The recent $1 Billion Qualifying Therapeutic Discovery Project Credit program will be a real benefit to many area small life science and medical device companies. A surprise to many though when reading the requirements of the program is that limited liability companies (LLCs) that have as an owner a tax-exempt organization are not eligible for a grant under the program. Having a tax-exempt organization as an owner is more common than one might think. Many university technology transfer offices, such as the Wisconsin Alumni Research Foundation (WARF), are tax-exempt organizations and frequently hold an equity interest in the startups to which they license patents. As a result, those LLC biotech licensees are not eligible for a grant under the program. As the CEO of an LLC with which I work (but did not set up) said earlier this week about being excluded from eligibility, “Ouch! That stings! Another painful learning experience.”

LLCs are Typically Not the Best Choice of Entity for Emerging Technology Companies

The “LLC issue” for emerging companies extends well beyond this grant issue for therapeutic companies. I say this even though many attorneys recommend LLCs for virtually all contexts. Sure, LLCs have their place. I frequently advocate using them as holding companies, investment vehicles, and joint venture entities. Among other situations, it also can be appropriate to use them when there is a limited, small group of owners actively participating in the business or when the owners want to have a certain allocation of profits and losses that cannot be accomplished when using an S or C corporation. But for many emerging companies that have or plan to have outside investors, the LLC is often not the best choice of entity.

Most people have a general understanding of the potential benefits of LLCs: pass-through tax treatment, flexibility, few formalities, ease of setup, etc. I will leave it to others to summarize in detail the benefits of LLCs, as there are many.

The “I didn’t know” LLC Issues for Emerging Technology Companies

What I often encounter is that an “issue” arises after the founders either worked with a drumbeating LLC advocate when they were initially organized or the founders organized the entity themselves through an easy-to-use website. In either case, frequently, the founders do not have a good understanding of the common issues that arise through the life cycle of the entity. These “I didn’t know” issues come up often after the company has been operating as an LLC for a while. Below is a list of some of the LLC issues that I have witnessed:

• A 10% owner of an LLC becoming a less than 1% owner of a corporation after conversion to a corporation because his capital account in the LLC was propotionately less than that of the other owners.
• A venture capital firm refusing to look past the heading of an executive summary after it discovers the entity is set up as an LLC.
• Spending tens of thousands of dollars (not to mention management and investor time) implementing and maintaining “blocker corporations” to limit unrelated business taxable income (UBTI) to the VC firms’ limited partners, while trying to maintain economic parity between investors, through several rounds of venture capital financings.
• “What do you mean I can’t take advantage of the losses because I don’t actively participate in the business?!?”
• A small, dissident group of members refusing to consent to a conversion, which in many states requires a unanimous vote of LLC members.
• Inability to take advantage of the special tax benefits of incentive stock options available to corporations.
• Spending several dozens of hours more than it would take to administer a stock option or restricted stock program to administer a profits interest program.
• Two members of an LLC (with negative capital accounts) owing taxes as a result of converting to a corporation.
• Significantly higher investment transaction costs as law firms generally do not have “standard” LLC investment documents for sophisticated transactions.
• When a company started to make money, requiring the owners to choose between receiving “phantom income” or making distributions to members to cover individual taxes at high marginal rates, despite a desire to reinvest that cash and grow the company.
• Inability to do a tax-free reorganization as an exit strategy.
• An LLC taking 5 months to obtain the required residency certifications and tax information authorization forms from each of its 78 members in order to limit the international tax withholding requirements in connection with a transaction.
• An LLC obtaining the required written authorizations and powers of attorney of 90+ nonresident members in order to file consolidated state tax composite returns in 8 states (and the corresponding K-1′s from each state sent to each member).
• Spending tens of thousands of dollars (attorney and accountant fees) converting to a corporation

I could go on and perhaps dedicate a post to each of these situations. And, of course, there are expensive and complicated solutions to some of these issues. But as some of my former colleagues at Michael Best said in a recent article, choosing an LLC can be a mistake for many companies and the decision should not be made without a full understanding of the ramifications.

