56 posts categorized "VCs"

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.

Lobbying group for venture capital firms weighs in on proposed changes to Reg D

This is interesting: the National Venture Capital Association, or NVCA, filed a comment letter with the SEC on the Commission's proposed rules to overhaul Form D.

Typically, this lobbying arm of the venture capital industry sits out policy matters, legislation, and rule changes that impact angels and entrepreneurs seeking seed financing.

523239430_0e69c5d00a_zFor instance, during Dodd-Frank, back in 2010, the NVCA sat out the attack on angel financing and let angels fend for themselves in persuading Congress that it did no good for America's innovation economy to effectively push two thirds of eligible Americans out of the accredited investor category. (The NVCA's policy priority at that time? Taxation of carried interest.)

And when it came to the JOBS Act, venture capital's lobbyists pushed for the IPO on-ramp and the raising of the number of shareholders a private company could have. Title II reforms - i.e., Lifting the ban on general solicitation and adding an angel platform exemption to federal broker-dealer registration requirements - those again were issues left to angels, as far as advocacy from the startup financing ecosystem was concerned.

To my knowledge, the NVCA sat out the opportunity to comment on the general solicitation rule, establishing new Rule 506(c), before it became final on September 23.

The letter is dated September 23, so I assume it is been on the SEC site for some weeks now. I only noticed it yesterday through a tweet from Joe Wallin.

Time permitting, I'll read through it this week and let you know what I think.

Photo: Brother O-Mara / Flickr.

Liquidation preferences matter!

Today's post is a shout-out to a piece by Trent Dykes on The Venture Alley.

Trent gives us the up-shot of a much-watched case having to do with the legal duties faced by directors in approving the sale of a company where the preferred shareholders will receive proceeds, but the common shareholder will receive nothing.

5486734383_26a5db3611_zIn this particular case, In re Trados Incorporated Shareholder Litigation, the directors were found to have not breached duties to common shareholders.

Big picture, the case is a reminder that liquidation preferences really do matter. Directors will have duties to all shareholders, of course, when considering whether or not to sell a venture. But it's also quite possible, and not at all uncommon, for a company to be sold in circumstances where the preferred shareholders will see a return and the common shareholders will receive . . . nothing.

I find this excerpt from Trent's post to be particulary instructive:

"Private equity and venture-backed company can sometimes find themselves in the difficult situation where the timing of the major investors’ need for liquidity (due to such investors’ investment time horizon) does not align with the company’s ability to obtain an optimal liquidity event (either in time or value)."

That's the tension, isn't it.

Almost all venture investors want liquidity at some point, but some venture investors have institutional imperatives for it. That's a critical factor to consider, not just when constructing liquidation preferences but in choosing what investors to let in.

Photo: schmechf / Flickr.

VCs, Protecting Ideas, and NDAs -- the Nextdoor.com Abhyanker Saga Continues

Nextdoor.com, Inc. v. Abhyanker, C-12-5667 EMC (N.D. Cal. July 19, 2013)

[Note from Bill: this is a post by Venkat Balasubramani, legal blogger par excellence. I am thrilled that Venkat is breaking, here on Counselor@Law, fresh new developments in this important, ongoing lawsuit. The case is not over, but it's getting juicy, and it throws into one package many of the disparate topics we like to cover on this blog (all that's missing is a securities law angle). Click here for a pdf of the written court ruling Venkat is analyzing.]

Abhyanker, who is a lawyer and well known entrepreneur, alleges that he tried to develop a neighborhood-based networking concept known as “Nextdoor,” that someone else ultimately took and ran with, to form Nextdoor.com. According to him, his Nextdoor idea was a spinoff from his concept called LegalForce, which was a private social network for inventors. He also developed “Fatdoor,” a Wikipedia-like public database of neighbor profiles. [sounds scary from a privacy standpoint!] Fatdoor’s assets were ultimately purchased by Google. In 2007 Abhyanker left Fatdoor (who wanted to bring in a new CEO) and came back to work on his Nextdoor idea.  

2757328137_b728306d92_zAbhyanker alleges that he told two people about his Nextdoor ideas and trade secrets: (1) Benchmark Capital; and (2) Sandeep Sood, a designer and contractor for LegalForce. At some point, Abhyanker pitched the Nextdoor idea to VCs, including Benchmark Capital. Although he did not discuss any confidential information in the initial meeting, he supposedly sought and obtained “assurances” from Benchmark that any confidential information disclosed by Abhyanker would be kept confidential. According to him, relying on these assurances, he pitched the Nextdoor idea to Benchmark. In 2007 Abhyanker left Fatdoor (who wanted to bring in a new CEO) and came back to work on his Nextdoor idea. According to him, while he returned to focus on his Nextdoor idea, others were independently working on the Nextdoor concept, and used confidential information and trade secrets to swoop in on the nextdoor.com domain name that Abhyanker had been pursuing for years. The Nextdoor.com founders were Benchmark capital “entrepreneurs in residence,” and Abhyanker alleges that the founders gained access to Nextdoor trade secrets through their work at Benchmark. 

