38 posts categorized "Exit Strategies"

Common versus preferred

More on the continuing legal education day I had at the Wilson Sonsini office yesterday:

One panel in the afternoon talked about the recent Trados decision, a case tried in Delaware under Delaware law, even though the company was venture backed and based in California.

494297160_1c17373199_oThat's typical, of course. The vast preponderance of Silicon Valley, venture-backed startups and emerging companies are Delaware corporations. Lawyers and entrepreneurs opt for Delaware, in large part because California is not a viable incorporation alternative. (That's not true in Washington. In fact, this case makes me wonder if it isn't a good tiebreaker when considering Washington and Delaware.)

As with the panel that talked about social media and material disclosures under Reg FD in the morning, this afternoon panel about Trados included a lawyer who had participated in the case. Again on the company side.

I won't actually discuss the case itself, because I feel I should read the court's opinion first, before doing that. Suffice it to say that the case stands for the fear (if your inclination is to equate the health of the startup and emerging company tech sector with the health of the venture capital industry) that Delaware corporations with interlocked or conflicted boards may have to clear an "entire fairness" test, if sued by founders or common shareholders alleging that a sale of the company was designed to clear VC liquidation preferences and management incentive plans, leaving no sale proceeds for the common.

In the Trados case, it just so happened that the company ended up establishing that the price paid in the M&A transaction was actually fair. But, not having the benefit of the business judgment rule or other lower standards, normally applicable when a non-conflicted board oversees an exit, it took years of expensive litigation to get there. (Practice tip from the litigator involved in the case: don't just get $1 to $3 million in D&O insurance; buy the $3 to $5 million coverage.)

Thus the fear. Because Silicon Valley is a small town, because VCs follow one another and everybody is on everyone else's board, doesn't it seem like this standard of fairness from Trados - something designed for the GE's and IBM's of the world, you might say - doesn't it seem like a disaster?

One of the Wilson lawyers walked through some possible strategies or tactics by which to cope. These include:

  • A really, really tough and comprehensive drag along covenant, applied to everyone;
  • Amending the company's charter prior to sale, to change the liquidation preferences to ensure that the common gets something;
  • Designing management incentive plans differently, to ensure that the preferred and the common contribute to it proportionally.

Fascinating stuff.

Of course, from the perspective of up here in Washington, it's a bit easier to also wonder, what about just selling common stock to everyone?

I'm being facetious, but I'm not.

I generally think it's entirely fair and appropriate, and even prudent, not to mention a market reality, for startup founders to give outside investors a simple liquidation preference on angel or VC investments. But if you (later) get into a cycle of down rounds and multiple liquidation preferences, and if you stop caring so much that the common stock options are underwater because you think management incentive plans can fix the problem for the management team, you may be approaching a situation where early founders and rank and file employees just don't get that a $60 million sale may mean as good as a bankruptcy, as far as they're concerned.

Photo credit: vistavision / Flickr.

Disney buys Valor (a peek at the 8-K)

Thought this morning we should look at the 8-K the Walt Disney Company filed yesterday in conjunction with the announcement that it would purchase Lucasfilm Ltd.

Dave Itzkoff of the New York Times had tweeted that Disney's codename for the acquisition was "Project Valor," and a reference in the 8-K seems to corroborate that.

"The Sole Shareholder has entered into an agreement pursuant to which it has, among other things, irrevocably agreed to approve the Merger Agreement and, subject to certain limitations, to indemnify the Company with respect to certain representations and warranties about Valor and other matters."

Lego star wars characters

Speaking of the Sole Shareholder (Shareholder Solo?): a Wall Street Journal story states that "Lucasfilm is wholly owned by producer George Lucas," but that's not exactly what the 8-K says or means by the defined term.

"The sole shareholder (the 'Sole Shareholder') of Lucasfilm is an entity affiliated with Lucasfilm Chairman and Founder, George Lucas."

Granted, that "entity affiliated" with Lucas might well itself be wholly owned by Lucas.

