Whether looking for an investor, a joint venture or joint development partner, or your next CEO, a warm introduction is almost always better than a cold one.  But the quality and effectiveness of warm introductions vary considerably.  In fact, setting up the right type of introduction from the right type of person can be a test of your entrepreneurial skills. 

Elements of a Good Introduction

In essence, there are at least two elements to a good introduction: (1) the introducer is someone who the prospective investor, joint venture or joint development partner, or CEO listens to; and (2) the introducer has something persuasively positive to say about you or your company.

Types of Introducers

Using an unscientific approach, here are my tiered groupings of people from whom to make your warm introductions:

Top Tier Introducers

1. The introducer successfully concluded a recent close business relationship in which the prospective investor, joint venture or joint development partner, CEO, etc., did very well. 
2. The introducer has an on-going regular business relationship with the prospective investor, joint venture or joint development partner, CEO, etc., that is going well.
3. The introducer is someone well known to the prospective investor, joint venture or joint development partner, CEO, etc., and he, she or it wants to do business with the introducer.
4. The introducer and the prospective investor, joint venture or joint development partner top execs, CEO, etc., are close socially (e.g., families going on vacations together)

 

Middle Tier Introducers

5. The introducer currently works with or has worked with the prospective investor, joint venture or joint development partner, CEO, etc., but not closely.
6. The introducer has a good close working relationship with an affiliate or existing partner of the prospective investor, joint venture or joint development partner, CEO, etc.
7. The introducer is an acknowledged scientific expert or significant player in the industry and is known to the prospective investor, joint venture or joint development partner, CEO, etc., by reputation

 

Bottom Tier Introducers

8. The introducer and the prospective investor, joint venture or joint development partner, CEO, etc., has an on-going regular or previous business relationship that is not going well (or did not go well) through no fault of the introducer.
9. The introducer knows the prospective investor, joint venture or joint development partner top execs, CEO, etc., only through casual social situations (e.g., reception, conference, party, mutual friends)

Of course, there are situations where a “warm” introduction from a hostile source can lead to a problem, one in which a cold call may yield a better result.  But in most cases, even a positive introduction from a “bottom tier” introducer is better than no third party introduction.  For example, I’ve heard a number of venture capitalists say that they have never (ever) invested in a company that sent directly its summary or powerpoint over the transom. 

Ensuring a Positive Message in the Introduction

Just because you have someone lined up who is a top tier or middle tier introducer, does not mean you are set.  As an illustration, I have a client who was looking for an introduction to a particular potential joint development partner.  The client discovered that an MD working at one of the company’s clinical trial sites had previously done a lot of work with the targeted joint development partner.  Upon discovering this, the CEO quickly moved to ask the MD for the introduction, which the MD agreed to do.  As it turns out, the MD by his nature was very measured in his words when making introductions.  In making this introduction, the CEO later found out that the MD spent as much time disclaiming knowledge about the company and its prospects as he did explaining in a measured way the positive results of the recent trials.  While the CEO did get the meeting, he spent considerable time explaining why the MD was not more enthusiastic about the CEO’s company.

So, how do you ensure a positive message in the introduction?  Ask the introducer what he or she is going to say.  Provide the introducer with an elevator pitch length email about your company.  Provide him or her an executive summary or the bullet points to touch on during the introduction.  You should do as much work as possible for the introducer to make sure that his or her job is easy and that he or she gets the facts right.  That said, the introducer should know the basics about your company as the prospective investor, joint venture or joint development partner, CEO, etc., will likely have at least one question for the introducer.  If the introducer does not know rough headcount or revenue numbers, or whether the company has filed an IND, for example, not only can that be embarrassing to the introducer but it will also degrade the effectiveness of an otherwise good introduction.

While serendipitous introductions or connections do happen, many times a good introduction is the product of deliberate, diligent entrepreneurial efforts of finding the right person with the right connection to deliver the right message.

The next 12-24 months should be interesting in the biotech/pharmaceutical arena.  We have the large pharmaceutical companies (such as Abbott, AstraZeneca, Bristoll-Meyers Squibb, Eli Lilly, GlaxoSmithKline, J&J, Merck, Novartis, Pfizer, Roche, Sanofi, and Schering-Plough) sitting on a lot of cash.  Yet, despite all that money in the bank, the number of high profile drugs coming off patent soon from large pharma is substantial.  According to Merck’s industry numbers, drugs coming off U.S. patent in 2011 alone will cause a loss of over $51.1 billion in revenues in 2011.  The following year does not look much better with another $42.9 billion in less revenue from drugs coming off patent in 2012.  Looked at another way, 85% of the top large pharma products will lose U.S. patent protection by 2012.