Converting an LLC to a Corporation

A frequent comment I hear from executives of companies that are set up as LLCs is that they can convert to a corporation at any time. This is generally true. With the exception of some of the issues I described above, it often just involves an analysis of the benefits of being a corporation versus the time and expense involved to convert to one. I have handled a number of conversions and co-authored a brief post on the topic: Changing Your Choice of Entity: Cross-Species Mergers and Conversions. The difficulty is that the longer a company waits and the more complex the company’s capitalization structure, the more expensive it is and the longer it takes to do.

As with most important decisions, it is wise to talk with your trusted advisors about choice of entity issues. Take the time to understand the potential (and likelihood) of the benefits and costs long term, especially if you are considering using an LLC as the entity for your emerging growth company. Sometimes an LLC is the best entity choice, but more often for emerging technology companies, it is not.

As a follow up on the angel investor and venture capital term sheet post, I want to elaborate on some efforts to streamline angel investor transactions and reduce related transactional legal costs. In the last year or so, there has been considerable effort to create standardized open source angel financing documents. The first of these recent efforts was from Y Combinator. With the assistance of the law firm of Wilson Sonsini, Y Combinator published the Series AA Equity Financing Documents. Another organization focused on seed stage companies, TechStars, subsequently released its Model Seed Funding Documents, which were prepared by the Cooley Godward law firm. And, most recently, attorney Ted Wang from Fenwick & West led an effort to put together the Series Seed documents. There are others as well, especially form term sheets, such as the one investor Basil Peters advocates: One Page Term Sheet. In coming months, a Midwest group of attorneys and law firms plan to publish a set of documents that will add to the mix, with a Midwest flavor of default terms.

This post provides a brief summary of each publisher of the open source form documents as well as a brief overview of the standardized terms for each set.

The Reasons for Using Standardized Forms in Angel Financings

As mentioned in an earlier post in connection with the National Venture Capital Association‘s (NVCA) efforts in adopting form venture capital investment documents (More Terms for Venture Capital Term Sheets), industry standardization would be helpful to achieve these and other goals:

• Reduce transaction costs
• Reduce time to closing
• Reflect industry norms
• Promote consistency among transactions
• Establish certain industry standards
• Provide basic explanations as to the reason for particular provisions or the context in which certain provisions should be included

While achieving these goals would be laudable, creating a standard set of angel financing documents that are used by various groups presents challenges. I will cover these issues in a later post. But first, here is a summary of the current open source documents:

Y Combinator Series AA Equity Financing Documents

Toward the end of 2008, Y Combinator was the first of the groups to release an open source set of angel financing documents. Y Combinator provides small investments (typically less than $20,000) to computer, Internet, and software startups. Along with the investment, they provide initial consulting and networking opportunities for startups, including a three-month training program in the San Francisco Bay Area. According to Y Combinator, they take a 2-10% equity stake in participating companies. To date, they have worked with over 140 companies.

The Y Combinator documents were originally created for Y Combinator’s portfolio companies to use for their angel financing rounds. Among other provisions, the documents contain a 1x nonparticipating liquidation preference, no springing future rights from subsequent issuances, participation rights, a basic set of representations and covenants from the issuer, and a board seat.

TechStars Model Seed Funding Documents

In early 2009, TechStars released its set of model seed funding documents. TechStars provides up to $18,000 in seed funding to emerging companies, primarily in Internet and software industries. In addition, they provide educational programs and mentoring for three months in Boston, Boulder, and Seattle, with the chance to pitch angel investors and venture capitalists at the end of the program. In exchange for the funding and services, TechStars takes a 6% stake in companies.