Last point: the deal reportedly is payable approximately half in cash, half in stock. But the 8-K says this instead:

"Under the Merger Agreement, the Sole Shareholder will receive merger consideration of $4.05 billion in the form of cash and stock.The amount of stock issued pursuant to the Merger Agreement will depend on adjustments based on cash distributions to the Sole Shareholder occurring immediately prior to closing, and subject to those adjustments, will consist of at least 32,348,243 shares of the Company common stock but in no event more than 40,348,243 shares of Company common stock."

The deal terms provide that the stock will be registered following closing, so the Sole Shareholder will be able to sell Disney shares on the open market. (In prepared remarks appended to the press release filed with the 8-K, Disney's CFO seems to say the Sole Shareholder's stock will soon be repurchased: "We continue to believe our shares are attractively priced at current levels and therefore, we currently intend to repurchase all of the shares issued within the next two years — and that’s in addition to what we planned to repurchase in the absence of the transaction.')

Sounds also like the Sole Shareholder has agreed to a no-shop. Though either party may walk if the deal doesn't close in 6 months.

Photo: chaines106 / Flickr.

Making an offer without making an offer

This is interesting: Richard Schulze has this morning sent a letter to the board of Best Buy, memorializing an offer to buy the company.

Except it isn't an offer. Call it a non-binding letter of intent, then?

BestbuyNo, not that either, because "neither Best Buy nor I shall be subject to any binding obligation with respect to any transaction unless and until a definitive agreement is executed and delivered."

Schulze writes that he has put a lot of work into his non-offer, and alludes to legal reasons for not being able to be more definitive about what he is proposing:

"Over the last two months, I have done an extensive amount of work to develop a plan to address the company’s challenges, and I have had conversations with several premier private equity firms with deep experience in retail who are interested in a possible acquisition of Best Buy. In addition, I have had discussions with highly-regarded former Best Buy senior executives, including Brad Anderson and Allen Lenzmeier, who have expressed an interest in rejoining Best Buy in this context. As you are aware, Minnesota law requires that I receive permission from the Board of Directors before I reach any agreement with potential partners in this effort. While I have not yet reached any such agreements, I am confident, based on my discussions to date, that I could in short order if the Board allows me to do so."

Except that he goes on to be pretty precise on what he'd pay for the company: "Based on my analysis of publicly available information, and subject to due diligence, I would propose to acquire all of the common stock of Best Buy for a purchase price in the range of $24.00 to $26.00 per share in cash."

Call it a proposal, then. One without the financing lined up, but credible, given the team of bankers and execs pulled together . . . er, lined up ready to be pulled together.

Photo:  Ron Dauphin / Flickr.

The IPO On-Ramp in the JOBS Act: Saviour, Scoundrel, or Hardly Relevant?

One of the key pieces of the recently passed JOBS Act - the one lobbied for by venture capitalists, and perhaps the only key piece  not waiting on SEC rulemaking before taking effect - has to do with lowering the burden of what is required for an emerging company to go public, and then to lowering the burden of compliance requirements, once the company has had its IPO.

The most rabid advocates for the IPO on-ramp herald it as the way to re-awaken IPO activity, as though regulation, not other market forces, pinched the flame. Some IPO on-ramp advocates think a vigorous IPO market is the very key by which to unlock the US economy. See for example this Seattle Times interview of Joe Shocken.

Saviours CometMuckraking journalists, on the other hand, mark the passage of the IPO on-ramp as one more shameful confirmation of Wall Street's unremitting control of national politics. See for example this NY Times piece by Andrew Ross Sorkin, which audaciously suggests that Groupon could have fooled more of the people more of the time, had the IPO on-ramp provisions been in effect a year or two ago.

There's a third hand to consider here, too. In this view, the IPO on-ramp provisions are neither panacea nor the product of plutocratic short-sightedness. In this view, the IPO on-ramp provisions are hardly relevant.

