rate for those foreign earnings. Returned earnings must be reinvested in the U.S. under a "domestic repatriation plan" that the company's board of directors has approved. The condition: the reinvestment should be related to job friendly activities. That's it. Some loophole!

Until I saw the Zale's note, I hadn't thought of the potential impact the AJCA could have on Canada. After all, the law was touted primarily as a way to reverse the trend to outsourcing work overseas. But consider these facts: the current estimate is that a total of $350 billion of foreign income has been repatriated by US public and private companies. As the 2005 annual reports make their way to the public eyes, we're seeing part of the story unfold. A quick Google gives some indication that Canada's share of the repatriated cash drain may be significant: Ceridian repatriated $130 million from its Canadian subsidiary; Silgan - $64 million; Weyerhauser $1.1 billion.

When one looks at the high tech and life sciences sector, the potential impact of this one-time cash drain could be even more significant. For example, Pfizer reported that it would repatriate $37 billion from its worldwide operations back to the US. Mike Langberg of the San Jose Mercury News reviewed financial statements for the 20 largest public companies in Silicon Valley and found they alone had $28.7 billion in foreign profits brought to the United States: Hewlett-Packard-- $14.5 billion; Intel $6.2 billion; Oracle $3.1 billion; and Cisco Systems $1.2 billion. Repatriation was also popular with big tech companies outside the valley: IBM - $9.5 billion; Motorola $4.6 billion, Dell $4.1 billion and Microsoft $780 million.

My favourite VC once insisted (over lunch in Palo Alto) that Americans just don't say "you're welcome." I put this to the test by thanking our waitress profusely throughout the rest of the meal, and damn him if he wasn't right: all I got for my troubles was an "uh-huh," "you bet" and "sure." Maybe she sensed my insincerity, but still. Manners are manners.

It may be too early to tell what effect this cash drain will have on job creation in Canada. But it can't be good. However, since I am Canadian and my mom raised me right, let me just say to my American friends, you're welcome.

Thursday, November 09, 2006

Series A: The Size of the Employee Stock Option Plan

A lot of my work includes compensation - sales incentive plans, executive compensation plans and stock option plan design. So I tend to be a bit of a theory wonk when it comes to compensation strategy. Which is why I find the consistently applied top of ESOP to 15 -20% of total capital such a weird feature of a Series A (or B) round of investment.

Incentive compensation should, in theory, vary from startup to startup depending on the key drivers of growth for each. To determine the apporpriate size of the stock option pool, traditional compensation theory would demand that a company:
  • take eligible headcount projections for the next 3-4 years of the business;
  • calculate the range of annual option award that may be awarded as a bonus to each eligible plan participant;
  • discount that total figure for notional attrition of employees;
  • assume that the company will follow a strategy of granting more options upfront to employees at time of hire; and
  • calculate an adequate reserve for attracting and retaining an IPO-calibre management team.

The headcount can vary widely between, say, a diagnostics or therapeutics startup, (where there is only incremental headcount growth until a major patent license deal is struck or until clinical trails are complete) and a software startup (where headcount must be added for product support, sales and channel development). So why the consistent result?

There are other variables which also should make the amount of top up vary widely. For example, some of the protective structures for management that were adopted to counter the harsh effects of down rounds post 2000 (options with anti-dilution mechanisms, IPO bonus pools) should perhaps lead to a higher top up than the rule of thumb 15-20% in order to attract and retain employees.

And let's not forget the impact of participating preferred shares, which provide holders with a liquidation preference ahead of the common shareholders. In the current M&A environment, where acquisition multiples for some software sectors – e.g., security - are low, liquidation preferences can erase much of the value of common shares, in turn reducing the value of common share options as an employee retention tool. Perhaps even worse, some commentators have pointed out that they can incent management to focus on "bet the farm" strategies and opportunities, even when market conditions do not warrant it. Surely, one might think, this would lead a comp committee or an investor to reserve a higher than usual option pool?

It is essential that VC investors do what is reasonably necessary to secure key employees during those phases of a company's growth when those employees are most vital. For many cases, the 15 -20% rule of thumb may not do the job.

Wednesday, November 08, 2006

Series A: Making every day like Christmas for your lawyers

A senior partner at my old firm explained the business of lawyering this way:

"Mr. A is trying to loan money to Mr. B. Your job is to grab as much of that money as you can on its way by."

As I gaze upon the list of documents my clients must prepare and negotiate at this early stage, it seems clear that this philosophy is alive and well. Investors' lawyers are consistently requiring investees to prepare and deliver documents that, in my view, are inappropriate and even unecessary in the context of a Series A transaction, raising legal fees by a significant factor without providing any significant additional benefit to the investors. The priciest of the lot? Requiring registration rights agreements and legal opinions.