TechStars provides its model documents to founders and lead investors as a starting point in seed and angel financing rounds in the $250,000 to $2 million range. The TechStars documents contain, among other provisions, a 1x nonparticipating liquidation preference, broad-based weighted average anti-dilution protection, springing future rights from subsequent issuances, participation rights, a basic set of representations and covenants from the issuer, and a limited right to a board seat that remains in place until the holders drop below 5% ownership of the company on a fully diluted basis.

Ted Wang’s Series Seed Financing Documents

The Series Seed Financing Documents were released last month (March 2010). An important characteristic of these documents is that they are, for the most part, slimmed down versions of the NVCA forms. As a result, investors who use the NVCA documents will generally be familiar with the terms of these documents. According to Ted Wang, the documents are intended for typical angel financing rounds in the $500,000 to $1.5 million range.

Although the documents are intended to be neutral, they generally contain the most investor-friendly terms of the three sets. Among them are assignment of the company’s right of first refusal to investors, drag-along rights, reimbursement of investor legal fees (up to $10k), and protective provisions typical for a company-friendly venture capital financing. Still, some investors have commented that the terms in the Series Seed documents are not aggressive enough.

The Series Seed documents are also intended to be used “as-is” without further negotiation (just fill in the blanks). The philosophy behind this approach is that the value of standardization outweighs the costs of customization: a controversial concept for many companies and investors. Ted Wang has invited comments and is planning to publish a revised set of documents after one quarter, including regular updates thereafter.

Comparison of Angel Investment Form Documents

All three sets of model documents anticipate that the security issued is preferred stock. Last month, attorney Yokum Taku of Wilson Sonsini put together a nice summary that compares the three sets of documents in tabular format: Yokum Post. Generally speaking, the Y Combinator and TechStars documents are more company-friendly than the Series Seed documents, although the TechStars documents contain anti-dilution protection and the other two do not.

While it may sound like only a self-serving comment, the open source forms should not be a substitute for involving an attorney experienced in angel and venture capital financing transactions. Selecting and negotiating terms (and alternatives), addressing the inevitable deal-specific terms not encompassed within the forms, providing a check as to what current “market” is, and securities law compliance are some of the reasons to involve an experienced attorney in the process. That said, industry or at least regional adoption of a standard set of angel investment documents (with common variations) should significantly reduce transaction legal costs, especially if both sides are represented by experienced counsel familiar with the forms.

If and when the Midwest-based angel financing documents are published, I will provide another update.

When raising funds from angel investors or venture capital firms (VCs), the offering terms are often summarized in a term sheet prior to consummating the deal.  Term sheets negotiated with angel investors are typically less complex than those proposed by VCs, but there can be considerable overlap between the two.

Negotiating with Angel Investors

When dealing with angel investors, it is typical for the company to produce the initial draft of the term sheet.  There are variations by region and it is not uncommon to see an angel investor or angel group prepare the initial draft of the term sheet, especially if the company has not already prepared one.  If an angel investor or angel group has taken on the role of lead investor, it is common to see the term sheet negotiated. In such cases when a term sheet has been negotiated, it is important that the company communicate that fact with subsequent prospective investors to avoid further negotiations and different terms.

Elements of an Angel Investment Term Sheet

In an equity financing with angel investors, the terms of the deal are often rather straightforward.  Typically, the security being offered is either common stock or a stripped down preferred stock. The angel investor term sheet will typically contain at least the following:

• A description of the security being sold
• The price for the security
• The company pre-money valuation
• The minimum (if any) and maximum amount to be raised
• Basic information about the issuer (e.g., whether it is a corporation or limited liability company, the state of incorporation/organization)
• The current capitalization table
• Any applicable security transfer restrictions

The term sheet may also contain other provisions that address issues such as board representation, veto rights over certain types of transactions or conduct, co-sale or tag-along rights, drag-along rights, dividends, put rights, piggyback registration rights, and anti-dilution provisions.

Once the term sheet is “finalized” for the equity financing with angel investors, it often becomes an important element of the issuing company’s private placement memorandum, if one is used.

