WSGR Entrepreneurs Report Summer 2009

8/14/2019 WSGR Entrepreneurs Report Summer 2009

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THE ENTREPRENEURS REPORT:Private Company Financing Trends

Summer 200

Cozying Up to Goliath: The Pros and

Cons of Taking on a Strategic InvestorBy Dave Panos, CEO and Co-founder, Pluck Corporation

Most early-stage entrepreneurs who arebuilding successful companies will have theopportunity to raise money from a corporatepartner that wants to invest for strategicreasons. You also may find that existinginvestors like the idea of filling out a round

with a partner that has deep pockets butisnt very sensitive to valuations. While theprospect of cozying up to a strategic investorinitially sounds appealing, the implicationsare significant and caution is advisable.

The Dance Begins

When in the throes of explicitly raisingmoney or developing a strategic partnership,it is fairly easy to become seduced with theidea of taking a strategic investment from aGoliath partner. Among other things, it

rounds out the corporate rsum with a verynice sound bite. You may rationalize thatthere is some sort of transitive propertythat

magically will make your company morevaluableif Goliath thinks its worthinvesting in, then the category matters andthis start-up must reallymatter.

The corporate partners appetite for this type

of relationship varies wildly according tomarket dynamics and the personalitiesinvolved, but in positive economicenvironments, it is fairly easy to rev upGoliaths engines. Some large companiesare very aggressive in their pursuit ofstrategic tie-ups at the balance-sheet level.In fact, it isnt uncommon for them toactually institutionalize the process to alevel where a formal and rigorousconversation around investment must takeplace before any strategic partnering deal isconsummated. However, note that many of

these companies arent investing solely torealize a return on their capital, but ratherare looking to attach themselves to the

(Continued on page 8)

Feature Articles

Cozying Up to Goliath: The Pros andCons of Taking on a Strategic InvestorBy Dave Panos, CEO and Co-founder,

Pluck Corporation ..................................Page 1

The Non-dilutive Cash Injection:Selling Your PatentsBy Kent Richardson and Erik Oliver,

ThinkFire Services..................................Page 1

From the WSGR Database:Financing Trends ................................Page 2

Is the Government Your NewLead Investor? .....................................Page 6

Mitigating Risks: ContractingConsiderations in a DownEconomy ............................................Page 10

The Fundraising Process: BestPractices for Entrepreneurs andDirectors .............................................Page 12

In This Issue

(Continued on page

The Non-dilutive Cash Injection: Selling Your PatentsBy Kent Richardson and Erik Oliver, ThinkFire Services

Many companies in search of a cash infusionare not aware that they might be sitting on an

asset that can be monetized to help meet theirliquidity needs. Whether you are an early- orlate-stage company in need of cash, if youhave a patent portfolio, you might considerselling some of those patents, particularlythose that you do not need today. Indeed, thecash generated from any such sale mayreduce the impact of, or eliminate the needfor, a dilutive down-round financing.

The Market for Patents

We estimate that approximately $1 billion ayear changes hands buying and selling barepatents. These patent sales occur almostexclusively in the information technologysector, including such fields as wirelesscommunications, Web 2.0, SaaS, and LCDTVs. Prices can range from a few thousanddollars to more than $10 million per patent.

In the last decade, the growth of this markehas been remarkable. In 1998, only a few

large companies, such as Intel, Broadcom, aIBM, were buying or selling patents. Today,there is a robust market of buyers and sellealong with a developing community of patenbrokers and finders. With the growth of thisemerging market also come the challenges volatile pricing, deal transparency, lack ofstandard terms and conditions, and lack ofstandard processes.


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THE ENTREPRENEURS REPORT:

Private Company Financing Trends

Summer 2009

The first quarter of 2009 saw a very sharpdecline from previous quarters in both thenumber of equity financings that werecompleted as well as dollars invested. Theacceleration of the decline from the fourthquarter of 2008 to the first quarter of 2009was steep in comparison to the decline fromthe third to fourth quarter of 2008. Thisaccelerated decline in the first-quarter privateequity financing market trails by roughly aquarter the steep decline in the public equitymarkets beginning in September 2008.

The backdrop for venture financing in the firstquarter continued to be challenging:

The decline in venture capitalfinancings in the first quarter of 2009that we saw in our database wasconsistent with the declines reportedby VentureSource and MoneyTree.These declines were experiencedacross all sectors and across all stagesof venture capital rounds of financing.

There were no venture-backed IPOs inthe first quarter of 2009, and only oneventure-backed IPO since the firstquarter of 2008. However, there were

two venture-backed IPOs that priced inMay 2009. While it is too early to tellwhat this portends for future periods, itis safe to assume that a high level ofventure-backed IPOs is not likely toreturn immediately.

According to VentureSource, thenumber of exits in the first quarter of2009 through merger and acquisitiontransactions deceased in comparison tothe fourth quarter of 2008, continuing adownward trend that began in the firstquarter of 2008. The average valuationsof merger and acquisition exits alsodecreased significantly from priorperiods.

These and other factors have had a significantnegative impact on venture capital investingin recent periods, which is borne out by thedata from the financing transactions capturedin our database. These trends continue toimpact the rate of return for the venturecapital asset class.

The number of financing transactions of alltypes decreased from 151 transactions in the

fourth quarter of 2008 to 101 transactions inthe first quarter of 2009, a decline ofapproximately 33%. This decline is evensteeper when compared to the financingtransaction activity in the third quarter of2008, during which 183 transactions were

completed. The number of transactionscompleted in the first quarter of 2009 wassignificantly lower than the number oftransactions completed in any recent quarte

There was also a steep decline in theaggregate dollars invested in the first quartof 2009. The $606 million aggregateinvestment amount was nearly 60% less thathe $1,485 million aggregate investmentamount in the fourth quarter of 2008. The fiquarter saw no megadeals, i.e., singlefinancing transactions involving an amount excess of $100 million. The absence ofmegadeals in the first quarter of 2009 hada significant impact on the aggregateinvestment amount (three such megadealsaccounted for approximately $550 million ininvestment amount in the fourth quarter of2008). However, even after eliminating themegadeals from the fourth quarter 2008 datthe decline in investment dollars from

From the WSGR Database: Financing TrendsBy Mark Baudler, Partner (Palo Alto Office)

1Q08 2Q08 3Q08 4Q08 1Q09

$1,478

$1,245

$1,616

$1,485

$606

$1,178$1,245 $1,294

$920

$606

155162

183

151

101

$0

$500

$1,000

$1,500

$2,000

$2,500

AmountInvested($M)

0

50

100

150

200

NumberofDeals

T ota l Amt. In ve s te d Amt. Inve s te d w ith ou t M e gade als T ot al # o f De als

Q1 08 - Q1 09 Amount Raised - By Quarter

For purposes of the statistics andcharts in this report, our databaseincludes venture financingtransactions in which WilsonSonsini Goodrich & Rosatirepresented either the companyor one or more of the investors(although we do not includeventure debt or venture leasingtransactions, or financingsinvolving venture debt firms). Thisdata consists of more than 600financings in each of 2005, 2006,2007, and 2008, as well as morethan 100 transactions in Q1 2009.


