Sunday, September 23, 2007

Parity begins at Home

For me, once the Canadian dollar began trading at par with the US dollar on Friday, it should have been payback time. All those years of jokes about the Canadian "dollarette" were finally over. No more, "Do I weigh 20% less in Canada?" nonsense. Or so I thought.

Then I opened my inbox to find this message from one of my college dorm mates: "Dollar may be big. Football players still tiny. Not real football, either."

Damn it, he's right. Take a look at the guy from the BC Lions (above). The ground appears to be a close neighbour. And what's with the black yoga tights? Is he a football player? Or did he lose his way en route to a track meet?

I should have remembered that Doug Flutie was a quarterback in the Canadian Football League for several years. To say he is petite for a football player is an understatement: back when he was still a college player in Boston, he borrowed a friend's apartment and left behind a tee shirt. We all took turns trying it on and it was so tight on each of us that we looked like a bunch of Hooters employees.

The biggest guy on the team (#3 below) is listed as being all of 6 foot 3. What would that make the sprite he is hoisting in the air?

The guy who ruined my happy Parity Day, that's who. Now my Laura Secord chocolates taste just a little bitter.

Wednesday, September 19, 2007

Selling the Startup: Can you sell your subscriber base?

When it comes to the legal framework for a web service or community, there's a real culture of scraping. Many startups will simply scrape and edit the terms of use, license agreements and privacy policies from other sites in order to save money.

I think that's fine out of the gate, so long as you review and re-assess this approach once the business begins to fire on all cylinders. With the increase in acquisitions in the web services space, you don't want to be caught short. Recently, a new client received a very favourable takeover offer for her business, including its subscriber base. Problem: the privacy policy did not permit her to provide the account information for her subscriber base to the acquiror. Same thing with the user license: it was non-transferable. We had to go back and rectify the matter in a ponderous way before closing.

A quick tour through some local communities and networks indicates my client isn't the only one with this oversight.

Here's what Facebook has added to their privacy policy for users. Please do a quick check on your and see if you've covered the issue:

"If the ownership of all or substantially all of the Facebook business, or individual business units owned by Facebook, Inc., were to change, your user information may be transferred to the new owner so the service can continue operations. In any such transfer of information, your user information would remain subject to the promises made in any pre-existing Privacy Policy."

Tuesday, September 18, 2007

Selling the Startup: Providing Price Protection in the Term Sheet

According to a recent poll, the vast majority of entrepreneurs in Canada expect to sell their businesses in the next 5 years. Let's get down to business, then: if you are reviewing a term sheet, remember that while a term sheet is a general statement of intent, the broad nature of the language does not favor you. I have never had a purchase price go up because of a matter that the term sheet did not address. It is important to specify in a term sheet when and how a purchase price will be adjusted.

As a general rule, term sheets provide for price adjustment based on revenues and a closing balance sheet, and based on the results of the buyer's due diligence (this is really a price reduction clause, as no one ever finishes due diligence and concludes "By God, they're really onto something here. Raise the price!"). Here are three other areas where you, as seller, need to consider providing for some price protection:

1. Who is Paying for Employee Severance? In Canada, if a business or part of a business is sold, the employees are deemed terminated and are entitled to receive severance. The one exception here is if the buyer hires the affected employees on terms that are not fundamentally or radically different from the ones enjoyed prior to the sale. In that case, no severance is payable and the purchase price remains unaffected.

Buyer - generated term sheets are typically vague on the issue of employees, simply stating that the purchaser will interview employees and make offers to those it wishes to retain prior to the closing. Consider what may happen, then, if a large purchaser decides just prior to closing that it now wishes to run your old business out of its head office in Missouri? This would leave you with the severance costs for your entire staff. It is therefore important to allocate responsibility for potential severance costs in the term sheet, and any corresponding adjustment to the purchase price.

(Note to founders/executives: if you have been taking a below-market salary to conserve cash, consider increasing the salary to market rates before engaging with interested buyers. Ask yourself if it is appropriate that you end up negotiating a salary for a new role with the buyer, or your severance package, from a starting point that is artificially low.)

2. Customer Contracts. As a general rule of thumb, the bigger the buyer, the less interest it has in continuing to run your business as a going concern. As a successor to your business, a large purchaser often does not wish to incur any legal liability for future support of all of your customers, and it therefore insists in the term sheet that you terminate certain customer contracts before the deal closes. Be very careful here: the costs of termination need to be shared or taken into account in evaluating the purchase price. It is likely that you have no right to terminate a customer agreement for convenience, which means you will need to negotiate with your customers, and likely pay a break fee. You may also need to negotiate special rights to allow the customer to continually support your product yourself. Make sure your term sheet stipulates that any license back you require will not reduce the purchase price. A price increase to reflect breakage costs is also apporrpatie, although it rarely succeeds.

3. Sale of Shares. You've agreed on a purchase price for a sale of shares. This will put cash directly in the pockets of your shareholders, taxed at the lower capital gains rate. However, half way through the process, the buyer announces that its tax advisors insist that the deal be done as an asset purchase. Suddenly, the potential proceeds to shareholders are significantly less. When you discuss grossing up the price to reflect the less favourable tax consequences, your buyer refuses, saying it has already received the necessary board approvals and does not wish to ask for more money. It is therefore important to address the issue at the term sheet stage, before the buyer has run through its internal approval process. Make sure that your term sheet has a price adjustment clause in it that will take effect if the structure of the deal changes.

