Beware the Non-Disclosure Agreement

Joseph W. Bartlett, Co-Founder of VCExperts

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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9 Reasons Your Start-Up Needs Patents

Guest post by Jim Cleary and Rob Latta – Mintz, Levin, Cohn, Ferris, Glovsky, and Popeo PC

1.  Patents Get Venture Capital.

Venture capitalists want to see patents.  67% of venture-backed startups report that patents were vital for them in securing investment.[1]  In a 2010 study, only 40% of startups held patents, 80% of startups that received venture capital owned patents.[2]

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How Venture Capitalists Talk

Joseph W. Bartlett, Co-Founder, VCExperts.com

This post reviews basic terminology commonly used in the venture world. First, the entities into which capital sources are aggregated for purposes of making investments are usually referred to as “funds,” “venture companies,” or “venture partnerships.” They resemble mutual funds in a sense but are not, with rare exceptions (AR&D was one), registered under the Investment Company Act of 1940 because they are not publicly held and do not offer to redeem their shares frequently or at all. The paradigmatic venture fund is an outgrowth of the Greylock model, a partnership with a limited group of investors, or limited partners, and an even more limited group of managers who act as general partners, the managers enjoying a so-called carried interest, entitling them to a share in the profits of the partnership in ratios disproportionate to their capital contributions. Venture funds include federally assisted Small Business Investment Companies (which can be either corporations or partnerships) and, on occasion, a publicly held corporation along the AR&D model, styled since 1980 as “business development corporations.” This book, following common usage, will refer to any managed pool of capital as a “fund” or “partnership.”

Once a fund makes an investment in an operating entity, the fund or group of funds doing the investing are the “investors.” A company newly organized to exploit an idea is usually called a “start up,” founded by an individual sometimes referred to as the “entrepreneur” or the “founder.” Any newly organized company, particularly in the context of a leveraged buyout (LBO), is routinely labeled “Newco.” The stock issued by a founder to himself (and his key associates) is usually sold for nominal consideration and those shares are labeled “founders stock.” (The use of the male gender is used throughout for ease of reference only.) The founder, as he pushes his concept, attracts professional management, usually known as the “key employees.” If his concept holds particular promise he may seek from others (versus providing himself) the capital required to prove that the concept works—that is, the capital invested prior to the production of a working model or prototype. This is called “seed investment” and the tranche is called the “seed round.” Each financing in the venture process is referred to as a “round” and given a name or number: “seed” round, “first venture” round, “second” round, “mezzanine” round, and so forth.

Once the prototype has been proven in the lab, the next task ordinarily is to place it in the hands of a customer for testing—called the “beta test” (the test coming after the lab, or “alpha,” test). At a beta test site(s), the machine or process will be installed free and customers will use and debug it over a period of several weeks or months. While the product is being beta tested, capital is often raised to develop and implement a sales and marketing strategy, the financing required at this stage being, as indicated above, “the first venture round.”

The next (and occasionally the last) round is a financing calculated to bring the company to cash break-even. Whenever a robust market exists for initial public offerings this round is often financed by investors willing to pay a relatively high price for the security on the theory that their investment will soon be followed by a sale of the entire company or an initial public offering. Hence, this round is often called the “mezzanine round.” A caution at this juncture: The term “mezzanine” has at least two meanings in venture-capital phraseology. It also appears as a label for junior debt in leveraged buyouts. In either event, it means something right next to or immediately anterior to something else. As used in venture finance, the financing is next to the occasion on which the founder and investors become liquid—an initial public offering (IPO) or sale of the entire company. As indicated earlier, the measures taken to get liquid are categorized as the “exit strategies.”

One of the critical elements in venture investing is the rate at which a firm incurs expenses, since most financings occur at a time when the business has insufficient income to cover expenses. The monthly expense burden indicates how long the company can exist until the next financing, and that figure is colorfully known as the “burn rate.”

 

FinTech Companies Face Big Privacy Challenges in 2016

Guest post by Natalie Prescott and Cynthia Larose – Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

According to the FBI, “there are only two types of companies: those that have been hacked and those that will be.”  It does not take an actual data breach, however, for a company to be liable for its data security practices.  In March 2016, the Consumer Financial Protection Bureau (CFPB) made this clear when it settled its first-ever data security enforcement action against an online payment processing company, Dwolla.  The CFPB pursued Dwolla because it found the company’s representations to customers about its cybersecurity misleading – disregarding the fact that Dwolla had never, since its inception, experienced even a single reported cybersecurity incident.  As a part of the settlement, Dwolla agreed to sign a Consent Order, pay a $100,000 fine, take certain steps to improve its data security for the next five years, and make accurate representations to consumers.  The Dwolla case offers important guidance to FinTech companies and provides a framework for data protection and preparedness plans.

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What Makes a Good Business Plan?

Guest post by Daniel I. DeWolf  – Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

The way most businesses are initially funded is by the three Fs. That is, by “friends, family, and fools.” After all, who else would provide the initial seed capital to start a new enterprise? But self-funding (or relying on friends and families) will only take you so far in building out your new business.

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