William Carleton, Counselor @ Law

Random thoughts about the startuppolicy.org domain

I'm returning home from the ACA 2013 Summit with heightened awareness of how organized angel investing is an international phenomenon.

So I'm thinking of broadening the scope of what is posted at the startuppolicy.org domain.

The buzz in the foyer after a session that included Jenny Tooth's report on policy in the UK was, how about that 105% tax benefit!

That kind of social welfare will never happen in the United States (unless Joe Wallin gets behind it), but, it might not hurt to have a ready link.

So we might organize the list on the domain by country or region of the world.

In terms of US policy, we should make a distinction between state and federal laws or programs.

And speaking of state initiatives: I have heard from someone knowledgeable in the field that six or seven different states now have non--accredited crowdfunding bills in the works. But I only know of two – Washington and North Carolina – on top of the two states – Kansas and Georgia – that have regulatory exemptions in place.

Dave Gillespie is keeping an eye out for us for activity in Ohio.

Anyone have a link or links to bills in other states?

Startuppolicy.org

My friend and fellow lawyer Joe Wallin thinks a lot about how laws passed by Congress - often including laws that have good purposes in the appropriate arenas - end up having adverse effects on startups.

I know this about Joe for almost as long as I've known him. In fact, we often collaborate on projects to identify threats to startups and startup investing, such as the Save Reg D campaign.

Even so, I was blown away by an email he sent last week on which I was copied, in which he laid out, bullet by bullet, what amounts to a truly pro-startup federal policy agenda. With Joe's permission, I'm posting his email below and at startuppolicy.org.

Joe Wallin's Ideas:

• Make Section 1202 permanent. Right now, it expires at the end of this year.

• Repeal Section 409A as it applies to startups. Watch this video. See also this quora post.

• Make the 60 day window on 1045 longer. 60 days is too short in startup land to find a replacement investment.

• Shorten the 5 year holding period under 1202 to 2 years.

• Repeal the bad actor provisions in the Dodd-Frank Bill. These provisions are a form of extreme overkill. They are going to make it a lot harder for startups to startup and grow.

• Repeal the increase the accredited investor threshold in the Dodd-Frank bill. Why make it harder to invest in startups?

• Repeal the second sentence of section 201(a) of the JOBS Act:

(a) Modification of Rules-

(1) Not later than 90 days after the date of the enactment of this Act, the Securities and Exchange Commission shall revise its rules issued in section 230.506 of title 17, Code of Federal Regulations, to provide that the prohibition against general solicitation or general advertising contained in section 230.502(c) of such title shall not apply to offers and sales of securities made pursuant to section 230.506, provided that all purchasers of the securities are accredited investors. Such rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission. Section 230.506 of title 17, Code of Federal Regulations, as revised pursuant to this section, shall continue to be treated as a regulation issued under section 4(2) of the Securities Act of 1933 (15 U.S.C. 77d(2)).

This second sentence is what has hung up the SEC. Why require SEC regulations at all. Repeal the current regulatory barriers directly!

Also, the crowdfunding bill ought to be amended. Bill and I have sets of amendments that are places to start.

Also see this on quora.com.

It's possible startuppolicy.org will be a place where Joe might further iterate his list, or where others might add or develop policy ideas.

Photo: "Petition of Ohioans to the Senate and House of Representatives Regarding Land Sale Policy, 01/10/1810," The U.S. National Archives / Flickr.

Benchmarking your startup's valuation

Yesterday the founder of a startup client and I had a phone conversation about valuing his company for purposes of a first round of outside investment.

I found myself flipping back, mentally, to the charts in the recent Wilson Sonsini 2012 private company valuation report (which I blogged about here; the full report is here).

Particularly at seed and Series A rounds, valuations trend up and down, not just arbitrarily but sometimes with pronounced swings. How early state venture financings happen to be trending is not something a given entrepreneur is going to be able to control.

But you need to know how the market is trending, of course.

What I liked most about the recent Wilson report was a new presentation of the firm's financing trend data, a chart expressed in terms of the impact of the first round of financing on founder equity, relative to outside investor equity.

There are other open resources on the web.

This morning I noticed that the Wall Street Journal's "The Accelerators" blog is running a series on setting valuations. I distill two essential points from the posts I see up there so far: (a) bootstrap if and as far as you can (see Joanne Wilson's post); and (b) if you have to take outside money, don't overprice yourself out of getting that money (see Naval Ravikant's post).

Another new open resource, and a good one: the valuation browser at AngelList. Looking at that data suggests that valuations have, overall, held fairly constant over the last year and a half. Though what's especially cool about the AngelList presentation is that you can filter the data lots of ways and watch the numbers adjust; for example, you can compare valuations for companies associated with Y-Combinator against valuations for those funded by the Alliance of Angels.

Here's a list of the sources mentioned above, with one or two others thrown in for good measure (pun intended):

• WSG&R 2012 private financing report
• AngelList valuations browser
• The Halo Report - Q3 2012 angel group update
• WSJ "The Accelerators" series on setting valuations
• Cooley 2012 venture financing report
• Fenwick 2011 seed financing survey (due for an update, presumably)

Photo: Burns Library, Boston College / Flickr.

Wilson Sonsini's 2012 private financing report

The new Wilson Sonsini report on private company financing trends is out, and it's even more interesting than usual.