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Summer 2009

$920 million in the fourth quarter of 2008 to$606 million in the first quarter of 2009was significant, representing a decline ofapproximately 34%. The decline in investmentdollars in the first quarter of 2009 issignificant in comparison not only to thefourth quarter of 2008 but also to otherrecent quarters.

The number of Series A financing rounds wasdown significantly in the first quarter of 2009when compared to not only the fourth quarter

of 2008, but also to each of the other threequarters of 2008. Given the macroeconomicclimate, this is not surprising, but it does shedlight on just how difficult it has been recentlyfor new start-ups to attract venture financing.Not shown in the tables is the significantdecrease of angel-led financing transactions.Our database only recorded two such angelfinancing transactions in the first quarter of2009. There are likely a number of factors

contributing to the paucity of angel financingrounds, including steep declines in many

angels personal net worth and increasedconservatism for new investments. As aresult, entrepreneurs are experiencingsignificant difficulties in securing early-stagefinancing for their companies in the currentenvironment.

Similarly, the number of Series B and thenumber of Series C and later rounds of

financing have continued to decline fromprior periods. These decreases are likelyattributable to a number of factors, includingheightened conservatism, increased diligencetime prior to making investments, and

venture capital firms deploying a greateramount of capital to their existing portfoliocompanies (and often only to certain of theseportfolio companies).

The first quarter of 2009 also saw a markeddecrease in the number of bridge transactions.Bridge transactions are often made for thepurpose of providing capital betweeninvestment rounds or to provide capital to

enable a company tocomplete an exit transactionor a wind-down. Bridge

transactions also are used insome cases as a means offinancing prior to a firstequity round of financing.This type of seed-investmentbridge financing also declinedsharply in comparison toprior periods.

Not surprisingly given theeconomic climate, the percentage of down-round financing transactionstransactionswhere a companys valuation declines fromthe prior round of financing, resulting in aprice per share of the new security that is lessthan the price of the security issued in theprevious roundhas increased significantly.In the first quarter of 2009, slightly over 50%of all Series B and later financings were downrounds, as compared to just over 25% in thefourth quarter of 2008. The percentage ofdown-round financings in the first quarter of

2009 is over twice as high as the percentagof down-round financings in the years from2005 through 2008.

Further on this point, in the first quarter of

2009, only 29% of Series B and later roundsfinancing were up rounds, as compared tofinancings that were down rounds or wherethe per share valuation was flat. Incomparison, at least 65% of such financingswere up rounds in the years from 2005through 2008. This data reflects thedeterioration of the national and globaleconomies combined with the severelychallenged exit opportunities for venture-backed companies.

The charts on the next page set forth the

median amounts raised and median pre-money valuations broken down by series ofequity financing. The first quarter of 2009,compared with the quarterly data from 2008reflects decreases in both median amountsraised as well as median pre-moneyvaluations. The same holds true for Series Bfinancings (with the exception that medianamounts raised in the first quarter of 2009increased slightly in comparison to the datafrom the fourth quarter of 2008) and for SerC and later financings. The steepest declineall of these charts is the median pre-moneyvaluation for Series C and later financings inthe first quarter of 2009 as compared to prioperiods. This ties to the down-round financidata trends discussed above.

In sum, the data shows that the deterioratioin the investment climate that began in 200accelerated in the first quarter of 2009.

0

10

20

30

40

50

6070

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09

#

of

deals

Series A Series B Series C and Later Bridge

Number of Deals by Quarter

2005 2006 2007 2008 Q3 2008 Q4 2008 Q1 2009

Down 21% 21% 14% 19% 16% 26% 51%Flat 14% 14% 13% 12% 11% 18% 20%Up 65% 65% 73% 69% 73% 56% 29%

Up vs. Down Rounds*

*Series B and Later


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The table on the next page reflectscertain terms regularly used in venturefinancing deals.*

Overall, the data does not show that dealterms in the first quarter of 2009 (other thanvaluations) changed dramatically as comparto prior periods. Nonetheless, given howdifficult it is to raise venture money in thecurrent environment, it is not surprising to sthat the number of Series B or later financinwhere there is a pay-to-play provision for suround of financing increased. Pay-to-play

provisions are structured so that existinginvestors have to participate in the nextfinancing or else lose some or all of thebenefits they currently hold as preferredstockholdersthese provisions are sticksto encourage investment in new rounds offinancing.

*To see how the terms tracked in this chart might be uin the context of a financing, you can construct a drafterm sheet using the automated term sheet generatoravailable on wsgr.com.

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Summer 2009

From the WSGR Database: Financing Trends (Continued from page 3)

$9.2

$12.1 $12.4

$6.1$8.0

$20.0

$24.0 $25.0

$17.0$15.3

$0.0

$5.0

$10.0

$15.0

$20.0

$25.0

$30.0

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09

$M

Median Amount Raised Median Pre-money Valuation

Q1 08 - Q1 09 Series B

$12.0 $12.0 $10.8 $10.0 $9.0

$58.0$61.0

$40.0

$50.9

$24.5

$0.0

$10.0

$20.0

$30.0

$40.0

$50.0

$60.0

$70.0

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09

$M

Median Amount Raised Median Pre-money Valuat ion

Q1 08 - Q1 09 Series C and Later

$3.1

$5.0

$2.7$3.0

$2.6

$7.0$7.6

$5.7 $6.0

$4.8

$0.0

$1.0

$2.0

$3.0

$4.0

$5.0

$6.0

$7.0

$8.0

$9.0

Q1 08 Q2 08 Q3 08 Q4 08 Q1 09

$M

Median Amount Raised Median Pre-money Valuation

Q1 08 - Q1 09 Series A (Excludes Angel)


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Summer 2009

2007All Rounds2

2008All Rounds3

Q1 2009All Rounds3

2008Up Rounds4

Q1 2009Up Rounds4

2008Down Rounds4

Q1 2009Down Round

Liquidation Preferences - Series B and Later

Senior 50% 45% 45% 37% 29% 69% 60%

Pari Passu with Other Preferred 48% 53% 48% 61% 64% 21% 28%

Complex 0% 2% 5% 2% 0% 4% 8%

Not Applicable 2% 0% 2% 1% 7% 6% 4%

Participating vs. Non-participating

Participating - Cap 29% 28% 21% 31% 15% 26% 16%

Participating - No Cap 32% 30% 35% 25% 15% 38% 36%

Non-participating 40% 42% 44% 43% 69% 36% 48%

Anti-dilution Provisions

Weighted Average - Broad 88% 92% 91% 91% 100% 77% 80%

Weighted Average - Narrow 3% 2% 3% 3% 0% 4% 4%Ratchet 4% 5% 4% 3% 0% 9% 8%

Other (Including Blend) 5% 1% 1% 3% 0% 10% 8%

"Pay to Play" - Series B and Later

Applicable to This Financing 7% 6% 11% 2% 7% 21% 20%

Applicable to Future Financings 8% 7% 5% 7% 0% 11% 8%

No 85% 86% 84% 92% 93% 68% 72%

Redemption

Investor Option 32% 31% 39% 32% 36% 32% 36%

Mandatory 3% 3% 3% 3% 7% 4% 0%

No 65% 66% 58% 65% 57% 64% 64%

Private Company Financing Trends1(WSGR Deals)

1Numbers do not always add up to 100% due to rounding2Includes Series A rounds unless otherwise indicated3Includes flat rounds and, unless otherwise indicated, Series A rounds4These columns include only Series B and later rounds. Note that because the numbers in the All Rounds columns include Series A and flat rounds, they are in some cases outside the rangesbounded by the Up Rounds and Down Rounds columns.