The best expression of this third view, I quoted at length in a prior post. But the remarks (from an experienced securities lawyers who wishes to remain anonymous) bear repitition:

"I personally think that the IPO changes are largely illusory. There has been a lot of noise about simplified regulation. But the SEC has done the equivalent of taking 1,000 pages of regulations and reducing them to 950. Big deal. Plus, the Sarbanes-Oxley stuff has become relatively routine. I also think that the decline in IPOs has little to do with over-regulation, even though it is a factor. It has more to do with what law firms and accounting firms are charging for routine SEC work.

"Tech companies that would have been a plum assignment for Alex. Brown or H&Q in 1999 wouldn’t come close to being eligible today. The boutique investment banks have largely disappeared, and the big ones want big deals. In 1999, $20 million in revenue and a good story was all it took. Plus I’m told the economics are radically different given the huge growth in off-market trading.

"The only way back for the small IPO is a change in the economics at investment banks, and a public resurgence in interest in buying those shares. Some of the changes eliminate much of the periodic SEC reporting regime. Brilliant. Who is going to buy shares in a company and how is it going to trade if there is inadequate public information?"

As if to ring a bell on this anonymous analyst's last point, check out this disclosure in ClearSign's IPO prospectus last week:

'We are an "emerging growth company" under the JOBS Act of 2012 and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.


'We are an “emerging growth company”, as defined in the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.


'In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We are choosing to take advantage of the extended transition period for complying with new or revised accounting standards.


'We will remain an “emerging growth company” for up to five years, although we will lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three year period, or if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30.


'Our status as an “emerging growth company” under the JOBS Act of 2012 may make it more difficult to raise capital as and when we need it.


'Because of the exemptions from various reporting requirements provided to us as an “emerging growth company” and because we will have an extended transition period for complying with new or revised financial accounting standards, we may be less attractive to investors and it may be difficult for us to raise additional capital as and when we need it.  Investors may be unable to compare our business with other companies in our industry if they believe that our financial accounting is not as transparent as other companies in our industry.  If we are unable to raise additional capital as and when we need it, our financial condition and results of operations may be materially and adversely affected.'

Photo: "Saviours Comet" by Bridget Christian / Flickr.

JOBS Act G+ Hangout - TODAY

UPDATE 11:21 am Pacific : We are live now. Join us at https://t.co/uvmnaDjx.

Today's the day Joe Wallin, Denise Howell, Doug Cornelius and I plan to hangout on Google+ to talk about the JOBS Act and its implications for startups and emerging companies. We plan to start at 11 am Pacific.

GplusJOBSActHangoutPromoShotYesterday, Joe Wallin and I experimented with the "hangout with extras" version of G+ hangouts, and it seemed to work fine. But I couldn't figure out how to reserve a url to be able to post ahead of time as a signpost to the event. So I guess we'll hop on a bit before 11 am Pacific, establish the url, and tweet and post it then.

A few background points about the JOBS Act.

"JOBS" in the title of the Act stands for "Jumpstart Our Business Startups." The President signed it earlier this month, and it is now law.

President Obama Signing the #JOBSAct in the Rose Garden April 5 2012

But not all provisions of the JOBS Act are in effect. Some are; some became effective when the President signed the bill. Others changes will require rulemaking from the SEC before they are implemented.

The JOBS Act means different things to different people, largely dependent on how they self-identify within the startup/emerging company ecosystem. I'm sure we'll talk about that today. We'll also talk about whether some of the pieces of the JOBS Act are overblown.

On the About page of this blog, near the top, there is a "quick reference" overview of the JOBS Act, with links, internal and external, to further reading and some resources.

Drop in later today if you can!

Buying startups in order to shutter them

News came last week that Google has decided to shut down Picnik, a year or two after purchasing it.

To Google's credit, the Picnik blog appears to be open for loyal Picnik users to complain, grieve, vent. The comment count is 1,027 as of this posting.