Negotiating with VCs

When dealing with VCs, in almost every case, it is the VC who prepares the initial draft of the term sheet. Unless the deal is very small, VCs commonly invest in small groups or syndicates (e.g., two or three firms), with one VC acting as the lead. The lead VC will typically present the term sheet, and the company will have a relatively short time period to accept it or negotiate its terms (in an attempt to prevent the company from “shopping” the deal).

Elements of a Venture Capital Term Sheet

Venture Capital term sheets are usually complex. Below is a list of issues that are often included or addressed in a VC term sheet. This list is in addition to the items listed above for an angel investment term sheet.

• Conditions to closing the investment
• Closing date
• Identity of investors.
• Dividends (the percentage and whether cumulatve or not)
• Liquidation preference (e.g., amount (multiple) and whether the security is participating preferred stock or not)
• Board representation (e.g., single board member or control of the board)
• Protective provisions (veto rights over certain types of transactions or conduct)
• Conversion rights
• Anti-dilution provisions (weighted average or full ratchet)
• Pay-to-play provisions (assuming more than one VC is participating)
• Redemption/put rights (requiring the company to buy back the investors’ shares on a given date)
• VC’s attorneys’ fees (shifting costs over to the company)
• Demand registration, S-3 registration, and piggyback registration rights
• Management and information rights
• Participation or preemptive rights
• Employee stock or equity incentive requirements and limitations
• Tag-along (co-sale) and drag-along rights
• Confidentiality and no shop requirements

There can be a variety of other provisions and requirements included, such as a tranche or milestone funding process.

Upon acceptance of the term sheet, the VC’s attorney steps into the process (if he or she had not already done so at the initial due diligence stage). The VC’s attorney typically produces the initial drafts of the investment documents.

Term Sheet Forms

There are many good resources on the Internet with sample venture capital term sheets. Likely the best known is the one published by the National Venture Capital Association (NVCA). The NVCA form term sheet contains many good explanations of the various provisions in a VC term sheet. However, as you might have guessed with the authors of the form (VCs and their lawyers), the NVCA term sheet is generally drafted in favor of the VCs.

A version of the NVCA term sheet form that contains more company-friendly terms and more detailed discussions of the various negotiating points was prepared by those of us on the American Bar Association (ABA) Private Equity and Venture Capital  Committee. The ABA Comments to the NVCA term sheet form is intended to do the following:

• Generate more options and alternative provisions, including many that are more company-friendly
• Provide more detailed explanations concerning key provisions and negotiating points
• Elaborate on current case law and the implications of various provisions
• Identify which of the alternative provisions are more frequently used

Using resources such as the NVCA term sheet and the ABA Comments can help prepare companies to negotiate effectively (and more efficiently) with angels and VCs.

One of the requirements in a private offering is that the issuer have a “pre-existing substantive relationship” with its investor. Once exhausting contacts with local or regional venture capital firms and angel investor groups, relatively few entrepreneurs seeking equity investments have adequate personal contacts with wealthy people who can provide sufficient money to meet the capital needs of the entrepreneur’s business. For those who don’t, one option is to engage an intermediary or “placement agent” to assist them in the process of finding potential investors. If a placement agent of an issuer has a pre-existing substantive relationship with an investor, that relationship generally extends to the issuer for purposes of avoiding the advertising restriction imposed on companies in private offerings. A placement agent usually refers to a person or firm that is a registered broker-dealer, but sometimes also includes “finders.”

Broker-Dealers vs. Finders

Broker-dealers are regulated professionals or firms that have passed a series of exams and have gone through a lengthy registration process that includes interviews. Finders, on the other hand, are not generally regulated. According to federal law, a broker-dealer is “any person engaged in the business of effecting transactions in securities for the account of others.”

For purposes of this article, the key language is “in the business of effecting transactions.” A finder is someone not in “the business of effecting transactions.” Rather, finders infrequently bring investors and companies together, but that’s all they can do. By law, a finder is not permitted to pitch for the company, develop deal terms, or negotiate for or represent the investor or the company.

