Tuesday, June 26, 2007

Startup Community: the Culture of Payback

Last week, I received a call from a California entrepreneur letting me know he'd referred a large piece of work to me. Why? Because 4 years ago, when he was starting out, I spent a few hours with him discussing various issues unique to his business model, trading notes on possible investors, and providing a few forms for him to use. Ultimately, he decided to move the business to San Jose, where it has since prospered. Good for him, but not so good for future business from me. But, I figured, that's part of business development - you win some, you relocate some.

Still, this entrepreneur stayed in touch, calling me every few months to let me know how he was doing and in each case ending the call with a thanks for the time I had spent with him. He made a point of letting me know that he had valued my time and effort. When he called last week, he let me know that he was glad he was finally able to return the favour.

What's important here? Think of what I did: provided feedback, information and some documents. I didn't invest. I don't think I even paid for coffee. But this founder understands the importance of the thank you. It's sacrosanct with him.

This is a trait shared by many entrepreneurs in the valley that I’ve met, and I think it has to be a key driver of the startup support system that thrives there. In my case, I know I’ll always make time for this entrepreneur when he calls, because somewhere down the road, it will help my own business.

A complaint I continually hear from Canadian entrepreneurs is that there few professionals will find time for them, or help them without a retainer, etc., etc. I hope that’s not the case. But so many more could be drawn to the table if, in my view, we cultivated more of the culture of payback.

Tuesday, June 19, 2007

Protecting Angels: The Supra Pro-Rata Right

One of the newer features in early stage financing is a supersized pro-rata right, which permits early stage investors to invest in later rounds to increase the overall size of their holdings. You can read a great comment on Venture Hacks here.

While there are some questions about how this incents investors in later rounds, I believe it can be a useful way to calm some angel concerns about future dilution. The feature hasn't gained hold here, but if it brings some angels that are hovering back to the investing table, I'm in.

Friday, June 15, 2007

Founder and Management Equity at IPO: A Rugged-ly Handsome Story

I remember taking a look at Rugged back when I was a VC. As a manufacturer of outdoors telecom network equipment for harsh environments, Rugged got a lukewarm reception from VCs who were then more interested in software than equipment. Now, their ability to secure other forms of funding has yielded results: this week, having given away only 25% of the company to strategic investors, the team finds itself with a successful IPO priced at $13.00 a share, raising proceeds that (unlike other recent smallcap IPOs) will be used for growth, not to retire debt.

A quick read through their prospectus shows that management sacrificed base salary for solid equity stakes in the Company: the founders (including the CEO) retained 15-20% of the company. The CFO holds approximately 1.5% of the shares pre-IPO, while the rest of management received what appears to be between 0.05% and 3.00% stake.

With annual sales just under $30 million, approx. 110 employees and only a few million in net profit, Rugged is a good benchmark for similarly-sized companies in executive compensation. Management teams, take note: here, the non compete provisions match severance paid (as they should): the CEO and CFO would 24 months severance pay and matching non competition period, while other management agreed to 12 months severance and 12 months non compete.

Data points to remember.

Celtic House Re-Forms

Last month's departure of Ron Dizy from Celtic House seems like the end of an era. I haven't felt this way since the Spice Girls disbanded. Ron, together with Brian Antonen (the "Sporty Spice" of venture capital) founded the Toronto office for Celtic House, originally in a snazzy Victorian house in the Annex. Ron's departure leaves Sporty as the sole Toronto partner to manage local investments (including Vixs, Novvx, Camilion Solutions and Fresco Microchip), together with entrepreneur-in-residence Sutha Kamal ("Baby Spice"). The remaining members of the group jam from Ottawa. Let's hope this is not the beginning of a retrenchment from Toronto.

Thursday, June 14, 2007

Venture Capital Through The Ages

I kept most of my lecture notes from college. Turns out, Williams gave a good grounding in venture capital. Just take a look at some of my notes from The History of Economic Development (slightly updated):

The Medieval Pre: a/k/a the Lord's Demesne, the right in the manorial system,of each lord to retain 25% - 1/3 of all land and crops.

The Medieval Liquidation Preference: He got to keep the barns, vineyards, orchards and workshops, too.

Angels of the Middle Ages: The Commenda, or a group of older merchants who provided capital for active partners, then split the proceeds 3:1.

Decline in Seed Investment: Known as "the treason of the Bourgeosie" in 17th century France.

The Portfolio Approach: originated in Europe in the Middle Ages, when the 3-crop rotation system became a key driver of innovation.

Other key driver of technology innovation in the Middle Ages: "Manure was used more intelligently."

Tuesday, June 12, 2007


I drove to work this morning. People, your car windows are not shaded. Others can see inside your car, and can see what you're doing. Stop sticking your fingers in your noses and use some kleenex.

Excessive nose picking is why I decided not to become a litigator. I'd sit through motions, keeping track of files, watching the judge and the lawyers pick their noses in broad daylight. While talking to each other. Like it was some secret brotherhood signal. (Freemason mystery revealed?) Usually, it was started by plaintiff's counsel, giving a whole new nuance to the phrase "he has a bone to pick."