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Summer 2009

6

Last years financial market collapse has madefor tough times for technology companies thattraditionally have looked to venture capitalists,venture lenders, or the public markets forfinancing. Venture capital investment in thefirst quarter of this year was down 47% interms of dollars and 37% in deals from thefourth quarter of 2008.1 After a banner year,capital investment in clean technologycompanies was down 63% in dollars and

48% in deals compared with the same periodin 2008.2 With potential customers cuttingback on purchase commitments, companieshave struggled to find sources of funding, andin many cases, to survive.

Government funding long has been availableto technology companies in the form of grants,loans, loan guarantees, tax incentives, taxcredits, and cooperative research anddevelopment arrangements that are cost-shared with the government. With the newAdministrations and Congresss focus on

mainstreaming renewable energy, ensuringenergy security and energy independence forthe United States, creating American jobs, andreducing greenhouse gas emissions, theAmerican Recovery and Reinvestment Act(ARRA) and 2009 federal budgetappropriations process already have directedtens of billions of dollars into programsadministered by federal, state, and localagencies to provide an immediate andsubstantial boost to the renewable energyindustry.

We expect this trend to continue in 2010 andbeyond. For example, the entire budget for theDepartment of Energys (DOEs) Office ofEnergy Efficiency and Renewable Energy forthe 2008 fiscal year was $1.7 billion, but theARRA alone provided the same office with anadditional $16.8 billion to commit by

September 2010. Given the state of thefinancial markets and the large amounts ofgovernment funding now available, technologycompanies, particularly those in the cleantechnology and renewable energy industry,should consider applying for some form ofgovernment funding.

For venture-backedcompanies, applying for

government funding maybe a foreign concept,approached only withgreat trepidation.However, in our firmsexperience withemerging technologycompanies and thegovernment, we havefound that thegovernment and venturecapitalists are not sodissimilar.

How do I decide which governmentfunding opportunities to pursue?

In the same way that certain venturecapitalists are known for their focus on certainindustries or on companies at a particularstage of development, each governmentfunding opportunity has a specific focus. Forexample, the DOEs Advanced ResearchProjects Agency-Energy (ARPA-E) fundingopportunity is targeted toward R&D-stagecompanies with transformational

technology, while the Advanced BatteryManufacturing funding opportunity focuses onshovel-ready projects for companies to createa domestic battery manufacturing industry forelectric vehicles, and specifically excludesR&D-stage companies.

Therefore, determining which solicitationsmight be useful should start with anassessment of your business and needs. Areyou an early-stage R&D company in need offunds to get to proof-of-concept? A later-stacompany in need of funds to put up amanufacturing or production plant? Isolate

what you want toaccomplish, theanticipated timing of yo

project, and your fundinneeds, and then assesswhich funding programsbest map to those of yocompanys business andscale of financial need.Federal agenciesfunding opportunityannouncements are listat www.fedconnect.orgState and local fundingopportunities are moredifficult to track becaus

of the sheer number of opportunities availaband the fact that a number of programs arestarting up with federal funds allocated tostates for various projects. A database ofstate renewable energy opportunities isavailable at www.dsireusa.org.

Given the number of applicants for eachfunding opportunity and the amount ofmanagement time (and in some cases, non-trivial sums of money) that can be expendedon a funding application, companies would well advised to make a very clear-eyed,

upfront assessment of which opportunities tpursue.

Is the Government Your New Lead Investor?A Technology Companys Guide to Making the Most of Government Funding Opportunities

By Sandra Pak Knox, Special Counsel (Palo Alto Office)

1 MoneyTree Report by PriceWaterhouseCoopers with the National Venture Capital Association and Thomson Reuters.2 Ernst &Young Cleantech Investment Group with Dow Jones VentureSource

With the government'snew focus, tens of

billions of dollars

already have been

directed into programs

administered by

federal, state, and

local agencies.


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Summer 2009

How do government agencies decidewhich companies to support?

Government agencies make decisions aboutwhich companies to back in much the sameway that venture capitalists do. Just asventure capitalists do not give handouts tocompanies based on financial need, neitherdoes the government. Each agency will makefunding awards to companies that it believescan best use its available funds (i.e., our taxdollars) to advance the agencys strategic

goals in particular target industries. Acrossthe board, we have found that governmentagencies ask the same basic set of questionsof applicants:

Is your projecttechnically sound?

When fundingapplications are reviewed,the bulk of the applicantsscore in most cases willbe based on the results of

the agencys technicalreview, which is to beconducted by reviewersschooled in the art of yourtechnology. Do you have good researchconducted by reputable scientists backing upyour claims? Do you have positive results fromsmall- or large-scale demonstrations of yourtechnology? Does your manufacturing processwork? Can you point to previous success inthis field to bolster your case? Applicants whoinspire the confidence of the government intheir companies technology are those most

likely to obtain funding.

Will funding your business help thegovernment achieve its policy objectivesand programmatic priorities?

The Obama Administration has high-levelpolicy objectives to mainstream renewableenergy technology, enhance energy securityand energy independence, reduce greenhouse

gas emissions, and create jobs; programswithin the federal agencies have more specificobjectives, such as developing the electricvehicle industry or encouraging partnershipsbetween academia and industry to collaborateon wind-energy technology research.Companies that are able to make the casethat their project will help the applicableagency achieve these goals quickly and withgreater success are more likely to receive agovernment funding award.

Is your project plan financially feasible?

In most cases, a separate financial reviewof your application will be conducted by

people who aresophisticated in suchmatters, includingmajor consulting firmsand accounting firmswho are retained toassist the applicableagency in applicationreview. Are your

spending plans andrevenue projectionsrealistic? Is the timingyou propose for the

commencement and completion ofyour project supported by reasonableassumptions? Overly optimistic projections arelikely to be viewed as just that, and maydetract from the credibility of an otherwisestrong application.

Do you have an experiencedmanagement team that inspires

confidence that the project can becompleted as planned?

Just like venture capitalists, the governmentwants to bet on horses that have won in thepast and are likely to win again. Anexperienced management team with pastsuccesses in a similar industry gives thegovernment confidence that it is backing acompany that will put taxpayers money to

good use. This is particularly important withrespect to funding obtained through ARRAprograms; the intense focus on weeding outwaste, fraud, or abuse of taxpayer fundsdistributed through these programs putsadditional pressure on the government to pilikely winners who will run their companiesa trustworthy and ethical manner that willachieve success.

Do you have good references?

When your funding application goes into thehopper at a particular agency, it is likely to bcompeting with many (possibly hundreds of)other applicants for the attention of theagencys reviewers. How will you differentiyourself?

One way is to try to get to know key peoplewithin the relevant departments or programand introduce your technology to thoseindividuals well before your application issubmitted. If you are able to meet with theskey individuals, you should treat that

opportunity as you would an opportunity topresent to a venture capitalist. Prepare welluse your time wisely, and have a succinct,high-impact presentation that will leave apositive and lasting impression of you andyour company that will give you namerecognition when applications are reviewed

In addition, try to make yourself known atindustry conferences and through positivemedia coverage. The program managers andapplication reviewers are going to the sameconferences and reading the same press

that you are; become a familiar face whosepresence in the application pool will beexpected and sought out by the grantingagency.