There are likely many finders out there who actually perform the services of a broker-dealer, but have failed to register as one because of either ignorance or the time and cost that it takes to become registered. However, it is a violation of federal and most state securities laws to fail to register if a person or firm is engaging in conduct that constitutes broker-dealer activities. A violation of one of those laws can bring fines, investment rescission, penalties, headaches, and in egregious situations, imprisonment.

Some states place significant restrictions on performing any “finder-related” activities, and take away common blue sky transaction exemptions if an issuer compensates a finder as part of a sale of securities to the particular state’s residents. Moreover, there are regulatory issues of giving transaction-based compensation to finders (e.g., an 8% finder’s fee), which often times is exactly what the company and finder want to do.

Because of these and other regulatory issues and various limitations associated with using finders, it is usually better to work with a broker-dealer rather than a finder. However, there are many more finders that are willing to work with early-stage companies than there are broker-dealers willing to do so.

Selecting a Placement Agent

You may ask, “how does one find a placement agent?” Entrepreneurs can talk with their lawyers, accountants, or other entrepreneurs about their experiences with various placement agents in their area. Generally speaking, for smaller transactions (e.g., under $5 million), placement agents will typically operate on a regional basis (rather than national).

When selecting a placement agent, there are many things to consider. Probably the most important consideration is trust. By using a placement agent, you are putting a lot of faith in an individual or firm. The reverse is true as well from the placement agent’s perspective in that their reputation is affected by the companies with which they work. Below are some other considerations:

• Experience generally as a placement agent
• Experience and success with companies in similar industries raising comparable amounts of money.
• Reputation
• Knowledge and experience with securities laws
• For broker-dealers, good written policies and procedures
• For finders, the impact of using a finder on state Blue Sky exemptions, and potential legal issues with using the particular finder
• Pre-existing substantive relationships with prospective accredited investors

Placement Agent Contracts

Contracts with placement agents vary significantly. At the extremes, I have seen handshake deals, which I strongly advise against, and I have seen 25-page agreements. Below is a list of areas that are commonly negotiated in arrangements with placement agents:

• Exclusivity
• Duration
• Compensation amount and type (e.g., retainer/monthly fee versus a transaction-based fee)
• Events that give rise to compensation
• Ability to terminate and effect of termination
• The duration of the “tail” post-termination
• Additional services
• Indemnity
• Representations, warranties, and covenants
• Use of affiliates to assist in process

Once a company decides to engage a placement agent, finding the right one(s) under the right terms are essential. The placement agent may not only affect the success of your offering, but the placement agent may also affect (positively or negatively) the reputation of you and your company, expose you to securities law liability and sanctions, and bind you to a long-term, comprehensive, and expensive set of services.

So, if you decide to work with one or more placement agents, choose carefully.

As outlined in the Overview of the Private Offering Process, when raising equity capital, one of the first things a company should do is prepare a business plan. Good business plans typically include a long-term capitalization strategy. The business plan often forms the centerpiece of the private placement memorandum (PPM), the disclosure document that is typically circulated to investors. When putting together a PPM, the goal is to create both a complete synopsis of the company’s current situation and an accurate summary of the company’s plans for the future.

With a good business plan in hand, people preparing the PPM often turn to “due diligence” and corporate “clean up.” As it relates to private offerings, due diligence is the investigation that ensures that the company-related information and summaries included in the PPM are accurate and complete.

It is not uncommon that during the due diligence process, issues are uncovered that either should have been addressed earlier but weren’t or that need to be completed or addressed prior to the company issuing securities to outside investors. Remedying those items is often referred to as corporate clean up.