So where will large pharma go to replace these lost revenue streams?  While acquisitions of large biotech companies (market caps between $5-50 billion) will likely be a partial solution, it is far from a complete solution.  

Where will the Next Blockbuster Drugs Come From?

One set of clues to the answer may be to examine where the large blockbuster drugs came from in the last decade.  Not surprising to many in the industry, the overwhelming majority of top-selling drugs were developed by companies that were different than the companies commercializing them.  According to Merck’s figures of the blockbuster drugs from the last decade,

• 60% of innovator small molecules,
• 82% of innovator biologics,
• 65% of follow on small molecules, and
• 62% of follow on biologics

were originated in a company other than the company commercializing it.  This trend seems like it will continue.  With the various numbers I have seen, the revenues from the pipeline of new drugs from large pharma is expected to be less than one third of the anticipated revenues from drugs coming off patent. 

Cash Strapped Biotech

On the other end of the spectrum, we have a number of smaller biotech companies that are very short on cash and have a number of products in the pipeline.  In the Spring of this year, it was noted by many sources that more than 1/3 of the public biotech companies had less than six months of cash left to operate.  For privately held biotech companies, the news is similarly bleak with the tight venture capital markets.  While the number of small deals, PIPEs, and mergers and acquisitions of biotech firms have picked up some in the last month or two, absent an unanticipated opening of the public markets and significant increases in venture capital or PIPEs, the day of reckoning for many biotechs is coming soon. 

Unless of course, large pharma goes on an investment or buying spree in an effort to make up their anticipated lost revenues.

After hunkering down for some time and receiving some initial responses from the flurry of grant applications that were submitted in the spring of this year, many Midwest biotech and medical device companies are once again beginning to consider the private capital markets for funding.

In this post, I discuss both the timing and preparation for the next round of equity financing.

Timing for the Next Round of Financing

Companies should factor in at least 4-6 months time between circulating an executive summary/business plan and closing a round of financing with new outside investors. For most companies, that range of time is likely the best case scenario. While there has been some modestly positive signs recently of transactions and valuations picking up, it may be prudent for companies to consider at least 6-8 months time as a more realistic period to raise capital.

Preparation for the Next Round

Regardless of whether a company chooses to put together and use a private placement memorandum, it is a good idea to do some internal checks and corporate cleanup prior to the offering. Not only does it marginally improve the chances of getting funding at a better valuation, it also decreases the fundraising time because fewer issues and surprises come up during the investor diligence period.

Here are some questions to consider before starting your next private offering:

Corporation and Limited Liability Company Issues

• For corporations:
  • Have you been following corporate formalities, such as the following:
    • Holding shareholder and board of director meetings at least annually and preparing minutes of these meetings;
    • Keeping separate your corporate and personal bank accounts; and
    • Signing corporate documents in a corporate capacity (i.e., as an officer of the corporation).
  • Do you have a stock ledger and option/warrant ledger, are they up to date, has all issued stock been properly authorized (e.g., board approval) and issued?
  • Are the Bylaws up to date and have you complied with them?

• For LLCs:
  • Does your operating agreement accurately reflect current ownership?
  • Does your operating agreement accurately reflect the management structure?
  • Does your operating agreement appropriately and accurately address allocation of profits, losses, and cash flow and does it address minimum distributions?
  • Does your operating agreement address information rights?
  • Does your operating agreement appropriately “opt-in” and “opt-out” of applicable statutory defaults (e.g., the ability to cause the LLC to dissolve)?
  • Have you complied with the member managed or manager managed requirements?
• Is your company current with its state filings and foreign registrations?
• Are your financial statements current and accurate?
• Have you been complying with Section 409A in valuing your stock options and other equity-based incentives?
• Has the company obtained applicable certifications for investor tax credits/incentives?