A registration rights agreement gives certain investors the right to: (a) force an IPO (so-called "demand rights") , (b) require the Company to include the investors' shares in the IPO or any subsequent offering to the public markets ("piggyback rights"), and (c) post IPO, the right to demand that the Company sell its shares in a simple Form S-3 registration.

I do not always see eye to eye with Brad Feld on things like fashion (more on that soon) but he is absolutely correct when he says that this is one of the more heavily lawyered parts of any deal, and that it ultimately is one of the most irrelevant. First, demand rights are almost never used, so spending time and effort negotiating them is much like trying to negotiate an extended service warranty for your Edsel. Second, even if the company manages to make it to the IPO stage without being acquired, it is unlikely that the underwriters will allow the rights your investors spent your money putting in place to survive in their current form.

So why do Series A investors need to spend money on such matters now? Why can't parties instead provide an irrevocable commitment to provide those rights at some point in the future, and save some money and effort now? In my view, this would be no less vulnerable to the whims of a future investor or the underwriters than a more bloated approach. The response I usually get to this question from opposing counsel is a chagrined shrug.

Similarly, requiring legal opinions in a Series A deal is ordering caviar with truffles from the legal services menu. Surely a salad would have done. When I see this requirement in a term sheet, I start thinking about how great it would be if my name finally made it to the top of the waiting list for the Hermes birkin bag. I always tell my clients to double my bill at least if I am to deliver a legal opinion. Why?

Legal opinions are, in effect, legal guarantees that: (a) the shares were validly issued, (b) the issuance is exempt from prospectus requirements, and (c) certain resale restrictions apply to the shares. In addition, the opinions required usually ask that the company's lawyer certify: (a) that the company has the capacity and authority to enter into the investment, (b) that the deal documents are enforceable, and (c) that there are no circumstances in which a third party may seek to challenge the validity of the transaction. The time, effort and risk associated with providing an opinion mean that each of these items has to be investigated and reviewed, mostly in duplication to what the investors counsel have already done. Not to mention the added bonus of additional fees generated in the negotiation of the form of opinion.

Is it fair to ask for comfort on the above matters? From the company, absolutely. In fact, the company must warrant that each of the above items are true. It's also why investors hold the pen and prepare all of the deal documents - they wish to ensure the enforceability and validity of all of the constituent elements of the deal. It's why they have their own lawyers also review the corporate records of the company ahead of time, and even draft/approve the authorizing resolutions the directors and shareholders sign. In other words, a lot of salad is prepared. Given all of this sunk cost and effort (which the investee must pay for) what additional comfort does the investor get from a legal opinion?

None, in my view. At the Series A stage, most companies simply haven't been around long enough to have any significant operating history or issues. There aren't any complex capitalization matters that have occurred. In short, the risks in most Series A deals are investment risk, not legal ones. A legal opinion on top of all this salad does nothing except, perhaps, cause bloat.

As a lawyer, I'm all for bloating (see Birkin bag reference above). But as an advisor to my clients, I have to ask whether it is appropriate to try and fit a Series A deal into a format better suited to mature companies. I'd rather earn my Birkin through real value added legal work.

Tuesday, November 07, 2006

Board Meetings: Why the Management Report is More than a Dimpled Chad

In the last month, much has been written here in the blogosphere about managing effective board meetings, setting the right board agenda, and the like. Very little, if any, attention has been paid to the issue of what exactly management should report to the board. Other than, that is, to recommend keeping management's slide deck short. With respect, this is selling short the utility and value of a comprehensive report. Here's my view:

Management reports are the primary means by which a board informs itself and oversees the affairs of a corporation. This makes them the single most important communication exchanged by the board and management. The form and content of the report are critical to a director's ability to fufill his/her fiduciary obligations to the board.

When a client completes a new round of financing, I urge them to speak with their directors and agree to metrics they wish to use to monitor and measure the business' progress. Those metrics then become the form for the report generated before each board meeting. The report is always in powerpoint, as befits a private company. A shortened version of the report may be used at the meeting (in accordance with the agenda), but the board should always have a complete, consistent view of all metrics, whether they are an agenda item for a particular board meeting or not.

There are a number of metrics which our form delves into in more detail than we would for a public company because, in our experience, they are where startups face the most challenges: human resources (and in particular, recruiting and retention); marketing; sales and business development (and in particular, the sales pipeline and the process for qualifying sales prospects); and product development. Data security and intellectual property management are also areas that we recommend companies that are post-beta regularly review with their board.