Do your traditional investors have skin the game?

Most funding opportunities have a cost-sharing requirement (or equity investment

Just as venture

capitalists do not give

handouts to companies

based on financial

need, neither does the

government.


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Summer 2009

requirement in the case of loans and loanguarantees) typically mandating that 20 to50% of the proposed project cost be borne bythe applicant company. One of the goals of theARRA is to bring skittish investors off thesidelines, and requiring cost-sharing or anequity investment alongside debt financingprovided or guaranteed by the government isone way to accomplish that goal. Thegovernment also has found that the higher theproportion of project cost borne by theapplicant, the higher the likelihood of successof the project, because the applicant is

literally more invested in the project. Notethat cost overruns will not be cost-shared bythe government, but borne by the applicant.Yet more reason to make sure that your costprojections are as realistic as they can be.

How is the government different from atraditional venture capital investor?

There are a few key differences, including:

No equity investment. The governmentsinvestment is not an equity investment

(though there has been some discussion aboutwhether this should continue to be the case).So long as government funding is in the formof grants, loans, or loan guarantees, your

traditional equity investors will have fargreater control from a stock ownershipperspective relative to the percentage ofcapital they have invested. Particularly if anequity investment is contingent upon receiptof a government funding award, you mustconsider the effect of this dynamic on thecompanys valuation when negotiatinginvestment terms with those investors.

More process, a different kind of control.The Energy Secretary is not going to come toyour board meetings if you receive funding from

the DOE. However, starting with the applicationprocess itself, you will be subject to strictprocedural requirements, and if you receive anaward, you will be subject to governmentcontracting regulations that sometimes can bequite onerous, especially compared to theinformation rights that are granted to boardmembers and key investors in a venture-backedcompany. Government funds come withrestrictions regarding the manner in which theymay be spent, and may require that anawardee company institute new accountingprocedures to ensure that the necessary

tracking and reporting can be done accuratelyand on a timely basis. If you are selected tonegotiate a funding award with a governmentagency, please consult with experienced

government contracting accountants andattorneys so that you understand and areprepared to meet these requirements.

Intellectual property rights of thegovernment should be understood andnegotiated wherever possible. Eachfunding program will have intellectual properights provisions in the relevant fundingopportunity announcement that should beconsidered when formulating an applicationand in negotiating a funding award. Thegovernment may have certain rights in

technology created using a funding awardby statute, or there may be flexibility tonegotiate those terms. Questions for anapplicant company to ask include: Does theBayh-Dole Act apply to me? If so, what doesthat mean? What position is the applicableagency likely to take when they arenegotiating intellectual property rights undeTechnology Investment Agreement? Will I beable to commercialize my technology asplanned, domestically and overseas, if I usegovernment funding? Companies shouldconsult with experienced government

contracting and intellectual property attorneto structure the award to preserve maximumflexibility to commercialize technologydeveloped using government funding.

Is the Government Your New Lead Investor? (Continued from page 7)

Cozying Up to Goliath: The Pros and Cons . . . (Continued from page 1)

perceived value they believe will be createdby virtue of them doing business with you. Ifthis is the case, your partnering deal is likelyto include a purchase option for your company.

Common Ground

I now have the benefit of having raised moneyor otherwise partnered with seven strategicinvestors over the course of five start-ups duringthe past two decades. With significant hindsightas my guide, I now believe that there areprimarily two scenarios where it is beneficialto take money from a corporate investor:

1. Access to new markets via partnerdistribution. In this instance, the investoragrees to distribute your product tomarkets that they dominate; ideally, these

markets are both large and cleanlyseparated from your existing distributionchannels. This kind of operating leveragemakes it worth taking on a corporateinvestor along with the potential pitfallsthat accompany this type of relationship.Early on in my career, my company soldIBM 10% of its stock in return for IBMdistributing a version of our software to

their customers through their massivesales force. They guaranteed a certainlevel of revenue and the product was tito their operating system. It worked

incredibly well for both parties, and wewere able to go public largely on the baof our mutual success. At a differentcompany, we took on a strategicinvestment from Cisco in return for a larinternal software license plus adistribution agreement that brought ourtechnology to their sizable customer basin Japan. It allowed us to safely and


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Summer 2009

quickly enter a new market and rack upmillions of dollars in revenue with littleoperating risk.

2. Access to proprietary technology. Inthis case, you take the investmentbecause it is coupled with a license tocritical (and potentially patented)technology that you would otherwise findchallenging or impossible to develop onyour own. If the technology is clearlygame-changing and you can box outpotential competitors from also gaining

access to it, a strategic investment easilycan make sense. I had a positiveexperience with Intel many years ago,where they spent tens of millions ofdollars developing a technology but werechallenged with bringing it to market. Mycompany exclusively licensed thetechnology from them, packaged it forsale to our customers, and quickly built itinto a multimillion-dollar revenue stream.They invested in our company andultimately profited from both the licensefees associated with the technology and

the sale of our company two years later.

Taking an investment from a corporate partnersimply because they are a very large customer(or plan to be) is typically not a good reason todo this kind of deal. You have all the potentialissues mentioned below, without adding anysignificant leverage to your business.Similarly, raising money from a strategicpartner as a means of getting closeri.e.,in hopes of some future operating agreementis generally not a sufficient rationale.

Common Pitfalls

The following are the more frequent commonpitfalls associated with raising money fromstrategic partners:

Stamina. Corporate venture investorsgenerally have a reputation for beinginterested in strategic investing when marketsare good. But when economic times are tough,the corporate VC group is often among the

first casualties. It is fairly routine to seecorporate VC funds turned into caretakers,sold off at a steep discount, or entirelyshuttered. Unfortunately, this usually occursexactly when the entrepreneur needs anengaged and supportive investor team. If youare hitting the road for a challenging follow-onround, you cant afford to also be scramblingto explain and fill in a new hole in yourcapitalization table.

Polarity. The presence of a well-knownstrategic investor on your capitalization table

(and perhaps on your board) can presentproblems later in life when youre trying toenter into a strategic relationship with one ofthat investors major competitors.Downstream deal-making can be verychallenging when the prospective partner isconcerned about information being sharedupstream, or when deal champions worryabout losing points internally for doinganything that can be perceived by their peersas aiding and abetting the balance sheet ofthe enemy. Why should they help theircompetitor when they can build a similar

relationship with yourcompetitor?

Absenteeism. This pitfall falls into thefrustrating but not fatal category. Unliketraditional venture capital and private equityinvestors, the individuals behind a corporateinvestment often have a different day job.They are being paid to run their businesses,not yours. Despite their best intentions, I foundthat getting operating executives to burn roadtime on your behalf is nearly impossible.