These were just the counterclaim wranglings. The case was preceded by a (still-ongoing) proceeding in the Trademark Trial and Appeals Board, and a short-lived state court proceeding (which Abhyanker filed and dismissed).  

Abhyanker initially asserted several other counterclaims, but withdrew those and filed an amended pleading asserting only a trade secrets claim.  Nextdoor.com (& Sood) moved to dismiss Abhyanker’s trade secret claims. 

Adequacy of trade secrets allegations: Nextdoor argued that Abhyanker’s trade secrets claim failed because he failed to set forth the alleged trade secrets with the sufficient degree of particularity. The court rejects this argument, saying that Abhyanker’s laundry list is sufficient, and requiring him to be more specific would run the risk of forcing him to disclose his trade secrets at the pleading stage. Nextdoor also argued that there were no allegations of how it allegedly exploited Abhyanker’s trade secrets, but the court says there are some allegations—principally, Abhyanker alleges that Nextdoor used the bidding history for the nextdoor.com domain to its advantage. 

The court does say that the parties should work together to come up with a process for identifying the trade secrets and whittling down Abhyanker’s laundry list.  After this process is over, the court says that Nextdoor can revisit the trade secrets issue at the summary judgment phase, hinting that Abhyanker's trade secrets claim may not be all that they are cracked up to be. 

Public disclosure of trade secrets: Nextdoor also argued that Abhyanker disclosed the trade secrets in question in a patent application. Nextdoor says that Abhyanker had filed a patent application disclosing much of the trade secrets at issue in connection with his Nextdoor idea; Abhyanker disagrees, and says that the patent application covered Fatdoor (the wiki site) technology. The court does not delve into the details regarding what facts were disclosed in the patent application (presumably because the facts regarding what Nextdoor does are as yet undveloped), but does say that the patent application discloses the use of nextdoor.com in connection with a  networking site. The court dismisses Abhyanker’s trade secrets claim to the extent it’s based on Nextdoor.com’s alleged misappropriation of “using the name nextdoor.com in connection with a  neighborhood-based social network.”

In addition to the above rulings, the court also (1) says that Abhyanker’s alleged admissions in other proceedings that he does not own the trade secrets at issue (and that the trade secrets were part of FatDoor, which was ultimately acquired by Google) are not necessarily binding against Abhyanker in this matter; and (2) strikes a few of his affirmative defenses. 

Finally, the court also denies Abhyanker’s request to disqualify Nextdoor.com’s law firm, Fenwick & West, on the basis that they previously represented LegalForce. Abhyanker says that Fenwick assisted him in protecting his IP for LegalForce, including preparing non-disclosure and invention and assignment agreements. Fenwick, for its part, had an independent Fenwick attorney review the files and billing records. This lawyer concluded that Fenwick did not really help LegalForce with its IP strategy and at most provided LegalForce with some form documents. The court credits Fenwick’s view, rather than Abhyanker’s view, and also says that the matters in question (this dispute and the prior representation of LegalForce) are not related. The court also says that Fenwick was not likely to glean confidential information relevant to this dispute as a result of its limited representation of LegalForce. (The court also notes that Fenwick implemented an ethical screen between the lawyers working on litigation matters against Abhyanker and lawyers who worked on LegalForce, the bulk of whom are no longer at Fenwick anyway.)


Yikes. A messy dispute that weakly promises to get at the answer of whether, patents aside, ideas are protectable in this context. In terms that will resonate with entrepreneurs, this case gets at the perennial question of "if I have an idea and a domain name, or the name of an app" should I require someone to sign a NDA before I disclose the details?" My money is on the parties running out of gas to pay their lawyers and eventually coming up with some sort of settlement.

Abhyanker has weak trade secrets claims overall. But he was undoubtedly pursuing nextdoor.com. The fact that after pitching it to Benchmark, it showed up as an idea pursued by former Benchmark entrepreneurs in residence can’t look particularly good for Benchmark. (In addition to the domain name, he also pointed out that the prototype used by Nextdoor.com was for the same neighborhood that Abhyanker focused on when he was working with concepts around next-door.) That said, VCs don't sign non-disclosure agreements for this very reason, and although they are from time-to-time accused of taking an idea that they may receive via a pitch and running with it using another team, I don't get the sense that what happened here is wildly outside the expectations of most entrepreneurs. (It's possible that I'm way off on this, feel free to correct me in comments. It's also worth noting that as domain names become scarce and more valuable, Abhyanker's allegations regarding the domain name--while seemingly menial--do get at an important part of a start-up's trajectory.) 

I’m curious about why Abhyanker withdrew his breach of contract claims that presumably included claims based on non-disclosure obligations Benchmark agreed to? Common wisdom suggests that non-disclosure agreements are over-rated and may even make you look amateurish, but you wonder whether a robust non-disclosure agreement would have helped Abhyanker in this scenario? 

