Can Rewards-Based Crowdfunding Help In Solving Issues Facing Founders Of Startups?

Joseph W. Bartlett, Council, Reitler Kailas & Rosenblatt LLC

You might be interested in a methodology for solving issues which confront the founder or founders of an early stage (the garage version) emerging growth company as the company launches.

The idea, which occurred to me while speaking to an event sponsored by the Crowdfunding Professional Association (“CfPA”) in DC, involves a dual approach for raising money, combining a pitch for donations under the rewards-based crowdfunding networks and platforms, the most prominent being Kickstarter and Indiegogo, with conventional fund raising under the auspices of Regulation D, Rule 506(b).

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Beware the NDA

Joseph W. Bartlett, Council, Reitler Kailas & Rosenblatt LLC

Any number of private equity transactions begin with the execution of a confidentiality or non-disclosure agreement (“NDA”). Assume a venture capitalist is investing in the private equity of an early stage firm, or two venture-backed companies are discussing a merger. The usual protocol insists that, before due diligence commences, each of the parties (in the case of a merger, particularly if stock is the consideration) or the issuer (in the case of a venture investment) seek to protect their confidential information by requesting the other party to execute an NDA.

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“Finders” vs. “Consultants”

Joseph W. Bartlett, Special Counsel, McCarter & English LLP & Co-Founder of VCExperts

Several decades ago, the Staff of the SEC publicly rejected the conclusions in the then-Bible on Securities Regulation by Professor Loss to the effect that individuals and firms classified as “finders” who were paid success fees for bringing sources of capital to the attention of capital hungry issuers were not required to register under the `34 Act as broker-dealers or to join what was then the NASD as long as their only activity of any relevance was to bring investors to the attention of the issuer and vice versa. The notion was that broker-dealers had a menu of responsibility and services if they were “engaged in the business” … retail customers, custody of securities, trading, market making, underwriting, etc.,… and participation in only such one activity did not require registration. The Staff set out publicly to disagree with Loss’s conclusion, provoking a series of articles on the subject by yours truly (see Appendix) which chronicled the various enforcement actions and public pronouncements by the Staff to the effect that transaction-related compensation was, of and by itself, enough to require registration and the activity was otherwise illegal, with a variety of consequences.

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Venture Capital Survey Silicon Valley Second Quarter 2015

Guest post by Barry J. Kramer and Michael J. Patrick of Fenwick & West LLP

Fenwick & West LLP analyzed the terms of 166 venture financings closed in the second quarter of 2015 by companies headquartered in Silicon Valley.

Overview of Fenwick & West Results
Valuation results continued to be strong in 2Q15.

  • Up rounds exceeded down rounds 83% to 8%, with 9% flat. This was essentially unchanged from 1Q15 when up rounds exceeded down rounds 83% to 9%, with 8% flat.
  • The 75 point difference between up and down rounds was the largest since we began calculating up/down rounds in 1Q02. The last two quarters have had the highest percentages of up rounds since 1Q02 as well.
  • The Fenwick & West Venture Capital BarometerTM showed an average price increase in 2Q15 of 107%, an increase over the 100% recorded in 1Q15.
  • Series B financings have generally had higher Barometer results than other series over the course of our survey, and in 2Q15 Series B exceeded the next closest series by 81 percentage points, the largest amount in two years.
  • The median price increase of financings in 2Q15 was 74%, an increase from the 62% registered in 1Q15.
  • The software industry again had a very strong performance in 2Q15 with 50% of all deals and generally the second highest valuation results. The internet/digital media industry, with the highest valuation results, and the life science industry, with the second highest percentage of deals and also strong valuation results, also had very strong quarters. The hardware industry had very solid results also in the quarter, but lagged the other industries.

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Valuation of Private Securities: The Way the Pros Handle It

In a recent opinion by Vice Chancellor Laster in the Delaware Chancery Court, he made the point, and I quote from an Orrick alert. [1]

“Among other things the Court found that the valuation firm … did not perform a comparable companies analysis even though only months before, during the ordinary course work, it deemed another transaction in fact to be comparable.”

The securities in question had been extensively analyzed as to valuation by various professionals who had focused on methods such as discounted cash flow (“DCF”), which entails an estimate of future cash flow and then discounting the number back to the present time to arrive at a valuation. And, of course, there are a number of other methods for valuing illiquid property and, in particular, securities in a company which are not traded on an exchange. [2] The problem with DCF and like valuation methodologies is that one can arrive at just about any number which is this side of the absurd, depending on how the various elements of the methodology are tweaked.

For example, in a situation in which I participated as counsel several years ago, each side had hired an internationally recognized valuation service to compute the value of the stock in the company which an individual (who was a good or bad leaver, depending on how you looked at his performance) had owned. The valuation expert retained by the company which was paying for the shares in accordance with a put/call agreement entered into when the individual joined the company came up with a valuation of $160,000. A well-known expert, which the former executive had retained, came up with a valuation in excess of $11 million. The legal fees run up while the parties went after each other, given (among other things) this disparity in opinions, were well into the seven figures because settlement negotiations were rocky from the start.

The second reason that comparables are used so frequently is my experience in the venture capital business. The fact is the way the VCs often arrive at a valuation when making, say, the Series A investment is best described as the herd instinct. The investment managers, the members of the general partner, will look at a company in the same line of business and in the same general location and their first question is, “How did Greylock or Sutter Hill value this other company?” With that information under their belts, the answer as to the ultimate valuation is tweaked in accordance with a comparison of the size and profitability of the two companies. And what counts is the comparable information.

It is available through VC Experts on a quarter by quarter basis, one can track, for example, pre- and post-money values of medical device companies in New England over the last seven quarters. That’s the kind of information the pros very much want to review when they approach this critical inquiry. It doesn’t mean they won’t use other methods as well; but comparables are the way at least to smoke out bizarre results such as the ones in the example above cited.

[1] Halper & Rooney, “Flawed Valuation Leads Delaware Court to Award Damages to Option Holders,” Orrick, Client Alert, 08/14/2015.

[2] Disclosure: I am the chairman of the Board and co-founder of VC Experts ( which provides officially derived comparable valuations with respect to which investments have been made as contained on, e.g., the MoneyTree Survey..