You and your nose have no reasonable expectation of privacy in the downtown core at 8:15 in the morning. If the two of you need to be alone, book a room for a lunch hour quickie. Stop doing it in the streets where you're frightening the children and the horses.

Monday, June 11, 2007

Not Espial-ly Good

If you are one of those who believes Canadian startups simply aren't competitive when it comes to executive compensation, take a look at last week's final prospectus for Espial over at Sedar. The equity given to management, together with the fixed and variable salary reported, contrast markedly with those reported by limelight and even by recent AIM debutante Redknee. Granted, there is a significant difference between Limelight's revenues pre-IPO and those of Espial. But is the equity component reported here an adequate reward for the reduction in base salary? The eternal question remains.

In The Limelight: Executive Compensation Pre-IPO

Last week's IPO of CDN startup Limelight Networks offered some good data points on executive compensation pre and post IPO. The highlights:

- Compensation is for a company with 168 employees, and $64 Million in 2006 revenues.

- Management and directors (excluding investor nominees) held just over 20% of the Company prior to IPO.

- Option vesting moved from 36 to 48 month period

- Executives agreed to a 24-month non-compete period in exchange for 12 months severance

- Bonus is included in any severance payment for executives. Some options will also accelerate, depending on circumstances of termination.

Note on Founder Indemnities: In an earlier private placement in 2006, some of the founders were permitted to sell some of their holdings and get some liquidity. As part of that deal, the usual seller indemnities were given, including an indemnity that there was no third party infringement of intellectual property rights. At the time, Limelight had no patents, but had 12 US patent applications pending. (No patents have issued yet)

Shortly after the sale, Akamai sued for patent infringement,a strategy it has successfully pursued in the past with Digital Island and Speedera. As the registration statement notes, the indemnities came into play and it appears that, even after some relief, the founders are still out $3 million plus for ther indemnity obligations, wih possibly more to follow. A story to remember when you are considering the indemnity as part of yoru next deal.

Thursday, June 07, 2007

Next Generation Mobile Messaging ?

Does you cellphone need to talk to your pants? Aren't the two close enough already?

This man is selling underwear which apparently protects the boys from the hazardous effects of cell phone use. Apparently, silver threads lacing the material somehow act as a protective shield. I don't want to know.

Angels, Advisors and VCs Beware: the Securities Commissions Are At It Again

Like me, I’m sure most of you begin each day with a nonfat latte and a browse through the website for the Ontario Securities Commission where, after 5-10 clickthroughs you can locate and read the latest proposed rules posted for “public” comment.

No? Then you’re missing what are increasing efforts by the OSC to regulate small and madcap market transactions in unprecedented detail. Take a closer look at the latest, National Instrument 31-103. As I read it, many advisors, consultants and angels are about to find themselves subject to a new regulatory regime.

Naomi Morisawa de Koven has posted the details on her blog here, but the bottom line appears to be this: under the proposed rule, angel managers, financial advisors and anyone else who is in the business of advising others on the buying or selling of securities will be required to register with the securities commissions as a dealer. (As I read it, it may also catch VCs in certain circumstances).

As an Exempt Market Dealer (the old category of “limited market dealer” would be eliminated), these people would have a number of new obligations. Naomi notes these would include meeting proficiency (exam-based) and integrity standards, being subject to audit requirements, and meeting solvency requirements which require the maintaining minimum excess working capital of $50,000, as well as insurance through a financial institution bond.

The comment period is open until June 20, and I strongly recommend all interested parties find a securities lawyer to prepare a comment letter addressing your concerns to the OSC. Naomi, who is on the OSC’s Small Business Advisory Committee, would have my vote. The last thing we need is yet another roadblock to building companies.

Monday, June 04, 2007

Using Finders to Raise Funds: the Securities Laws Issues

For every venture capital deal that’s completed, there are 10-20 angels/friends and family financings done. In my view, there is a model way (using model documents) to do these deals, regardless of who your backers are and whether you ultimately seek venture capital. This week, my posts are going to focus on common issues in completing these deals.

Issue 1: The finder. More and more, early stage companies are using self-styled consultants, or financial advisors, to help them find investors. These consultants typically create the pitch slide deck, shape the business plan and even negotiate and structure the investment terms. In return, the consultant is paid a success fee based on the amount of money raised, or a combination fee plus fixed consulting fee.

The potential problem? Applicable securities laws may deem this consultant to be an unregistered broker-dealer. In which case, you may be liable for fees and penalties under securities laws for completing a financing that was not compliant with private placement exemptions. There’s a great analysis of this issue under US Securities laws here, on the website of investment bankers Carter, Morse & Mathias.

In Canada, there is a second issue: the angel manager. Some formal angel alliances have managing angels who, in exchange for their services to startups, command a fee from the investee. How do/might these fees impact your ability to raise future funding? This is a moving target to watch - in the last twelve months, the OSC has clearly been focusing its attention on small and madcap markets.

The bottom line: make sure your lawyer understands that you have a "consultant" on your team helping you raise funds. Ask her to specifically advise you on this issue. The landscape is changing, and you need to flag it for your lawyer's consideration.