Contracts and Leases

• Are all your key contracts in writing and signed?
• Do you have copies of the key contracts readily available?
• Do you have a system in place to keep track of contracts, including knowing those that are up for renewal, require notice for termination, require a payment, etc.?
• Have your significant contracts received necessary corporate/LLC approvals?
• Do you have standard terms and conditions for the sale of your products and services and do you use them consistently?
  • If you sell products to other companies, do you understand the basics of “battle of the forms” issues and do your contracting procedures take advantage of the rules?
  • Do your standard terms and conditions for product sales address warranties, disclaimers, liability limitations, indemnity, risk of loss, interest rate and cost of collection (including attorneys fees), jurisdiction, forum, and choice of law issues?
  • Do your standard terms and conditions for services address warranties, disclaimers, liability limitations, confidentiality/privacy, indemnity, intellectual property ownership, interest rate and cost of collection (including attorneys fees), jurisdiction, forum, and choice of law issues?
• Does your lease contain a renewal option, right of first refusal on adjacent space, and caps on tenant repair obligations?
• Have you reviewed your lease to determine whether you and your landlord are complying with it?

Employee Matters

• Have your key employees signed confidentiality, invention assignment, and noncompetition agreements?
• Do you comply with the federal requirements regarding documenting the citizenship of your employees?
• Do you comply with the applicable requirements regarding classifying individuals as employees or independent contractors (e.g., tax, workers compensation, unemployment)?
• Do you comply with applicable law concerning compensating employees for overtime?
• Do you understand how to limit exposure for wrongful termination and employment description lawsuits and have you taken steps to limit that exposure?
• Do you regularly document decisions made regarding employees in order to be able to support these decisions should they be challenged on the basis of discrimination?

Protecting Intellectual Property

• Do you have third parties sign non-disclosure agreements before they are allowed to view or hear about your confidential information?
• Do you have a standard non-disclosure agreement form that you use that has been reviewed by an attorney (rather than one that you found on the Internet)?
• Do you have trade secrets and if so, what steps do you take to maintain their confidentiality?
• Have you obtained trademarks or service marks to protect the names and logos of your business, products, and services?
• Have you obtained copyrights to protect your important written materials and software?
• Are you taking steps to ensure that you are complying with the U.S. and foreign general rules as to the timing of whether an invention can be patented?
• If anyone working with or for the company is associated with a university or uses university equipment in connection with company matters, do you understand the basics under the Bayh Dole Act and have you taken steps to avoid Bayh-Dole issues?
• In contracts with outside vendors and providers that involve intellectual property, do the contracts have work made for hire provisions?

The items listed above are just some of the items that may come up during investor legal and business due diligence. There are a number of industry or niche specific questions that typically come up as well. For example, for software companies, investors will want assurances that no open source, copyleft, or community source code is contained in any of the Company’s software products. For a medical device or biotech company, investors will likely spend more time on intellectual property and possibly FDA matters. In either case, more scrutiny should be spent prior to the private offering in those areas where investors are likely to focus.

Regardless of whether they are called university spinoffs, spinouts, or just plain start-ups, the University of Utah sure has a lot of them: 23 that started just last year— that’s second best of all universities in the nation. Think about how impressive that is. Like many places here in the Midwest, Utah has not historically had the amount of venture capital, the number of serial entrepreneurs, or the depth of tech company managerial talent that much of the coasts and the handful of hotspots in between enjoy.

As might be expected in light of the economy and tight capital markets, the last 12 months have been atypically poor in terms of the number of start-ups coming out of many Midwest universities; most of our universities only had a handful or fewer new startups this last year. Of course, there were a number of tech companies that started up that were not based on university technologies and they shouldn’t be overlooked. But, this is the land of the Big 10 and other top universities, whose R&D dollars dwarf those spent at the University of Utah. University of Wisconsin’s federal R&D expenditures are consistently in the top three of the country and are more than three times those spent at the University of Utah. It’s not just the money spent, either. I’m told that roughly 50% of the world’s peer-reviewed nanotech articles come from an institution within a 200-mile radius of Chicago. Midwest universities are responsible for discoveries ranging from nuclear fission to stem cells. So, how can we better translate some of our incredible university-based science and technologies into more start-up companies in the region?

In this article, I outline some of the things that the University of Utah and the infrastructure around it has done to facilitate start-ups. I also outline some of the good things that are already happening here in the Midwest. Finally, at the end of this article, I put my “services” where my mouth is and offer free legal services (yes, free) in helping to encourage university start-ups. I also call upon others, whether they are investors, service providers, mentors, university faculty members, or government agencies, to think about or relook at what they can offer to encourage more university start-ups.