Apart from the merits of the dispute, the disqualification ruling is very interesting. Fenwick, which is one of the go-to firms in Silicon Valley (and in Seattle), works with a huge number of entrepreneurs and ventures. To the extent the judge here would have disqualified it, I would guess it would end up taking a second look at its policies around conflicts and whom it can continue to represent when clients (or former clients) have disputes against one another. I’m not saying its representation of Nextdoor.com against Abhyanker here is improper, but I found it very curious that the court relied heavily on summaries of billing records, when it’s widely known that lawyers in this space often work with smaller clients in the hopes that they may grow into more viable clients—it’s not about billing in the early stages of the relationship. Abhyanker’s testimony about him going to his “family friend,” Fenwick attorney Rajiv Patel, for help regarding intellectual property protections for stuff Abhyanker was developing (based on the partner’s IP expertise) did not put Patel in a particularly favorable light. Abhyanker’s argument is that this IP protection involved protection for situations such as when Abhyanker was pitching the nextdoor concept to Benchmark, or working with contractors such as Sood. How can Fenwick, who signed up to help him with these issues, now represent an adverse party in a lawsuit involving these same issues. Not a terrible argument in my opinion. 

Anyway, a crazy dispute that continues to grind on, but one that raised some interesting points.

The takeaway: to the extent you are looking to protect something like an idea and a domain name, I wouldn't rely on trade secrets. Any sort of implied confidentiality obligation is tough to enforce as well. You have to weigh the extent to which doors will slam in your face as a result of requesting an NDA, but that's what would have probably saved Abhyanker here.

Added: Check out the comments below. Also, as Jeff John Roberts noted in this story from January of this year ("Kickstarter project wants to expose idea thieves of Silicon Valley"), Abhyanker launched a Kickster project titled "Entrepreneurs in Residence"!

Photo: Kelli Anderson / Flickr.

The future of angel investing and venture capital fund formation

Important post by Joe Bartlett on VC Experts this morning: Joe's take on the future of both angel investing and venture capital fund formation.

2336664183_a85c824b59_zIt will be, Joe says, aggregation of capital by funds formed online, which permit investors to cherry pick what deals they want to participate in (indirectly, through an investment-specific fund).

The no-action letters secured recently by FundersClub and AngelList validate (most) of the necessary legal framework, but Joe sees the successful funds of the future as perhaps being more niche specific - "each Super Platform will aggregate investment opportunities by specific categories … e.g., medical devices; robotics; solar power; wind power; bio-pharma; clean tech; spin outs from a specific academic center's lab . . . ."

I love seeing how Joe puts all the pieces together.

What I like most about this post, though, is this paragraph of quintessential Bartlett prose about the age in which we live (diction note: "gazelle" is a Bartlett term for an emerging growth company):

"There is a high level of agreement among scientists and techies with the proposition that the next few decades (and, of course, beyond) will experience a worldwide (and principally in the U.S.) explosion of inventions and discoveries capable of giving birth to a multitude of promising Gazelles. The curve is accelerating upwards, approaching a 90 degree angle. The advances in communications, information technology, manufacturing, robotics, alternative energy, biotech, nanotechnology, agribusiness, mental health, transportation, etc. are multiplying geometrically, as theorists, physical scientists, mathematicians and technicians continue to expand the envelope to realms which once were the province of science fiction writers. You needn't go to the limits (or, better, the lack thereof) to which Ray Kurzweil's Singularity University is pushing the boundaries to accept the premise of the science and tech expansion, continuing a curve which has been building since the Enlightenment."

We ain't so special. Tomorrow is.

Photo: Swamibu / Flickr.

Morning reading

Fascinating stuff on the blog of Union Square Ventures this morning.

Fred Wilson writes about the firm's new investment that he describes as being "in the Bitcoin ecosystem."

The company USV has invested in is called Coinbase. Fred writes that the company has three key features:

"an online wallet to store Bitcoin; a merchant platform that allows services to accept Bitcoin as payment; and a service that allows individuals and merchants to buy/sell Bitcoin into fiat currencies."

It sounds to me like USV sees Bitcoin like it saw Twitter and other social media companies it has backed. "There is much that must be built on top of of . . . digital currencies," Fred explains, "to make them work well enough to support real business at scale." Wonder how long it will be before startups raise Bitcoin to fund operations (and will Bitcoin investors have to be accredited?).

Usv site screen shotThe other piece on the USV blog I found really interesting this morning - and maybe this was just the news of the investment - was Andy Weissman's about the firm's investment in CircleUp (this post actually appears to have been from a couple days ago). CircleUp is one of the early leaders in accredited crowdfunding, and we seem to have a tradition here of liveblogging CircleUp co-founder Rory Eakin's public appearances (examples here and here) to evangelize how his company is shaping the industry.

I don't normally turn to the USV website or blog in the morning, but a Disqus feature, an email that tells me where people I follow are commenting of late, led me right to it. That's a powerful service, something that seems to be getting better with time and sorely needed since the demise of Engag.io.

A word about Danielle Morrill's list of zombie VCs


Danielle Morrill has assembled and is curating a list of venture capital firms that spin the wheels of earnest entrepreneurs by taking meetings and asking for follow-up, even though recent history suggests the firms aren't actually actively investing.

A word about Danielle Morrill's list of zombie VCs

This is a terrific project, and should prove an invaluable resource for entrepreneurs. Check out the progress on Morrill's blog: http://www.daniellemorrill.com/.

Photo: Eric Ingrum / Flickr.

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