Entanglement. Finally, the more your

strategic partner puts into the operatingagreement portion of the deal, the greater thechance that your investment will come withsignificant strings attached. If the strategicinvestor is helping to make you an importantplayer in your shared industry, they will wantto be sure your company isnt easily snatchedup by somebody else. This concern typicallymanifests itself in some form of Right of FirstRefusal (RoFR) or Right of First Offer (RoFO) aspart of the investment agreement. Many early-

stage companies will want to avoid this deafeature, but if you are pressed on the mattetry to negotiate a time constraint so thatyoure freed up if they dont move within thefirst year of the arrangement. In the one caswhere we were stuck with an unboundedRoFR, it nearly derailed an acquisition. Theprospective acquirer refused to negotiate adeal price unless the strategic investor agreto waive their RoFR. There was little incentifor our investor to waive the right to acquireus, but after numerous very intensivediscussions, we ultimately convinced them

that they should. Of course, this did little tothen help us maximize priceour suitor hadflushed our greatest leverage point completout of the picture.

Conclusion

Every deal is different, but the patterns andpitfalls associated with strategic investors anow well chronicled and understood. Theyhave repeated themselves through multipleeconomic cycles and across virtually alltechnology sectors. As a start-up company

executive, its your duty to distance yourselffrom the emotional and qualitative argumenassociated with taking capital from a strateinvestor. Instead, you must relentlessly insisthat any investment be associated with realoperating leverage and without theentanglements that can sub-optimize aliquidation event. Follow these rules and yocan land a strategic investor deal that stronpositions your company for growth, withoutmisdirecting your energy or sub-optimizing tfinal outcome.

Dave Panos is the CEO and co-founderof Pluck Corporation, a social mediasoftware pioneer that successfully soldto Demand Media in early 2008. Anexecutive in five early-stage softwarecompanies, Dave also spent two yearsas a venture partner with AustinVentures. Dave can be reached [email protected].

Cozying Up to Goliath: The Pros and Cons . . . (Continued from page 8)


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Summer 2009

When entering into commercial contractsduring uncertain economic times, it isimportant for a company to contemplate theconsequences of a counterparty becominginsolvent or otherwise failing to perform.While such considerations are prudent for allcompanies, they can be particularly critical forearly-stage companies, which inherently tendto have fewer contracts and less

diversification and, consequently, may bedisproportionately harmed by the failure ofone or more commercial relationships.

When a counterparty to a commercial contractfails, there are a variety of potentialconsequences for the other company. Thespecific consequences depend on the natureof the relationship, the type of failure, andwhether or not the failing party files for, or isinvoluntarily forced into, bankruptcyprotection. In most cases, a party can mitigatethe risks of a worst-case outcome by

negotiating protective provisions at the outsetof the relationship, by paying attention to thecounterpartys performance, and by takingaction before a bankruptcy petition is filed.

Bankruptcy Law

To understand the risks, one has to knowsome basics about the overlay of bankruptcylaw. First, because bankruptcy law is a body offederal law, it takes precedence over (orpreempts) commercial arrangements, whichare governed by state law. In other words, if

bankruptcy law requires one outcome and acontract provides for a different outcome, theoutcome dictated by bankruptcy will prevail.One of the more important provisions ofbankruptcy law (and an illustration of theconsequences of preemption) is theimposition, effective immediately upon thefiling of a bankruptcy petition, of an automaticstay, which is in essence a wall that dividesthe failing partys world into pre-bankruptcy

and post-bankruptcy periods (also called pre-petition and post-petition periods). Theautomatic stay severely limits the ability ofaggrieved counterparties to take any actionagainst the failing party without the approvalof the bankruptcy court, even if there is anexplicit contract provision to the contrary.

Payment Issues

A primary purpose of bankruptcy law is toensure that when debt claims are too muchfor the failing party to handle, those claimsare processed in anorderly manner. Thus,claims for paymenton amounts that relateto pre-petitionperformance must bebrought before thebankruptcy court. If theclaim is unsecured

meaning there is not alien or other securityinterest that serves ascollateral for the debtthen the party owedpayment under that claim will stand at theback of the line, behind aggrieved parties thathave secured collateral or that are otherwisegiven priority status, and fight to collectpennies onthe dollar.

A party can mitigate payment risk by getting

and perfecting a security interest in collateral,or something that approximates this kind ofprotection, e.g., a performance guaranty froma credit-worthy third party, such as a parentcompany, or a letter of credit from a bank thatcan be drawn upon to make payment. Gettingthese protections is easier said than done,however, and in many cases these are notpractical options. But even where theseprotections are not possible or practical, a

party can mitigate payment risk by requiringpre-payment, or including a right in thecontract to suspend performance of servicesor shipment of goods following nonpaymenta contract does not have these protections athe outset, it might be possible, when acounterparty begins to fall behind on itspayment obligations, to amend the contract put such protections in place or to otherwise

reduce the counterpartys credit and paymenperiod. But due to the limitations imposed bthe automatic stay and other aspects ofbankruptcy law, timing is important and can

affect the validity of anysuch amendment; thus, is important to closelymonitor payments.

Termination Rights

Many contracts containexpress rights to termina

in the event the otherparty is subject to abankruptcy filing. Butbecause of the automatstay, that right cannot be

exercised without the approval of the court,which in the absence of extraordinarycircumstances, is unlikely to be granted. Inmany cases, being held in a contractualarrangement while the bankruptcy processplays itself out may be perfectly acceptablebut often this can leave parties in limbo whwaiting to find out whether the agreement

ultimately will survive.

If it is important to be able to exit arelationship upon signs of instability, then thtermination rights need to be carefullystructured so that the right to terminate arisprior to the actual filing for bankruptcy. Thismeans identifying events that are commonprecursors to a bankruptcy filing (such asmaking a public statement regarding financ

Mitigating Risks: Contracting Considerations in a

Down Economy

By Paul Huggins, Eric Natinsky, and Jay Reddien, Associates (Austin Office)

In most cases, a party

can mitigate the risks

of a worst-case

outcome by negotiating

protective provisions at

the outset of therelationship.


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Summer 2009

difficulty or amending a credit facility) orproviding a more general right to terminateupon a material change in financial condition.Additionally, a company procuring goods orservices can mitigate risk due to the failure ofa vendor by insisting upon termination rightsin the event of an uncured material breach ora number of immaterial breaches, becausesuch breaches may indicate that thecounterparty does not have the resourcesneeded to support its business. Further,deeming the non-payment of anyamount to be

a material breach and providing for a shortercure period for non-payment than for othermaterial breaches can further mitigateexposure. But these rights only help if usedbefore the bankruptcy filing, and so it isimportant to promptly send notices of default,and to be diligent and precise in complyingwith notice provisions, in order to start thecure-period clock running and reduce orpreclude arguments that rights of terminationhave not arisen.

Conversely, as part of the bankruptcy process,

the bankrupt party canreject, and therebyterminate, certain types of contractsgenerally, any contract that has unperformedmaterial obligations of both parties. This rightis provided by federal bankruptcy law and,thus, is available to the failing party even ifthe contract does not expressly provide such a

right. If the failing party exercises its right toreject a contract, the other party will be leftwith an unsecured claim for damages.

Integrity of Inbound Licenses toIntellectual Property

As an exception to the bankrupt partysgeneral right to elect to terminate a contract,parties holding a license to the bankruptpartys intellectual property, including patents,copyrights, mask works, and trade secrets (but

nottrademarks), are afforded specialprotections under Section 365(n) of the U.S.Bankruptcy Code. In short, a license within themeaning of Section 365(n) will be preservedirrespective of whether the contract grantingthat license is rejected by the bankrupt party.In other words, the right to use intellectualproperty within the scope of the licensegranted by a licensor that subsequently failswill be unaffected by a bankruptcy filing. Thatis good news for the licensee and underscoresthe importance of being explicit that a licenseis intended to fall under Section 365(n).