In addition to keeping tabs on median valuations by round and other trends in VC preferred stock investment terms, the 2012 report is now tracking convertible note terms.

You've always been able to go the latest WSG&R report to buttress your argument, say, that pari passu liquidation preferences were normative and trending stronger. Well, now you can go to the report and confirm that a 20% discount on a pre-Series A convertible note is normal.

And there is new, useful, graphic rendering of historical data in the report.

This chart, from the report, shows the impact of first-round equity deals, in which Wilson Sonsini has been involved for the past five years, on the relative equity split between founders and investors. Among other things, it shows that founders keep more of the company post Series-A.

But the founders' line includes the option pool. This passage from the report explains:

"Many founders assume that the split in ownership between investors and founders in the first financing is about even. Since the option reserve almost always comes out of the founders' share, this would result in an approximate split of 50%/30%/20% among investors, founders, and employee stock option plans. The study, however, shows that founders actually have done considerably better than this at almost all times during the past five years. Except for a relatively short period during mid-2009, founders' and investors' percentages have varied in opposition in a narrow band between 45%/35% in favor of investors and 45%/35% in favor of founders through the end of 2011 (again, with a constant 20% for the option reserve)."

Chart from the Wilson Sonsini Goodrich & Rosati Entrepreneurs Report 2012.

What I like about the WSJ's "The Accelerators" content

If you haven't seen it yet, check out what the Wall Street Journal has going on online with a series they are calling "The Accelerators."

It looks like the WSJ is commissioning well written, punchy and thematic content from well-known entrepreneurs, angels and VCs, about the startup experience.

What I like most about it is that it is, first and foremost, content. Not pictures, not tiles, not embedded mulitmedia, nothing to pin or swipe or stick in your virtual ear. I don't know about you, but I've lost my tolerance for such bullshit. The window dressing either gets in the way of the actual entertainment value of content (the very best way to be entertained as a reader is to be engaged), or else is a sign that in fact no one is really home and there is no content there.

Editorial care is obviously given to the headlines. The headlines are easily tweeted and supply the surveyer with the theme of the given post.

The posts I've read so far are short, punchy, with voice, and worth reading.

How to organize content that is not book content, not magazine content, that is tough, and I don't think we as a culture have figured it out. The Accelerators seems to commit to organizing the building library by author (as pictured here). I think that works and is reader-friendly, particularly as most of the audience for a service like this is going to be familiar with many of the names. And as you trip across a voice you find engaging and valuable, you can easily scan for additional posts from that person.

Startup lifestyle

The best lens from which to view startup culture this week has got to be Eric Koester's post, The Things All Unexceptional Entrepreneurs Do. Startupping, particularly for founders, is a day to day grind.

At the same moment, startup culture is being processed, filtered and homogenized by the forces that identify fashion and the people who extrude TV shows.

Startupping may have already become a recognized "lifestyle," alongside surfing, investment banking and veganism. It's probably not that important that the image have anything to do with what entrepreneurs do every day.

Somewhat ironic: the assimilation of startupping into popular culture coincides with the flight of angels and VCs from me-too social media startups to enterprise software and other B2B markets.

But I think it is okay for startups in the popular mind to be stuck in associations with consumer applications. A broader cultural suspicion that it can be hip and cool to work for yourself, that is more than okay.

Souring on LLCs

I love LLCs.

LLCs are the lemon drop in the candy store of entity formation choice.

They are hard, they are sour, you have to have patience to enjoy them and you have to suck on them to make them sweet.

A corporation is a Hershey's kiss. Don't bite it, don't roll it around in your mouth, that's fine; it will melt nonetheless, just sitting on your tongue.

The group of entrepreneurs who want to found a company together, want to raise money from investors whom they have yet to identify, want to set up an option plan to incentivize their first key employees - these folks should ordinarily not be forming an LLC. They should form a corporation.

Just last month, I had a group of founders tell me they had been advised that they should form an LLC, then go out and seek financing. And they wanted to spend hardly a nickel on company organization and founders docs.

They got bad advice. No question they really needed to form a corporation.

Have a look at Asher Bearman's post from yesterday on The Venture Alley. At first blush, the post appears to be on an obscure legal topic. But the upshot is of practical import to entrepreneurs considering choice of entity, and sobering: not even the Delaware Supreme Court knows whether or not managers of an LLC have standards of fiduciary duty by default.

What it comes down to is this: if you want to form an LLC, you need to be prepared to write your own rules. No two LLCs have ever looked exactly the same. And what you forget to cover? For LLCs, the law may or may not supply defaults, or backstops.

WIth a corporation, you can use the same charter as the last startup that was incorporated, and be fine. If you need to change things later, any lawyer will know how to help you do it, without having to do research or study an LLC's operating agreement. What you don't specify in your corporate organizational docs, the corporate code will fill in for you. And believe me, the Delaware Supreme Court will tell you *precisely* what fiduciary duties you will have as a director, in virtually every corporate situation.

LLCs are good for companies controlled by one person; for deals that are self-funded; for deals that are backed by one or two super sophisticated investors who have their own in-house "family office" or a staff of finance people who relish the opportunity to make a bespoke company; or for brick and mortar businesses that are off the high-growth or venture paths.

Otherwise, pick the corporate chocolate.

Lemon drops from WIkipedia. Hershey's kisses found on the Harrisburg Holiday Inn site. This post is general information and is not legal advice.