The University of Utah Tech Transfer Office Overhaul

The University of Utah has just under 29,000 students. For frame of reference, that’s roughly 70% of the student population of the University of Wisconsin-Madison. Its technology transfer office went through a significant overhaul in 2005 after a new University president (Michael Young) was appointed. The University created the Office of Technology Venture Development (Tech Ventures) to drive regional economic development and commercialization efforts. The group coordinates activities between the University’s Technology Commercialization Office (TCO) and other college and university groups. As part of the restructuring, a new Director was hired and the TCO established itself as what its Director refers to as a “service-based business.”

Since the restructuring in 2005, the University of Utah has averaged 20 start-ups per year. Compare that figure to the less than 5 per year average that the University had prior to the restructuring. The overwhelming majority of University start-ups in Utah are now started by professional management–not the professor/inventor as is often the case here in the Midwest. For the first year or two of the company, many of these entrepreneurs work part-time or telecommute from California or neighboring states. They will often split their time between more than one company during the company’s first couple years. The Utah start-ups are typically in the biotech, medical device, energy, Internet and software industries.

Utah’s Initiatives with Seed Stage Money, Entrepreneurial Talent, Communications, Research Support, and Venture Capital

I met the Executive Director of Technology Commercialization at the University of Utah, Brian Cummings, at a biotech/pharma collaborations conference last month in San Francisco. Brian attributes much of their success to the common vision, cooperation, and collaboration that is present across many Utah groups and constituencies—the University, investor groups, entrepreneurs, State government, professional services sector, etc. When I asked him about the challenges that many areas of the country face with the lack of seed and early stage capital and the lack of early stage professional management pool, he pointed out Utah’s efforts to address those areas and other issues:

• The University of Utah established a seed fund named KickStart that was launched in April 2008. It is expected to fund 20-30 start-ups that are involved in the clean technology, life sciences and software/engineering industries. Average size investment per company for the fund is $100,000 – $250,000.
• The TCO is currently establishing separate specialized investment funds that focus on key high-value research areas within the University, such as interventional medicine, software, imaging, and energy. Each of these funds will focus on early stage technology companies and be roughly $20 million each. The money is being raised by the TCO from private investors.
• The TCO actively recruits entrepreneurs to start companies in Utah. Brian mentioned that the Utah ski resorts have been a particularly fruitful place for recruiting management talent visiting from places further West.
• Venture Bench, a University-based accelerator, provides a suite of services for pre-revenue University of Utah start-ups, such as business plan development, market assessment, networking, accounting and insurance, federal and state grant application assistance, corporate governance counseling, legal costs, and state filings, each at no cost to qualified companies.
• The TCO has a myriad of other very popular programs, such as business plan competitions, law clinics, entrepreneur in residence programs, etc. Many of these programs are cross-disciplinary or involve different colleges within the University.
• There are multimedia initiatives (e.g., utahpulse.com) in place to help ensure industry news, opportunities, and trends are shared among the state’s newspapers, magazines, blogs, and websites.
• The Utah Fund of Funds, a state of Utah economic development program (currently, $300 million), was created to support early-stage and growth-stage companies in Utah. Rather than investing directly in specific companies, the Fund of Funds is structured to influence venture capital and private equity firms to focus more of their investment efforts on Utah ventures.
• The University has implemented what it refers to as a “virtual incubator” program for qualified small University of Utah start-ups. Under the program, each company receives a voucher that entitles them to a $50,000 credit for sponsored research conducted at the University to further product and market development of a given technology.

Current Midwest University Initiatives to Encourage University Start-ups

While the University of Utah has done a lot, not all of their initiatives would work or “fit” here in the Midwest. But, there are a number of initiatives that we should consider. I don’t mean to suggest by this article that Midwest universities have been standing still. To the contrary, there are a number of initiatives that are currently underway and good things that are happening here at Midwest universities and their surrounding infrastructures. Being from Wisconsin, I know the most about those in Wisconsin. For instance, at the University of Wisconsin-Madison, the Wisconsin Alumni Research Foundation (WARF) offers a number of translational (from concept/lab to patent/commercial application) grant programs (typically up to $50,000 each), such as the Draper Technology Innovation grants, the Industrial & Economic Development Research grants, and the Coulter Foundation grants. WARF will also soon launch a significant new program that is designed to further these translational efforts of moving technologies from the lab to commercialization (details to follow soon). WARF has also set up a “co-invest fund” to invest in University of Wisconsin early stage companies alongside venture capital firms and strategic partners. WARF fully deployed its initial $10 million co-invest fund and has deployed roughly 20% of its second $10 million fund. WARF was also instrumental in setting up an early stage company mentoring group called MERLIN. The mentors in the group consist of experienced area business people that volunteer their time to support area start-ups.

