An increasing number of traditional software and hardware companies are accepting the idea that software as a service (SaaS) is here to stay for some time. In September, Oracle announced that it was significantly increasing its on-line, subscription-based software tools available for middle market companies. Salesforce.com and Cisco announced last week a partnership that brings together Salesforce.com’s online customer service software with Cisco’s IP telephony. The service, called “Customer Interaction Cloud,” is designed to provide a complete, cloud-based customer service offering for small to medium sized businesses. Even Dell, with its recent acquisition of Perot Systems, has signaled an interest in expanding its presence in the SaaS space. From a customer’s standpoint, SaaS generally offers quick deployment, low upfront cost, easy management and scalability.

Legal Difference Between Traditional Software Licenses and SaaS Agreements

Before delving into the SaaS market, it is important for traditional software companies (whether that be off-the-shelf product companies or customized software developers) to understand the differences between a typical software license or software development agreement and a SaaS agreement. At a fundamental level, what is being conveyed in a software license or software development agreement is different than a SaaS agreement. A software license or development agreement typically grants either a limited or exclusive right to use the software. In some cases, they include an assignment or transfer of the actual code from the developer to the purchaser of the software. A SaaS agreement, on the other hand, typically grants only a limited right to use a “service,” with no rights to the underlying software.

Key elements of a SaaS Agreement

With the legal difference between the two business models in mind, as well as the practical differences (web based offering versus an on-site thick client or server-based offering), below are some highlights of the provisions of a typical SaaS agreement:

Subscription for a Service.

Typically, SaaS agreements provide for a subscription to a service for a specified period of time. Many states give this structure more favorable sales tax treatment over traditional shrink-wrap software license agreements.

Performance and Up-Time Guaranties.

Most SaaS agreements address at least a base level of performance and functionality requirements of the service. For more sophisticated SaaS offerings, it is common to see Service Level Agreements (SLAs). The SLAs typically address issues like site and application downtime limits, support response times, and system response times.

Privacy and Security.

SaaS agreements usually address privacy and security issues as the SaaS provider typically holds its customers’ sensitive data. SaaS vendors generally provide some base level of assurances of privacy and security, even in low price SaaS offerings. For the large and more sophisticated offerings or where there are unique confidentiality concerns, the privacy and security provisions in the SaaS agreement can be very detailed. For example, many public companies require that a SaaS vendor’s systems and offerings be compliant with Statement on Auditing Standards No. 70 (SAS 70), which is a rigorous audit standard for controls on accuracy and security.

Data Backups and Data Porting.

In most sophisticated SaaS offerings, the SaaS agreement should address data backup, redundancy, and disaster recovery. Similarly, many customers of sophisticated SaaS offerings will want assurances on the ability to move the customer’s data either to an internal system or another vendor.

Renewals, Termination, Fees and Payment Terms.

Having a continuing relationship requires that the SaaS agreement address items like automatic renewals, termination (who has the ability to terminate upon how much notice), fees (when and how often charged and for what and the ability to change), and payment terms.

Obviously, there are other provisions as well, such as warranty disclaimers, indemnification, limitation on liabilities, export laws, etc. How much these terms vary from traditional software licenses or development agreements are dependent upon the particular SaaS offerings.

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:

For companies that go public, how do those that were backed primarily by angel investors fare against those primarily backed by venture capitalists? That was one of the questions addressed in a working paper recently published by two professors from the University of New Hampshire. They examined data related to the pre-initial public offering (IPO) shareholders of companies that subsequently went public. The conclusions from the study provide interesting information that should be considered for companies looking to go public as part of their long term capitalization plan.

The Paper: Initial Public Offerings and Pre-IPO Shareholders: Angels versus Venture Capitalists

The working paper, entitled Initial Public Offerings and Pre-IPO Shareholders: Angels versus Venture Capitalists, was authored by William Johnson and Jeffrey Sohl. The authors examined the public offering documents of IPOs between 2001 and 2007, eliminating public offerings under $5, REITs, banks, foreign issuers, and the like. Their final sample consisted of data from 665 IPOs.

The authors took a look at the details of who owned more than 2% of the issuer prior to the offering, classifying them as management (including family of management), angel investors, venture capitalists, or other corporate entities. In drawing their conclusions, the authors made a number of assumptions as to which category a given shareholder fit. In the data sample, roughly 13% of the issuers had only angel investor backing, 33% had only venture capital backing (with very little or no angel investor backing), 16% had a combination of angel investor and venture capital backing, and 38% had neither angel or venture capital backing.

Reexamining the Value of Angel Investors

Here are some of the authors’ interesting conclusions:

• While VCs were generally able to attract higher quality investment bankers to underwrite public offerings, venture capitalists tended to be involved with public offerings that were underpriced when compared to companies that were only angel investor backed or that did not have angel or venture capital backing.
• Shareholders in angel investor backed companies were significantly more likely to sell some of their shares in the IPO as compared to other companies that were not backed by angel investors.
• Angel investors invested money in more diverse industries (e.g., wholesale and retail, manufacturing) than venture capital firms. VCs tended to focus overwhelmingly on technology-based industries.
• The average size IPO for venture capital backed companies was smaller than any other group of companies. The highest average size IPO came from companies that were neither angel investor nor venture capital backed; in fact, the average size IPO of this group of companies was more than 2.5 times that of venture backed firms.
• While firms that had neither angel investor nor venture capital backing had the largest IPOs, they also took the longest to go public (average of 28 years). Of the types of companies examined, the quickest to go public were those companies that had both angel investor and venture capital backing (average of 11 years).

A few things to keep in mind when reviewing the results of the study. First, the data in the study was correlational, not causational. In other words, having angel or venture capital backing does not necessarily cause lower public offering valuations or earlier public offerings. There could be, for example, other reasons for the apparent underpricing such as the higher quality investment bankers creating higher post-offering interest in the offered securities. Second, there were a number of assumptions built into the study’s data as to who was an angel investor and who was not. When I was reviewing the assumptions, I could think of a number of examples in my experience that were counter to the assumptions made. In fairness to the authors of the study, with imperfect information one needs to make a number of assumptions when looking at a large amount of data and counterexamples do not necessarily invalidate the general trends or conclusions of the authors.

Long Term Capitalization Plan

As the authors indicated in their conclusion, “[o]ur results suggest that prior to making a decision about obtaining angel versus venture financing, private firm management should also consider the consequences of such early investors on IPO firm proceeds raised in an eventual IPO.” Indeed, drawing from the results and conclusions such as those in this and other studies is an important part of developing a good long term capitalization plan.