780825372_797e7b9a7c_zIt's a bit humbling how many of the comments seem to be from people who appear to have loved the service but in their earnestness don't appreciate the business calculus that drives Google and the other major players. Some users suggest that Picnik should move over to Facebook. (There are exceptions to the general pattern of naïvité. Here's one from A.S. Swanski: "Simply another dirty trick by Google to make everyone join Google + . Well, my dear Larry, my dear Sergey, I would rather die than join you in the war on Facebook.")

Often, when a larger company buys a startup, the immediate purposes of the deal include shuttering the startup as a going concern. That obviously wasn't the original intention in this case. Instead, it appears, at least in retrospect, that Google was waiting for other Google initiatives to be ready, in the meantime perhaps holding open the possibility (however remote) that Picnik might endure as a standalone brand and service.

Among the benefits Google might derive from extending the (arguably inevitable) wind-down:

  • data on the behavior of the Picnik demographic;
  • more time to assess and integrate the technical talent (employees) purchased in the acquisition;
  • ability to experiment and compare different approaches to products and services around photos.

As for users of the service (in this context, I suppose we are supposed to use the term, "consumers"), many seem crestfallen. But Google's terms of service appear to have put everyone on notice:

"You acknowledge and agree that the form and nature of the Services which Google provides may change from time to time without prior notice to you. As part of this continuing innovation, you acknowledge and agree that Google may stop (permanently or temporarily) providing the Services (or any features within the Services) to you or to users generally at Google’s sole discretion, without prior notice to you."

Flickr photo, "Closed down factory along the Leeds and Liverpool Canal in Burscough," by Uli Harder.

Good Failure, and Pernicious Failure

One of the things I learned during the fight in 2010 to save angel investing in America, is that startups are responsible for all net job growth in the US. What's more, failed businesses generate as many or more jobs as successful ones.

So, while I am no Mitt Romney fan, I wasn't particularly scandalized by a tweet going around yesterday, to the effect that, over a multi-year period, 22% of businesses involved with Romney's Bain Capital had closed or gone bankrupt. No conviction for moral turpitude on that stat alone. Without knowing more, it could still be possible that more jobs were created by the activity enabled by Bain's investing than had Bain not invested; and it could still be possible that the businesses that failed nevertheless generated work experience and other assets put to productive uses by the entrepreneurs and employees in the next ventures they got up to.

4838974324_51ba8e69d3_zNo, you can't, or shouldn't, blame a person for investing in businesses that fail. We need more of that sort. And plenty more of the angelic sort who will withstand failure at rates three or four times 22%.

But leave it to Romney's fellow Republican, Newt Gingrich, to explain Romney's real moral failure. It's not that Bain shut businesses down; it's that Bain looted them and, having deliberately crippled them, left them for dead. Or so Gingrich alleges.

Here's what Gingrich said on the Fox propaganda network about the difference between honest failure and vulture capitalism:

"I am for capitalism. I am for honest entrepreneurs investing. I am for people creating businesses. Calista and I have created four small businesses in the last decade. I get it. But I am not for looting.

"There's a company in the Wall Street Journal today, that Bain put 30 million dollars into, and took 180 million dollars out of. And the company went bankrupt. Now you have to ask yourself: now, was a six to one return really necessary? What if they had only taken 120 million out? Would the company still be there? Would 1700 families still have a job? I think there's a real difference between people who build in a free market, and people who go around, take financial advantage, loot companies, leave behind broken families, broken towns, people on unemployment . . . .

". . . [I]n three or four cases, they [Bain] don't look like capitalism. They look like rich guys looting companies, taking all the cash, and leaving behind all the unemployed. That's not the kind of free market I want to be part of. I want to be in a free market where everybody has a fair chance. That doesn't mean you always win. There are times you lose. There are times you go bankrupt. That's fine, if the person who's getting rich is also taking the risk, and is also suffering some of the consequences. It's not fine, if the person who's rich manipulates the system, gets away with all the cash, and leaves behind the human beings."

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