Next: Selling the Startup: Should Your VCs run the Process?

Monday, September 17, 2007

Longview Solutions - More Liquidity Events

This morning's announcement of the acquisition of Toronto's Longview Solutions by Exact Software for $51 million and change spells some kind of success for Vengrowth. At 1.8 times revenue, the purchase price represents a nice multiple. But the question remains as to how much of that was received by investor Vengrowth, who since 2001 has invested $30,952,000 in the company. Whatever the answer, Vengrowth, who has shed its labour-sponsored VC moniker and is now positioning itself as an asset manager, should be relieved to see another exit out of its aging Fund I. Doubtless Wellington Fund, whose $3.5 million convertible debenture investment in 2005 appears to have been the last money in, will be far happier.

Sunday, September 16, 2007

Advertising Law and the High Tech Startup

Whenever one of our clients is about to go to commercial release on a product or service, we take them out for a beer (okay, three, but the last two are always Coors light, which is hardly beer at all). The purpose is to review with them our pre-launch checklist of legal issues. Beer tends to make this exercise go down easier. Last, but not least on that list is a discussion of the content of their go-to-market materials for the new product and their compliance with advertising laws.

For those who doubt the relevance of advertising laws, I point to the case of Symbol Technologies (now part of Motorola). At the height of the telecom boom, Symbol was successfully sued by a competitor, Telxon Corporation, for making false and misleading statements about (a) the interoperability of its wireless LAN products with other 802.11 compliant products and (b) Symbol's conformance to 802.11 standards.

The statements themselves were, as one of my Nortel colleagues noted at the time, really half truths at best rather than falsehoods. Nonetheless, the court noted that:

1. The 802.11 standard had not yet been finalized, so compliance was a premature claim.

2. Compliance with 802.11 would not automatically result in interoperability, as the standard itself did not include specifications for communications between wirelss access points.

In this case, Symbol was required to issue a retraction. Long term, the company did not suffer (in fact, it acquired Telxon in 2000 and earlier this year, was acquired by Motorola for $3.9 Billion). Had the complaint come from a customer, the resulting damages could have cost the company far more.

The lesson? Scrub your press releases and marketing collateral carefully so that your competitors don't steal your thunder at launch. Make sure you prouct/service descriptions are equally scrubbed so your customers can't scream fraud.

A related lesson? If as part of your launch you want to give away swag in exchange for customer surveys or registrations, you need to talk to your lawyer about that, too, and your compliance with contest laws. It wouldn't hurt if you sprang for soe nachos, too.

Wednesday, September 12, 2007

The Take on East Coast Startups: Lessons for Toronto

Yesterday's post by Scott Kirsner on the lack of successful internet companies in Boston sparked a thoughful reply by Spark Capital's Bijan Sabet. They could have been talking about Toronto.

Bijan believes that Boston's failure to keep investing in emerging niches through market downturns has created a limited investing culture. He points to Boston VC's responses to the dot-com bust as a contributing factor:

"When the crash hit, Silicon Valley kept investing in the consumer web while east coast VCs cleaned up their portfolio's and double downed in infrastructure or didn't make investments at all. Local entrepreneurs that wanted to build a consumer company either morphed their ideas into tech infrastructure or they moved to the west coast. Of course there were exceptions.

East coast investors weren't the only ones that avoided consumer internet companies. Great boston consumer entrepreneurs re-invented themselves as infrastructure people. The press stopped covering consumer internet entrepreneurs and startups. Industry magazines stopped the local coverage. The Boston Globe still doesn't really cover the local tech scene except for Scott's contributions (and I'm so glad he's back).

This combination over the years created a culture."

Now, as Bijan points out, Boston finds itself taking a back seat in the rise of Web 2.0 and new media companies.

A good cautionary tale on the need for a committed base of investors that deploy cash through all phases of the market.

Tuesday, September 11, 2007

My Kind of Advisory Board

A few days ago, a local CEO got together with members of her advisory board to discuss strategy, finance make products. TASHODI is the latest local beauty startup out of Toronto and its eye is on what many believe is the next big trend in body care: products made from fair trade ingredients. The founder's story is compelling (watch for their web site launch to learn it firsthand). The products? First water quality.

Whenever I hear the old saw that Toronto is X(5, 15, 150) years behind Silicon Valley as a business creation centre, I think of the thriving local infrastructure that supports the beauty industry. Toronto is perhaps one of the best centres for nurturing startups in the beauty and body care industry, home of many of the independent and quirky brands that feed stores like Sephora, Ulta and Bed, Bath and Beyond. It's a business that can be built by bootstrapping, and entrepreneurs are regularly taken under the wings of world class designers and formulators. The kind who will sit in a loft discussing the relative merits of different distribution channels while mixing soap.

Think this is a cottage industry? Take a look at the many private equity firms who've started playing in this space. In particular, note the sale by Ottawa's tiny Fusion Beauty of a stake in its home grown company to Eugene Melnyk for a rumored $80 million.

Watch for the roll out this fall of a startling number of serious players, including Organic Revolution (the second successful company from its founder in this space).