At my firm, we have developed a detailed template for a management report to the board which we provide to our clients for their own information. Anyone who would like a copy should email me; powerpoint does not blog well. I also recommend you check out Pascal Levensohn's presentation on Best Practices for Running a Board Meeting for a good discussion of what are appropriate financial emetircs for a board to review.

Friday, November 03, 2006

Satan was an angel, too

Just got off the phone with a disgruntled investee, who gave the most acerbic critique of his investors I've heard in a while:

"F*! them all but 6, and save them as pallbearers."

I am collecting colourful comments - send'em on in.

Thursday, November 02, 2006

Web 2.0 After-Party...


Sometimes clothes aren't just about fashion - they're a way of life. When the Web 2.0 conference ends, Fred Wilson, Rick Segal and the boys will be heading to a place where their corduroy ways will be welcomed and understood. November 11 - "11/11 is the date that most closely resembles corduroy" - is the date. "The festivities will include keynote speaker author Jonathan Ames, corduroy-inspired art; and the Corduroy Awards, for which the nominees include actor Heath Ledger (Exemplary Usage of Corduroy in a Motion Picture: Brokeback Mountain), fashion designer Isaac Mizrahi (Exemplary Usage of Corduroy in Fashion), and British comedian Marcus Brigstocke (Exemplary Usage of Corduroy as a Comedic Channel). All attendees are strictly required to wear at least two items of corduroy, but of course the more items of the material, the better." You can learn more here. Or, you check out Hugo Boss' latest wool and cashmere blend slacks. I'm just saying.

Thanks to Manolo for the tip.

Wednesday, November 01, 2006

Startup Lawyer: Why I now retain more than just water

I've been a lawyer for more than 16 years, and this week marks the first time that I have ever had to seriously consider suing a client for non-payment. The client in question is an angel-backed startup which was referred to me by an VC. It had an urgent need for advice and since it was a referred deal, I took the matter on without a retainer as security for payment. Guess how that turned out.

The client had no issue with the amount of the bill or the work that was performed. He just got low on funds and decided that I was some kind of Legal MasterCard.


My late father would tell me that it served me right. His view was, always get the client to decorate the mahogany before doing any work. Nothing was prettier, and made everyone focus better, than a retainer check sitting on his desk.

Now, before you roll your eyes, let me say the following:


  • I agree that companies with less than 250 employees are poorly served by the legal profession. SMEs have the same breadth of legal needs as larger companies - they have on-line sites and stores, and related contest and promotions, to operate; their major customer base is in the US and Europe; they have channel partners to manage - in short, the breadth of their legal needs (if not the complexity of them) is the same as major corporations. But large firms are no longer shy about letting you know that their own rule of thumb is to reject clients who will generate less than $50k a year in recurring revenue. Access is a significant problem.
  • I agree that the legal profession has not kept pace with the realities of Canada's economy. 95% of Canadian companies have 250 or less employees and account for over half of the GDP. Only a fraction of Canada's business lawyers have spent time as part of a business' management team, and very few of those have returned to private practice. Access to lawyers with relevant operational experience also is a critical problem.
  • I even agree that price makes legal services for startups and other SMEs unaffordable. Taking shares as barter for legal services or deferring fees were never good alternatives. Despite what some (and the New York Times) may tell you, virtually no firm in or out of Silicon Valley offers this option anymore, unless a startup is already in the middle of a financing or liquidity event at the time it hires its lawyer. Holding shares in your client creates an untenable conflict, unless perhaps your firm has created a truly standalone investment arm. (I once sat on a call where the company lawyer, also an option holder, refused to accept a purchase offer for his client because at the proposed price, his own options would not be in the money.) Deferring fees makes sense for those few companies where the lawyer believes that the fees later will be recouped by the fees generated by a large funding or a liquidation event. I've never felt comfortable with the idea of lawyers, whose help can have a profound effect on a business' future, making decisions about who to represent based on their own evaluation of the future prospects of a client. The only way to fix pricing concerns is to lower the price.

We've tried to addresss most of these issues at our firm, through Venture Law Line and fixed fee pricing. When our clients have cash flow issues, we work out alternatives, like any advisor would. We wouldn't be in this business if we didn't share risk. But being a risk sharer and being a doormat are two different things.

There's a growing chasm between the numbers of small businesses who need sophisticated corporate advice and the number of lawyers who can accommodate them. Startup savvy lawyers are an important component of any business generation centre. For those of us in this area, trying to attract, retain and train lawyers to meet this need is challenging enough without having to teach them how to collect debts. Cut it out.

Looks like I'm going to have to get a new desk, because from now on, my mahogany will always look pretty, too.