According to my former partner at Michael Best, Alec Fraser, the University of Wisconsin-Milwaukee has had success recently with its initiatives. Brian Thompson, President of UWM Research Foundation (UW Milwaukee’s tech transfer group), attributes some of their success to their industry focus and catalyst grant program. UWM has targeted applied research and commercialization efforts in healthcare, biomedical, water, advanced manufacturing, and energy industries. They work with area large companies and foundations, such as Rockwell Automation and the Lynde and Harry Bradley Foundation, to help fund grants that support the evaluation of technologies and moving the technologies from the lab to commercial applications. The UWM Research Foundation also provides some funding support for writing grant applications.

Other Midwest Initiatives to Improve Start-ups

The positive initiatives are not limited to the universities. For example, the number of angel groups in the region has grown considerably over the last few years, through the efforts of people like Joe Kremer, Dennis Serio, and Tom Still. Most of these groups continue to actively invest, despite the economic downturn. Some states in the Midwest, such as Indiana, Michigan, Wisconsin, Iowa, and Kansas, have adopted aggressive tax incentives to encourage investments in technology company start-ups. More Midwest-based law firms are making concerted efforts at creating specialized teams that focus on technology companies and venture capital. New mentoring groups like that headed by Terry Sivesind (MERLIN) have popped up to assist early stage companies. And of course, websites such as Mike Klein’s WTN Media (wistechnology.com), Russ Smestad’s BiotechProfiles (biotechprofiles.com), and midwestbusiness.com, among others, provide great communication platforms.

The AlphaTech Counsel Offer

While a lot is going on and many people are pouring considerable efforts in encouraging university start-ups, our raw numbers can and should be better. I know that we, collectively, can do more to facilitate more quality university start-ups in the Midwest. It’s always easy to point out what other people or groups should be doing. Instead, I like to think about what I can offer personally. So this is what I am willing to do. For any Midwest-based entrepreneur (or group of entrepreneurs) that is entering into discussions with a technology transfer office to license technology from the university, I am willing to offer free legal services to set up their organization and get them off on the right foot. Specifically, I will offer the legal services associated with the following, free of charge:

• Choice of entity counseling
• Articles and bylaws/operating agreement
• Initial subscription agreements
• Initial consents (incorporator, shareholder, and director)
• EIN application
• S election (if applicable)
• Negotiate license agreement with university tech transfer office
• Negotiate equity agreement with university tech transfer office (if applicable)
• Employee invention assignment agreement
• Employee confidentiality agreement

This offer is obviously subject to a conflicts check and compliance with applicable laws and doesn’t cover government filing fees. I’ll extend this offer at least until the end of 2009.

If you are involved or want to be involved with the commercialization of university-based technologies, I encourage you to consider (or reconsider) what you can do to better support both the number and quality of university start-ups. It does not matter whether you are an investor (or would-be investor), accountant, attorney, consultant, mentor, university faculty member or administrator, government employee, or entrepreneur, we all have a role. And, collectively, we can do a better job to ensure that more of the incredible discoveries that are coming out of our universities are commercialized through local efforts to produce promising companies with good paying jobs.

The other day, I sat down with Scott Button, who is a Managing Director of Venture Investors, a venture capital firm in Madison, Wisconsin.  In the attached excerpt from our conversation, Scott elaborates on the following:

• the stage and industry focus of Venture Investors

• the Venture Igniter program

• important points (and red flags) for company executive summaries and business plans

• how long it is currently taking between the initial investor pitch and closing the deal

• how often Venture Investors invests as part of a syndicate

• current trends in company valuations

The mp3 excerpt is just over seventeen minutes:

Podcast: Play in new window | Download

Below is a glossary for venture capital and merger and acquisition transactions. Users are encouraged to submit additional words for inclusion and suggestions for improved definitions. Once updating starts, the most up to date version of the glossary will be maintained at this link: Current Venture Capital and Merger and Acquisition Glossary.