The bad news is that, while the license ispreserved, the license agreement itself canberejected. Accordingly, if a failed licensor hasongoing performance obligations (e.g.,development work, maintenance, and supportobligations), it can get out of those obligations

by rejecting the license agreement. If thecontract is rejected and the license grant isnot broad enough to enable the aggrievedlicensee to support the intellectual propertythe licensee may not have very useful rightsAnd even with broad use rights, if the licensdoes not have access to the source materia(e.g., source code, blueprints, and technicalinstructions) or personnel with know-how, tuse rights may be significantly handicapped

Consequently, if an inbound license to

intellectual property is of vital importance anmere use rights are not in and of themselvessufficiently protective, it can be criticallyimportant to require that relevant supportingmaterials be placed into a third-party escrowaccount, to carefully define the release trigg(e.g., material breaches of performanceobligations, insolvency, and termination of thcontract by licensee for cause) and, ifapplicable, provide for expanded use rightsupon release, so that the licensee can accesthe materials and use them to support itslicense. Here again, monitoring performance

can help to mitigate risk. If a licensee whonegotiated for source materials to be placedan escrow account never bothered to verifydelivery or periodic updates, it may be leftwithout access to those source materials popetition and left at the back of a line with anunsecured breach-of-contract claim.

Tools

WSGR TERM SHEET GENERATORAlways looking for ways to better serve the entrepreneurial community, Wilson Sonsini Goodrich & Rosati is pleased to offer the WSGRTerm Sheet Generator, an online tool that allows entrepreneurs and investors to generate an initial draft of a term sheet for a preferredstock financing. The tool is publicly available on our website at www.wsgr.com. By answering a series of questions, users are guidedthrough the principal variables contained in a venture financing term sheet. Brief explanations of the questions and typical deal terms areincluded. After answering as many questions as desired, users can generate, print, and save a Word version of the term sheet, which isintended to be useful in deal discussions between entrepreneurs and investors and in crafting a final, customized term sheet with thehelp of attorneys. Please go to http://Display.aspx?SectionName=practice/termsheet.htm to learn more.


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Summer 2009

Fundraising in todays tight capital marketsmay present entrepreneurs and boardmembers with unique challenges.Entrepreneurs may find that it is difficult toidentify new, outside investors that are willingto participate in a round at a valuation thatreflects the companys progress as viewed bymanagement and insider stockholders.Companies may find themselves with fewerfinancing opportunities and may have an

immediate need for cash to fund operations,begin critical projects, or make payroll. Insituations where companies have limitedalternatives or have to rely on inside investors,it is particularly critical that they implement aprocess whereby they can balance the need tobring in that vital cash infusion with therequirement that the board and managementmaintain an appropriate level of oversight tosatisfy their fiduciary duties and lessen therisk of stockholder litigation.

Good Process Leads to Good Substance

Corporate law generally holds directors to astandard of conduct that ensures that theyaddress the various interests involved,carefully weigh important decisions, consultwith appropriate advisors, and discloseconflicts of interest. In theory, implementingprocedures early in a transaction to ensurecompliance with such fiduciary duties willlead to an optimalor at least a more fairresult when looking at the transaction throughthe eyes of the stockholders as a group.

In recognition of these principles, courts haveprovided certain protections for the benefit ofdirectors and the decisions they make whereminimum standards of board conduct are met.For example, the business-judgment rulegenerally provides that if directors complywith their fiduciary duties of due care, loyalty,and good faith (further discussed below), most

state courts will not second-guess thebusiness judgment of the board. Further, evenin many cases where a director has a financialor other interest in a transaction (such that itmight be considered an interested-directortransaction), the transaction may beprotected from invalidation on that basis aloneif the directors interests are fully disclosedand it is otherwise approved by a majority ofthe disinterested directors or the stockholders,

or if it is ultimately determined to be fair tothe stockholders as a group. Whether or not atransaction is fair to the stockholders will bedetermined by reviewing the transaction underthe entire-fairness standard. The entire-fairness standard encompasses two majorconcepts: fair price and fair process (i.e.,timing of the transaction; how it was initiated,structured, negotiated, and disclosed tostockholders; and how the approvals of thedirectors and stockholders were obtained).

The rationale underlying the business-

judgment rule and upholding certaininterested-director transactions is that riskybusiness decisions are better left to thoseimmersed in the operations of the businessand the surrounding circumstances rather thanjudges and legislators. Directors should not beviewed as guarantors of success or guardiansagainst mistakes. Directors do not have to beright in every decision so long as they satisfytheir fiduciary duties in good faith.

Understanding the Fiduciary Duties

Directors are subject to the duty of care, theduty of loyalty, and the duty of good faith, asdescribed below:

Duty of Care. Directors must inform themselvesof all material information reasonably available(which includes seeking input from relevantmembers of management); engage in a

deliberate decision-making process; seekadvice from lawyers, accountants, andbankers when appropriate; consider the shorand long-term effects of a decision; and weigthe risks associated with making a decision,including a decision not to act.

Duty of Loyalty. Directors must not takeadvantage of corporate opportunities at theexpense of the company and shall refrain fr

self-dealing.

Duty of Good Faith. This is generallyconsidered a directors duty to act with anhonest purpose and without a disingenuousmindset.

It is important that a board implementprocedures to ensure that it discharges itsfiduciary duties, especially with respect totransactions that involve interested directorTherefore, companies should implementprocedures engineered to maximize

compliance with fiduciary duties andminimize, or at least fully disclose, conflictswith respect to a given transaction andappropriately evidence such actions.

Accordingly, and in l ight of some of theprotections for directors and their decisionsdescribed above, this article focuses on thedecision-making process rather than thesubstance of the decisions themselves.

So What Do You Do?

Certain steps can be taken to minimize aboards exposure to liability from stockholdeclaims in connection with the fundraisingprocess, particularly where one or moredirectors or funds affiliated with them areparticipating as investors in the financing. Anumber of these are practical and easy toimplement, and often make good business

The Fundraising Process: Best Practices for Entrepreneur

and Directors

By Robert Housley and Evan Kastner, Associates (Austin Office)


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Summer 2009

sense from the standpoint of maximizingstockholder value. Others are more formalisticprocess protections that have proven to bebeneficial under scrutiny by trial courts.

It is important to be mindful of best practicesfrom the very onset of the fundraising process.While there usually will be a sense of urgencyto close a venture financing once a term sheetis signed, often six months or more will have

passed from when a company identifies theneed to raise money to when it finally signs aterm sheet and advances to a closing.Therefore, it is crit ical to contemporaneouslyconsider these best practices throughoutthis entire process to create a clear recordevidencing the companys deliberationsand discussions.