The Due Diligence Process

While the due diligence process conducted by venture capital firms is often more detailed than that conducted by angel investors, one should expect at least a base level of due diligence from both groups. Virtually all venture capital firms and most angel investor groups have a formal due diligence process in which they request in writing certain information and access to particular documentation. Here’s a sample put together for angel groups. According to a study sponsored by the Kauffman Foundation in 2007, the median duration of actual due diligence work conducted by angel investors in their large sample was roughly 20 hours per investment. Interestingly, the same study found that the those angel investor groups who spent more than the 20 hours had a 5.9x return on their investment, while those who spent less than the median 20 hours had only a 1.1x return. Regardless of the actual duration of the diligence conducted by groups you may work with, the point that is imperative to get your “house in order” before opening the company up to outside scrutiny.

As part of your disclosures in the PPM, it is essential to accurately summarize all “material” facts concerning the company. A fact is material if a reasonable investor would consider it important in determining whether to purchase the securities that the company is selling. In other words, you need to include all relevant facts that an investor might consider important in making his or her investment decision.

The due diligence process for an individual company should be designed to capture those material facts. The areas that are subject to the due diligence investigation vary from company to company, but often include the following:

• Organizational documents (e.g., charter documents)
• Cap Table and Shareholder and option/warrant holder lists
• Copies of agreements that affect equity holders (e.g., shareholder agreements, voting agreements, investor rights agreements)
• Financial statements
• Summaries of litigation or threatened litigation
• Governmental licenses and filings (including patent applications)
• Biographical summaries of officers and directors
• Material contracts
• Any conflict of interest transactions or arrangements involving the company and its current owners (including their affiliates)

The PPM should include summaries and descriptions of not only the items listed above and the business plan, but also anything else that may be material to a prospective investor’s investment decision.

Government agencies (such as the NASD) have frequently commented that there can be no definitive list of items to be described in the disclosure documents. For example, a company that is seeking funding to support clinical trials should likely also include a summary of additional funding that the company will need after the current financing in order to get the drug or product through all phases of the clinical trials. A software company that is reliant on the adoption of certain third party technologies probably should include details about that technology. In essence, every company is different and each due diligence process must be customized based on the nature of the offering and peculiarities of the company and the industry in which it operates.

Conducting corporate clean-up

Early-stage companies typically spend much of their financial and human resources on product or technology development and attracting and retaining talent. Whether it is because of lack of time, money, or experience, companies often fail to keep up with many tasks that may prove to be important to the success of the company.

What usually occurs is that during the due diligence process, areas that need clean up are revealed. If you think your company is good shape, consider these questions:

• Have your key employees signed appropriate nondisclosure, assignment of inventions, and noncompete agreements?
• Have you granted stock options or issued restricted stock to your key employees (perhaps as previously promised or alluded to) and if so, have you complied with the tax code section 409A requirements on valuations?
• Are your shareholder and director meeting minutes up to date and in compliance with statutory and organizational document requirements?
• Have all previous stock issuances and significant agreements been properly authorized in the board meeting minutes?
• Have you filed applicable patent applications (or at least provisional patent applications)?
• Do you have any agreements or arrangements with others that should be reduced to writing?

These and other matters need to be remedied or addressed before the private offering.

The other form of corporate clean-up prepares the company for its planned structure following the financing. For example, a company’s articles of incorporation and bylaws may need to be amended to reflect changes from the company being owned and run by a small group of founders to one in which there will be a significant number of outside investors. This is especially true if you plan to offer a type of security in the private offering that has not been previously authorized (such as a new series of preferred stock).

Also, sometimes a company will try to complete certain transactions or enter into agreements with one or more “household-name” companies in order to validate the company’s product or technology prior to the offering.

Conducting a thorough due diligence and corporate clean up are essential when offering securities. Doing both creates the foundation for a solid PPM: one that both provides a prospective investor with an accurate picture of the company and limits the liability exposure of the company and its officers and directors.

From brand new start-ups to eighty-year old Fortune 500 companies, most companies, even publicly traded ones, raise equity capital through private placements of securities.

A private placement, sometimes referred to as a private offering, is a sale of restricted securities by an issuer pursuant to an exemption from the registration requirements of the Securities Act of 1933. Frequently, the exemption falls under the safe harbor provisions of Regulation D (or Reg D, for short).