Accredited investor

A person or entity that meets certain requirements under the federal securities laws for investment purposes. For example, a natural person is an accredited investor if he or she has a net worth (with spouse) that exceeds $1 million at the time of the purchase of securities, or has income either individually that exceeds $200,000 in each of the two most recent years or jointly with spouse that exceeds $300,000 for the two most recent years.

Angel investor

A wealthy individual (accredited investor) who provides seed or early-stage financing from his or her own funds in return for equity. Angel investors sometimes provide industry knowledge and contacts and sometimes play a direct role on the board, but infrequently participate in management. Angels invest either as individuals or in groups.

Anti-dilution provisions

An adjustment mechanism for preferred stock, options, or convertible securities that provides the holder the right to receive additional securities in the event of a future financing in which securities are sold at a lower price than originally paid by the holder of the right. Typically, anti-dilution provisions come in two types: full ratchet and weighted average. There are typically exceptions for the adjustment mechanism that carve out situations such as the issuance of certain employee options or existing convertible securities.

Assignment of inventions agreement

An agreement that states who owns the rights to intellectual property that is developed. An assignment of inventions agreement typically makes clear that an entity owns the relevant intellectual property developed by its employees, contractors, and agents.

Blank check preferred stock

Unissued class of preferred stock of a company, the terms and conditions of which (such as liquidation, voting, dividend, and conversion rights) may be expressly determined by the company’s board of directors without further shareholder approval. An issuer will typically use blank check preferred stock to simplify the process of creating new series of preferred stock to raise additional funds from sophisticated investors without obtaining additional shareholder approval.

Bridge financing

Interim financing used to meet a short-term, cash-flow need until more permanent financing (typically larger amounts) is secured. For example, bridge financing can be used to carry a firm to an initial public offering, a venture round of financing, or long-term debt.

Burn rate

The rate at which a company that is not profitable uses available cash to cover expenses that exceed revenues; the figure is usually expressed in monthly terms, as in a $100,000/month burn rate.

Business issue

An area that is traditionally negotiated between the clients, rather than attorneys (or in some cases, an area that one or both lawyers don’t want to negotiate for whatever reason).

Call right

A right that enables one person (or the issuer) to purchase securities held by another, usually at a fixed price and after a specified date or the occurrence of a certain event.

Capitalization

The combined sources of equity capital, consisting of convertible debt, common stock, and preferred stock.

Cap table

Short for capitalization table, it is a summary of a company’s issued and outstanding securities.

Common stock

A type of security representing the residual ownership rights of a corporation. Usually, company founders, management, employees, and some angel investors own common stock, while other investors own preferred stock. In the event of a liquidation of a corporation, the claims of secured and unsecured creditors, debt holders and holders of preferred stock take precedence over holders of common stock.

Convertible debt

A debt instrument (such as a promissory note) that can be converted to equity of the issuer (either as common stock or preferred stock).

Co-sale or tag-along rights

These rights enable the holder to participate in a sale of stock from another shareholder to a third party, typically in proportion to the number of shares the holder holds in the company. Co-sale rights are usually designed and intended to protect the holder if a founder or a majority shareholder decides to sell his, her, or its interest in the company. The co-sale rights holder can participate in the sale, usually on the same terms and conditions as the founder or majority shareholder.

Covenant

A contractual obligation to do or not do something in the future. For example, an affirmative covenant could be to provide quarterly reports to investors and a negative covenant could be to not enter into another financing without enabling existing investors to participate.

Cram-down financing

A financing that results in significant dilution of non-participating existing shareholders, usually reducing the value of the inon-participating existing shareholders’ original investments or the rights held by such non-participating existing shareholders.

Cumulative dividends

Dividends that accrue when unpaid and must be paid out before dividends are paid to subordinate classes of stock.

Deal flow

The amount of potential investments that an investor reviews in a given period of time.

Demand registration rights

Rights that enable a holder to demand that the company register the stock held by such holder under the Securities Act of 1933 in order to enable the holder to sell the stock in the public market without restriction.

Dilution

The reduction in the ownership percentage of shareholders caused by the issuance of new securities or the conversion of convertible securities of the issuer, typically with the connotation that the new securities are issued at a lower price than that paid in the previous round of financing.

Discounted cash flow

A valuation method in which the present value is calculated of anticipated future company cash flows.

Dividend

Payment made by a company to the owners of one or more of its types of securities.

