Angel Financing Transaction Form Documents

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 this one from gust. 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, 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. 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.

Term Sheets for Angel and Venture Capital Investments

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. This post covers the basics of angel and VC term sheets.

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.

Using Placement Agents in Private Offerings

When raising capital, many companies use 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.”

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.

Due Diligence and Corporate Clean Up in Private Offerings

Due diligence and corporate clean up are important steps in the private offering process and putting together a private placement memorandum. This post elaborates on these steps.

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.

Preparing for the Investor Presentation

This post covers a number of best practices for presenting to investors, whether they be angel, venture capital, or strategic investors.

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

Differentiating Introductions

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. Setting up the right type of introduction from the right type of person can be a test of your entrepreneurial skills.

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

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.
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.
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.
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

The introducer currently works with or has worked with the prospective investor, joint venture or joint development partner, CEO, etc., but not closely.
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.
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

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.
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.

Preparing for the Next Financing Round

This post discusses both the timing and preparation for the next round of equity financing for emerging companies.

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.