Cast a Wide Net

Make your companys fundraising pitch to asmany potential investors as possible. Reach

out to the investors who are known to makeinvestments in your companys space; take afresh look at whether it makes sense to bringin strategic investors (see Cozying Up toGoliath on page 1); even consider makingovertures to investors who have previouslypassed on making investments in yourcompany. If a board is required to demonstratethe fairness of a financing transaction in theface of a stockholder challenge, showing thatthe company canvassed the community ofpotential investors can be strong evidencethat the company tried to obtain the best

terms for its stockholders that it couldparticularly in the case of an inside-led round,where it may be helpful to show a lack ofinterest from outside investors on morefavorable terms.

Compliance with a boards fiduciary dutiesdoes not require it to turn down a term sheetjust because the terms are tough. However, a

board should be prepared to show that itmade an informed decision in approving afinancing. Having as many data points aspossible demonstrates that the board wasadequately informed.

Keep Detailed Records

When your company does receive a financingterm sheet, whether from an outsider or for an

inside-led round, the company is likely tohave pressing short-term cash needs andmay want to close quickly. A displeasedstockholder may seize on this as evidencethat the board did not carefully consider theterms, did not actively weigh the financingalternatives, or that the transaction was notfair to the stockholders. In order to dispel anysuch perception, the officers and directorsprincipally involved in the fundraisingprocess should carefully document each stepof the process.

Make sure board discussions of fundraisingalternatives and status are recorded inmeeting minutes during the months leading upto the financing. Save copies of meetingrequests, presentation materials, and othercommunications with potential investors(including no, thank you correspondence).Make it a habit to jot down notes after eachinvestor meeting or telephone conference witha brief explanation of the results. Follow up onpotential leads and inform the board of thecurrent status of all discussions. Then, even ifyour company is required to move quickly to

close a fundraising, the board still candemonstrate that the company engaged in amethodical, well-informed negotiation andapproval process.

Inform Stockholders

Throughout the course of fundraising, considerkeeping stockholders who may not otherwise

have day-to-day visibility into the processinvolved and apprised. If the board is calledupon to defend the fairness of an interesteddirector financing transaction in the face of stockholder challenge, it may be helpful todemonstrate consideration of minoritystockholder interests and solicitation oftheir feedback during the transactionnegotiation process.

From a practical perspective, stockholders ware kept informed or consulted during thefundraising process may be less likely toinstigate a stockholder lawsuit; they also mabe more cooperative during the closing proce(e.g., submitting signatures required of themon a timely basis). For example, if initialinvestor feedback indicates that the companis likely to receive a low valuation or that arecapitalization may be necessary as acondition to their investment, you may notwant to surprise your stockholder base withthis information late in the fundraising proce

Maximize Stockholder Approval

Your companys charter documents orapplicable corporate law typically willnecessitate obtaining approval from yourstockholders as a whole before you can closa financing transaction. There also may beseparate approval requirements associatedwith specific series or classes of yourcompanys stock. However, you also shouldconsider whether seeking separate approvafrom other groups of your stockholders wou

be beneficial, even where such approvals arnot legally mandated.

For example, if as part of a financingtransaction current holders of preferred stocare treated more favorably than holders ofcommon stock, you should consider obtaininseparate approval from the holders of amajority of the outstanding shares of comm


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Summer 2009

stock. You also might consider obtainingapproval from the holders of a majority of theshares held by stockholders who are notparticipating as investors in the financing.Obtaining these separate approvals mayprovide your board with an advantage in itsdefense of an interested-director financingtransaction. Additionally, actively seekingthese approvals may help you identify inadvance of closing a financing whichstockholders are likely to object to its terms.

Conduct a Rights Offering

Consider conducting a rights offering inconnection with your financing. This involvessetting aside a meaningful portion of theshares or debt being sold in the financing andmaking them available for purchase byexisting stockholders. Generally, a substantialmajority of the securities being offered in afinancing are sold to one or a few leadinvestors who negotiate the terms of thefinancing with the company. However, werecommend that you offer your otherstockholders (at least those who are

accredited for the purposes of applicablesecurities laws) the opportunity to maintain at

least their pro rata ownership in the companyby investing alongside the lead investors onthe same terms.

This can be strong evidence of the fairness ofthe financing in the face of a stockholderchallenge. This also may foster goodwill withstockholders who may otherwise feel thatthey are being excluded from the process ordisadvantaged by the terms of the financing.

Special Committee; Fairness Opinion

If your financing could be considered aninterested-director transaction, your boardshould consider whether it would bebeneficial to empower a special committee ofindependent directors to negotiate on behalfof the company and approve the terms of thefinancing. While the use of a specialcommittee does not in itself insulate a boardfrom liability for breach of fiduciary duty inconnection with a financing, in some casesthe use of a truly independent specialcommittee can shift the burden ofdemonstrating that the transaction was not

fair to the party challenging an interested-director transaction (as opposed to the board

bearing the burden of demonstrating thefairness of the transaction).

While it is not cost effective, a board also mconsider engaging an outside financial advisto render an opinion to the board or specialcommittee that the transaction is fair to thestockholders (generally referred to as afairness opinion). This assists the board incarrying out its fiduciary duty of care, andhelps it defend the fairness of an interesteddirector financing transaction.

Conclusion

Interested-director and fiduciary-duty issuescan be complex and fact-specific and may vby jurisdiction, but with the assistance of lecounsel, there are steps that companies matake to maintain a high level of oversight antransparency in a challenging financingmarket. Entrepreneurs can help focus theboard on potential issues early and implemeprocedures that should lead to good decisiomaking, disclosure, and, ultimately, a betterresult for all stockholders as a group.

The Fundraising Process . . . (Continued from page 13)

The Non-dilutive Cash Injection: Selling Your Patents (Continued from page 1)

Who is buying? Specialized private equityfunds, specialized start-ups, large and mediumcorporations, licensing organizations, anddefensive patent pools. Depending upon thepatents in a transaction, there may be more

than 50 buyers to contact. The mix ofbuyersand their interestschanges often,but it has been, and continues to be, an ever-growing pool.

Who is selling? The sellers pool is similarlylarge and growingfrom Fortune 500corporations to individuals and small

corporations, and from bankrupt companies touniversities. Investors, in particular, are findingthat patents are one of the few underexploiteddistressed assets that are also uncorrelatedwith the broader markets.

The patent-transaction market today breaksdown into two broad categories: (1) high-quality patents with high market impact and(2) everything else. Even during this recession,the first category has seen prices increase.The second category, however, has witnesseda steep decline.

How Do We Participate?

For context, here is an example of the kindstransactions we have done at ThinkFire: Aventure-backed company is running out of

cash. An infusion of a few million dollarscould bridge them to a crucial partnership ofinancing deal. The company has a fewpatents issued and a few more pending. Byselling some of their patents, the companyraises cash without impacting their productoffering or operations, and without dilutingtheir shareholders.


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Summer 2009

Whether you use a broker or not in thisprocess, the first step is developing the salespackage, which typically includes:

Patentsoverview and specific patentnumbers

Third-party data on the impacted market Important patent claims Seller background Estimated price range

The sales package is then distributed to likelybuyers. Over a period normally ranging from

45 to 90 days, buyers review the materialsand ask questions about the market data, thepatents, and the bidding process. Bids arethen accepted and sales are typically closed inthe following 45 days.