Down round

A financing in which the new securities are issued at a lower price than the previous round of financing.

Drag-along rights

Rights that enable a shareholder or group of shareholders (usually those who own a controlling interest in the company) to compel other shareholders to sell their stock in the event a purchaser desires to purchase more than what the controlling shareholder(s) own(s).

Due diligence

A prudent and proper investigatory process to assess a company and the viability of a potential transaction.

Earn out

An arrangement in which sellers of a business may receive additional future payments if certain financial performance metrics are met.

Exit strategy

The method or plan for enabling shareholders to sell their shares and earn a return on investment. Typically, it refers to either the sale of the company or a public offering.

Founder

A person who participates in the creation of a company.

Founders’ stock

Nominally priced common stock issued to founders, officers, employees, directors, and consultants at or around the time a company is formed.

Full-ratchet, anti-dilution protection

Rights that enable investors to reduce the share price at which they can convert their earlier investment or debt to the lower price per share that the company subsequently sells or issues its securities.

Fully diluted basis

The total number of shares of common stock issued by a company, assuming all warrants, options and other rights are exercised and all preferred stock and other convertible securities are converted to common stock.

Initial Public Offering (or IPO)

The first registered offering of securities to the public that is in compliance with the Securities and Exchange Commission requirements.

Inside round

A round of financing in which the investors are the same or a subset of investors that invested in a previous round.

Institutional investor

Large, licensed entities that invest capital on behalf of companies or individuals.

Investment banker

A firm that raises capital, trades in securities, or facilities or brokers mergers and acquisitions (or a combination of some or all of the above).

Issuer

Refers to the company that issued or sold its securities.

Joint venture

An agreement or understanding between two or more companies in which the companies work together for a particular business undertaking.

Lead investor

The investor who manages the negotiation, documentation, and closing of a round of financing, and typically makes the largest investment in such round.

Liquidation preference

The amount of assets holders of preferred stock are entitled to prior to any distribution of assets to holders of common stock upon a liquidation event, such as the dissolution or sale of the company. The preference amount is often based on the original purchase price paid by the holders of preferred stock, or a multiple thereof (e.g., a 2x liquidation preference).

Living dead

Refers to investors who go through a few down rounds of financing, are unwilling or unable to invest any more, and for whose interests in the company there is no liquidation event on the horizon. When the term is applied to a company, it means that the company continues to operate, even though the company is insolvent or has little chance of thriving.

Lock-up provision

A contractual requirement that for a period of time (such as 180 days) a shareholder is restricted from selling such shareholder’s securities following a public offering.

Mezzanine financing

Typically a hybrid of debt and equity financing that is used to finance the expansion of an existing company. It is generally subordinated to debt provided by senior lenders, such as banks

No-shop requirement

A contractual requirement that prevents a company from soliciting or negotiating other deals for a specified period of time, while it is exclusively negotiating with a potential investor, group of investors, or acquiror.

Outstanding stock

Shares of stock that have been issued and are not held by the issuer

Participation right

A right that enables the holder to purchase the holder’s pro-rata percentage of the company’s equity securities in future rounds, enabling the holder to maintain his, her or its percentage ownership in the company.

Participating preferred stock

Preferred stock that entitles the holder not only to holder’s stated liquidation preference, but also allows the holder to participate in liquidating distributions to holders of common stock after the initial liquidation preference is distributed to the holders of preferred stock.

Payment in-kind dividends

A dividend paid in equity rather than cash.

Pari passu

A Latin term referring to the equal treatment of two or more parties in an agreement. For example, an investor may want to have a certain right that is pari passu with investors in a previous financing round.

Pay-to-play

A requirement that in order retain a right, the holder must do or pay something in the future. In the venture capital context, if a holder of preferred stock desires to maintain certain rights as a preferred stockholder, he, she, or it must participate and invest pro rata in future financings or lose those rights.

Piggyback registration right

A right that enables an investor to force an issuer to register the investor’s previously issued, but unregistered shares of the issuer in the event the issuer decides to register some of its other securities.

Placement agent

An individual or firm that assists with identifying investors to purchase securities.

Portfolio company

A company that has received an investment from a venture capital fund is said to be a portfolio company of that venture capital fund.

Post-money valuation

The value of a company after investors invest in a given round of financing.

Pre-emptive right

The right of an existing shareholder to purchase such shareholder’s pro rata share of any new stock that is being issued by the company prior to that stock being offered to new investors. Pre-emptive rights are similar to participation rights.