Generally speaking, restricted securities are ineligible for resale into the public market until certain conditions have been met. To sell restricted securities, either a resale registration statement must be filed with the Securities and Exchange Commission and declared effective, or resale must be permitted pursuant to an exemption or under an applicable rule, such as Rule 144.

As most experienced entrepreneurs know, raising significant amounts of equity capital for an early-stage company is rarely easy. The uninitiated often believe that all they need is an introduction to a couple of wealthy investors, an hour or two in a room with them to show them the wonders of their great idea or product, and out will come the checkbooks.

This rarely (if ever) happens. Selling equity securities is a deliberate process. While every private offering or sale by a company of its securities is somewhat different, the ramifications for a misstep sometimes leads not only to an unsuccessful offering but can lead to personal liability of the promoters of the offering.

Personal liability is imposed not only for malicious fraudulent conduct, but could apply, for example, when the company issuing securities cannot comply with an order to rescind a sale to an investor because the company failed to comply with the private-offering legal requirements or omitted to state a material fact to the investors concerning the company. Again, it does not require intentional misconduct or deceipt. This is why it is important to do the process right. Not only will doing the process right limit personal liability exposure, but your offering will likely be more professional and attractive to investors.

Below is the general sequence of events in a private offering of securities:

• Prepare business plan, including an executive summary and a long term capitalization plan
• Conduct organizational “clean up” and “due diligence”
• Obtain necessary company authorizations
• Decide whether to use a placement agent and if so, identify, contact, interview, and select placement agent(s)
• Negotiate agreement with placement agent(s), if applicable
• Define parameters, procedures, contingencies, timing, and geographic scope of offering
• Conduct initial blue sky (or state securities law) research
• Identify investor qualification standards (e.g., accredited, sophisticated, state residency requirements)
• Prepare offering terms or term sheet
• Prepare offering agreements and documents (e.g., subscription or purchase agreement, investor questionnaire, shareholder agreement, charter amendment)
• Prepare the private placement memorandum (PPM)
• Identify prospective investors
• Select desired offering exemption
• Set up monitoring mechanism for PPMs
• Identify printer and forward PPM for copying
• Obtain applicable investor introductions and conduct initial investor presentations
• Circulate the PPM to interested prospective investors
• Close the transaction
• Make necessary federal and state filings
• Issue stock certificates

The list above describes how the process typically works, but sometimes tasks are eliminated or abbreviated, the order changes, or other tasks are added, such as obtaining a legal opinion, amending articles or bylaws, preparing an investor rights agreement, qualifying for the state angel investor tax credit program, etc.  In coming weeks, we’ll cover a number of these steps in more detail.

Several companies we are working with are currently preparing for investor presentations.  This post covers a number of best practices for presenting to investors, whether they be angel, venture capital, or strategic investors.

Identify your Objectives for the Investor Presentation

Many companies try to accomplish too much with their initial investor presentation.  Rarely do term sheets get prepared after the first presentation, let alone checks, unless it is a modest sum of money from an angel investor who is already inclined to invest.  So what is a good objective for an initial investor presentation?  In most cases, a good objective is merely to get to the next stage of the investor’s evaluation process. In some situations, the next stage could be a second presentation to a broader audience or a different group within a strategic investor’s organization.  In other cases, it could be to start a formal due diligence process.  Try to identify the prospective investor’s evaluation process prior to the initial meeting to help shape your objective for the presentation.

Know your Investor Audience

As is true for most presentations, your investor presentation should be tailored to your audience.  Prior to the meeting, try to identify who from the investor’s organization will be present during the meeting.  If it is going to be primarily business/finance people (as opposed to technical/scientific), you can expect the questions and discussions to center around their areas of focus and expertise.  Also, see if you can identify who in the room is the ultimate decision maker, gate keeper, or influencer who can enable you to get to the next stage in the evaluation process.  Adjust your presentation accordingly.