Many sellers use brokers and some buyersprefer to buy from qualified brokers, whousually provide the following services:

Creating the sales package, includingidentifying the important claims

Contacting the buyers

Answering buyer questions Running the bidding process Helping to set price expectations Providing sellers with the current state

of the patent market Acting as a sounding board for deal

terms Helping to close the sale

Often, brokers do this work on a contingency-fee basis, so there is no cost to the seller ifthe deal does not close. Depending on thecomplexity and expected price, the range of

fees is typically 15 to 30% of the sales price.

Finding the Right Price

Pricing the patents may be the most difficultpart of the sales process. Valuations canrange from zero to millions of dollars for the

same patents. One might assume that theprice range varies due to the differentinformation possessed by each of thepotential buyers. For example, finding an asyet undiscovered problem with the patentscan lead to a zero valuation. Similarly, aprospective purchaser may have bettercomparables data. Since there is no multiplelisting service (MLS) for patent transactions,only a few large buyers and brokers haveinformation on enough transactions to reallyhelp here. But even when all the parties havethe same market, patent, and pricing data, the

valuations can vary considerably.

The primary reason for this variation is thatpatent value is context specific, with thecontext of the owner dictating the value. Forexample, a patent held by a licensing companycan generate multiple royalty streams, whilethat same patent held by a start-up is unlikelyto generate any. That makes the net presentvalue for each potential owner significantlydifferent. Thinking about who the potentialbuyers are and how they would use thepatents is a critical element in pricing and,

ultimately, obtaining a higher valuation.

Importantly, keep in mind that, in any context,the sales price is also significantly lower thanthe cumulative future royalty stream. Where abusiness case exists for $100 million in futureroyalties, when risk adjusted, the samepatents likely will sell for $1-10 million. Asurprisingly large discount, but the patentlicensing risks are numerous and large, andthe investment is likely to be slow to yield anyfinancial returns.

What Happens After You Sell?

After the sale has closed, you now can usethe proceeds to move forward. Imagine a fewyears into the futureyour company hasannual revenues greater than $50 million, forinstance, and big competitors have begun to

enter the same market. These competitorsmight have patents that are a concern.

But you are prepared to meet these challengbecause you planned ahead. Your companykept a license back in the patent sale, so yoknow that your former patents will not beused against you. Also, you never stoppedinnovating and you continued your patentprogram. You've also bought a few companialong with their patent portfolios. Now,because of your increased revenue, you canparticipate in the patent market as a buyer t

purchase patents to address the specificthreat posed by your competitors. In otherwords, by selling your patents early, you gavyourself the cash to move the businessforward, and the time and resources to rebuyour patent portfolio.

Other Structures for Monetizing Patents

There are other structures that you can use make money from your patents. Licensing,hybrid licensing-brokering, or patent pools(depending on your specific market) all can

yield attractive returns. Licensing your patencan involve planning and executionrequirements as complex as productdevelopment and launch. As such, it is oftentoo much of a distraction for the patentowners to pursue as a strategy. However, yocan spinout the patents to a limited liabilitycorporation (LLC) responsible for licensing aparticipate as a limited partner. As a limitedpartner in the LLC, you can receive revenuefrom the licensing activities without control or direct responsibility for managing, thelicensing process. This structure allows

tremendous flexibility. For example, once seup, the LLC can pursue hybrid models oflicensing some companies and then selling tpatents to another company or group.Transferring the patents or patent rights to athird party in exchange for a portion of futurlicensing fees is a relatively common

The Non-dilutive Cash Injection: Selling Your Patents (Continued from page 14)


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Summer 2009

650 Page Mill Road, Palo Alto, California 94304-1050 | Phone 650-493-9300 | Fax 650-493-6811 | www.wsgr.comAustin New York Palo Alto San Diego San Francisco Seattle Shanghai Washington, D.C.

For more information about this report or if you wish to be included on the email subscription list, please contact Eric Little ([email protected]).There is no subscription fee.

This communication is provided for your information only and is not intended to constitute professional advice as to any particular situation.Please note that the opinions expressed in this newsletter are the authors and do not necessarily reflect the views of the firm or other Wilson Sonsini Goodrich & Rosati attorneys.

2009 Wilson Sonsini Goodrich & Rosati, Professional Corporation. All rights reserved.

Editorial Staff:Derek Willis, editor-in-chief (Austin); Mark Baudler (Palo Alto); Doug Collom (Palo Alto); Herb Fockler (Palo Alto); Craig Sherman (SeattYokum Taku (Palo Alto)

Knowledge Management Staff:Eric Little, Heather Crowell

practice (for example, MPEG LA acts as aclearinghouse for MPEG patents). All of theseoptions can result in significant revenues;

however, the time to money can be too long for acash-squeezed start-up.

Kent Richardson is the general manager ofthe Silicon Valley office of ThinkFireServices, a leading patent brokerage,licensing, and strategy consulting firm that

includes leadership from several of theworld's most-renowned IP organizations,such as Lucent/Bell, IBM, Cisco, and

Rambus. Kent advises clients on patentstrategy, management, and licensing.He has licensing and marketing patentportfolio experiences resulting in morethan $600 million of patent licensebookings. Kent can be reached [email protected].

Erik Oliver is the managing director of theSilicon Valley office of ThinkFire ServiceWith licensing experience involving

several hundred million dollars of patentand technology licenses, Erik advisesclients on patent strategy, management,and licensing. He can be reached [email protected].

ENTREPRENEURS COLLEGE

In 2006, Wilson Sonsini Goodrich & Rosati launched its Entrepreneurs College seminar series. Presented by our firms attorneys, the seminars in eachsession address a wide range of topics designed to help entrepreneurs focus their ideas and business strategies, build relationships, and access capitaIn response to attendee demand, there also are occasional additional sections that address issues of concern to particular industries. Currently offeredevery spring, the sessions are held at our Palo Alto campus and are webcast live to our national offices. These events are available to entrepreneurs anstart-up company executives in the Wilson Sonsini Goodrich & Rosati network, which includes leaders in entrepreneurship, venture capital, angelorganizations, and other finance and advisory firms. For more information, please contact Norilyn Ingram ([email protected]).

REMAINING SPRING 2009 SESSIONS

Events

Clean Tech Session, July 1An in-depth look at the important issues that entrepreneurs need tomaster in order to grow their clean tech ventures. Whether you have adeveloped technology or are merely interested in getting involved in the

clean tech industry, this session will guide you through the stages in thelife cycle of financing your venture and bringing your ideas to themarketplace.

Exits & Liquidity, July 15An exploration of recent developments in exit events, including the IPOprocess and M&A trends. Provides an understanding of the expectationsof investors and the public capital markets and covers the recentcorporate governance and regulatory issues involved in liquidity events.

Board Relations & Corporate Governance, July 18A discussion of key issues in dealing with your board of directors,including the composition of the board, how to run board meetings, anddealing with conflicts of interest. Explores the important details of good

corporate governance for private companies and how to prepare yourcompany for future growth.

Biotech Session, July 29An examination of the issues that biotech entrepreneurs shouldconsider when starting their ventures. Explores the process for acquiringa core technology, from both universities and big biotech andpharmaceutical companies. Discusses how these agreements will affectyour ongoing business operations, partnering activities, and exit andacquisition opportunities.

WSGR Entrepreneurs Report Summer 2009

Documents

Transcript of WSGR Entrepreneurs Report Summer 2009