Pre-money valuation

The value of a company before investors invest in a given round of financing.

Preferred stock

Stock that gives its holders certain rights, preferences, and privileges over holders of common stock and other securities.

Private placement memorandum (PPM) or offering memorandum

A document explaining the details of an investment opportunity related to the sale of unregistered securities to potential investors.

Put right

A right that enables the holder to force the company or another investor to purchase the holder’s securities, usually for a prior agreed upon price, after a specified date or the occurrence of a specified event.

Qualified public offering (QPO)

A public offering that meets certain requirements, as agreed between investors and an issuer, such as a minimum amount or a specified return for holders of preferred stock.

Reg D or Regulation D

Refers to certain alternative rules promulgated by the Securities and Exchange Commission that enable an issuer to sell its securities with certain restrictions, without registering them, to a limited number of people, most or all of whom must meet certain standards of sophistication or wealth (see “accredited investor”). Each rule under Reg D has different requirements, such as those relating to the size of the offering, the number of investors, and the types of required disclosures.

Redeemable preferred

Preferred stock that can be redeemed by its holder in exchange for a prior agreed upon price.

Rights offering

An offering of securities only to current shareholders of an issuer.

Road Show

A series of presentations made in several cities to potential investors.

Securities and Exchange Commission (or SEC)

The federal agency that is in charge of enforcing the federal securities laws and regulating the securities industry (including the stock exchanges).

Stripped down preferred

A type of preferred stock that carries only the very basic rights of preferred stock (e.g., a liquidation preference), but does not carry the variety of other rights (contractual or otherwise) frequently associated with the issuance of preferred stock.

Syndicate

A group of investors that participate in a round of financing or a group of investment banks that participate in a public offering.

Term sheet

A document that outlines the key terms of a proposed transaction. The term sheet is typically non-binding, except for certain provisions.

Underwater option

An option is underwater when the current fair market value of the underlying shares is less than the option exercise price to purchase those shares.

Veto rights

Negotiated rights that enable the holder to prevent a company from taking certain actions or cause it to take certain actions.

Warrants

A derivative security that gives the holder the right to purchase securities (usually common stock) from the issuer at a specific price within a certain time frame.

Weighted average anti-dilution protection

Adjusts the investor’s conversion price downward based on a weighted average formula reflecting the number of new shares sold and the new price per share at which the additional shares were issued. It can be a narrow-based, weighted average or a broad-based, weighted average. Compare to full-ratchet anti-dilution protection.

The 2009 second quarter MoneyTree™ Report from PricewaterhouseCoopers (PwC) and the National Venture Capital Association (NVCA) came out earlier this week. As expected, the news was generally not good, but there were some rays of hope. Total amount invested nationwide was up some (15%) over last quarter but the number of deals was flat compared to the anemic numbers from the first quarter. In comparing last quarter to the 2008 second quarter figure, the number of deals was down by more than 40%.

Life Science Sector Leading the Way

By sector, life sciences faired the best. The report defines life sciences as biotechnology and medical device. According to PwC, investments in life science companies accounted for the highest percentage of total venture capital investments since the inception of the report. While the figures are not staggering, life science investments are proving to have slow but continuing exits for investors while exits for other industry have mostly stalled. With the increasing number of drugs coming off patent for large, cash rich pharma in the next few years, acquisitions of biotech companies are anticipated to increase. Many drug development companies (and investors) plan to take advantage of this as part of their exit strategy and long-term capitalization plan.

Also in the report, there was an increase in the combined size and number of seed and early stage investments, which coupled with the increasing interest in life sciences, bodes well for the Midwest if the trend continues.

Midwest Figures

In the breakdown of the regional data, the national trends generally hold true here in the Midwest. It is important to remember though that here in the Midwest, the numbers can fluctuate considerably from quarter to quarter because the deal volume is lower. So, an unanticipated quarterly spike of a given statistic (e.g., deal volume, industry investment, deal size, IPOs) in either direction is likely to be an anomaly rather than a material change in the trend line. As an aside, for purposes of the report, Minnesota, Wisconsin, Iowa, North Dakota, South Dakota, and Nebraska make up the “North Central,” while Illinois, Missouri, Indiana, Kentucky, Ohio, Michigan, and western Pennsylvania make up the “Midwest.”