Adhere to the Investor’s Rules and Be Respectful of your Audience’s Time

Sometimes, investor groups or forums have particular rules about presentations.  They can limit companies, for example, to a certain number of slides, certain types of slides, or a specified presentation duration.  Adhere to their rules.  If you have a one-hour meeting with a VC or strategic investor, don’t bring a 50-minute slide deck to the meeting (more on this in a bit).  Unless going over the agreed upon time slot is driven by investor questions or two-way discussions, don’t be guilty of holding the investor audience hostage by continuing on with a presentation that seems to never end; a long presentation won’t make your case for investment more compelling. 

Presentation Format and Investor Slide Deck Composition

Assuming you have identified your objectives for the presentation, you know your audience and the restrictions you are under for the presentation, what should the presentation look like?  Usually, the presentation is given by one or two members of the management team (e.g., the CEO and CSO/CTO or CFO).  The appropriate number of slides of an initial one-hour meeting is somewhere between 15 and 25 and should take no longer than fifteen to twenty minutes to present, without interruption. And yes, I know it’s not easy to do and I know it can be a time consuming process to get the presentation that short and succinct.  If the investor is interested, you will have no problem taking the entire hour.  If the investor is not interested, well, everyone can spend the balance of the hour answering emails.

The breakdown of the slides typically works something like this:

• Speaker introduction and the investment that you are looking for  (1 Slide)
• Company introduction and “elevator pitch” (1-2 Slide)
• Identify market(s) and current market problems/opportunities (2-3 Slides)
• Company solutions and product(s) to address market opportunities (2-6 Slides)
• Current development status of solution/product line (1-2 Slides)
• Competition (1-3 Slides)
• Marketing and distribution/regulatory approval process (1-3 Slides)
• Revenue model(s) and financial history and projections (1-3 Slides)
• Use of funds (1 Slide)
• Management team (1-2 Slides)
• Anticipated Exit and Timing (1 Slide)
• Recap the 2-3 main points and state the investor “call to action” (1 Slide)

Of course, there can be variations to this format.  For example, a presentation to a potential strategic investor technical team should include less on market opportunities and more on product and technology.

Many times, the initial presentation is the first opportunity that an investor has to evaluate you, which for most early stage angel and VC investors is more important than your product or technology. Presumably, if a prospective investor has read your executive summary/business plan and wants a presentation, you’ve passed the initial screen and the investor is already at least somewhat interested in your company.  So, it’s important to remember that you are not only selling them your product/technology, but also you and your management team.

Backup Slides for Investor Questions and Areas of Focus

It is generally a good idea to prepare backup slides to address the key questions that you anticipate or areas that you are likely to be asked to elaborate on if the investor is interested.  This goes back to knowing your audience.  You may also want to develop a system to figure out how to access particular backup slides so that you are not fumbling through the PowerPoint while the investor has to wait.

Miscellaneous Best Practices for Investor Presentations

Finally, here are some miscellaneous nuggets to consider, based on the investor presentations I’ve seen over the years:

• Coordinate in advance the audiovisual requirements (who is going to have/bring what)
• Have a backup plan (e.g., hard copy of slides)
• Use the PowerPoint slides as a guide to the discussion, not as cue cards
• Maintain eye contact with your audience, not the screen
• Let your passion and excitement about your business show through
• Do not say that your company does not have competition or any other naive faux pas
• Walk the fine line between exuding confidence, but not appearing overconfident
• Address any 800 pound guerillas positively in the presentation rather than waiting for the inevitable questions and what could be construed as defensive responses
• Avoid eye charts (e.g., detailed spreadsheets, elaborate process or flowchart diagrams); more text does not yield a more compelling case for investment
• Similarly, convey no more than 2-3 points per slide, with font no smaller than 24 pt
• If possible, use a good mix of images and text
• And lastly, rehearse, rehearse, rehearse