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Issue 27 • 2011
produced by the NatioNal VeNture capital associatioN aNd erNst & youNg llp
National Venture Capital Association (NVCA)
As the voice of the U.S. venture capital community, the National Venture Capital Association (NVCA) empowers its members and the entrepreneurs they fund by advocating for policies that encourage innovation and reward long-term investment. As the venture community’s preeminent trade association, NVCA serves as the definitive resource for venture capital data and unites its 400 plus members through a full range of professional services. Learn more at www.nvca.org.
National Venture Capital Association
1655 Fort Myer Drive Suite 850 Arlington, VA 22209 Phone: 703.524.2549 Fax: 703.524.3940 Web site: www.nvca.org
IPO Readiness – Preparing VC-backed Companies for the IPO Value Journey®
By Jacqueline A. Kelley and Bryan Pearce, Partners of Ernst & Young LLP
Growth Equity: A Lawyer’s Perspective
By Al Browne, Partner in Charge, and Eric Grossman, Partner, of Cooley LLP
Fair Value, Who Cares? and Why They Should!
By Steven Nebb, CFA, Director, and David L. Larsen, CPA, Managing Director, of Duff & Phelps LLC
The Case for LLCs for Venture Capital Financings
By Richard Small, Partner and Co-Chair of Edwards Angell Palmer & Dodge’s Private Equity & Venture Capital, with contributions made by Karl Fryzel, Partner of Edwards Angell Palmer & Dodge
Tapping Winning Talent
By Jeff Markowitz, Managing Partner, and Brad Stadler, Partner, of Heidrick & Struggles
Venture Fund Wind Downs to Achieve Strategic Objectives
By Laurence Allen, Managing Member of NYPPEX, LLC
Preventive Medicine for Patent Portfolios: Getting More Out of IP Due Diligence
By Kristin H. Neuman, Esq., and Elias Schilowitz, Esq., of Proskauer LLP
Please send comments about articles in this issue or suggestions regarding topics you would like to see covered in future issues to Jeanne Metzger, NVCA’s Chief Marketing Officer, at email@example.com.
IPO Readiness –
Preparing VC-backed Companies for the IPO Value Journey ®
By Jacqueline A. Kelley and Bryan Pearce, Partners of ernst & Young LLP The first six months of 2011 continued the positive momentum for us IPOs that began in 2010. Through June 2011, there were 78 deals (compared to 163 in all of 2010) raising proceeds of $28.8B (compared to $43.5B for all of 2010). The chart on page 4 provides the comparison. However, the US and global debt situation and related market volatility at the time of writing is creating uncertainty relative to IPO markets for the balance of 2011. While capital market volatility continues to be a concern in good times and bad, strong businesses that are well prepared for the rigors of being public companies can generally find a receptive investment market.
is Now the time – are your portfolio companies ready?
Over the past several years, venture investors have financed a multitude of promising new companies in segments such as cleantech, social media, biotech, cloud computing and software as a service, which have continued to grow despite the economic downturn and challenging capital markets. Many of these companies have reached a stage of development where a strategic transaction, such as an IPO or M&A, is required to fund the next phase of growth for the company and provide an exit for venture investors. Some of these companies will go public and become tomorrow’s market-leading companies. For venturebacked companies contemplating an IPO in the next 12 to 24 months, now is the time to think about readiness and understand what is required to operate successfully as a public company.
Key US IPO Statistics
2008 Number of deals Capital raised (US$) Average deal size (US$) VC-backed IPOs (number of deals, capital raised) Private investment backed IPOs5 (number of deals, capital raised) Top sectors (number of deals) 37 $26.8b $724.9m4 8 deals, $1.4b 13 deals, $3.0b Energy (8) Financials (5) Health care (5) Industrials (5) High technology (4) Financials ($20.0b) Energy ($2.7b) Materials ($1.3b) Industrials ($0.8b) High technology ($0.6b) 2009 67 (▲81%1) $27.3b (▲2%1) $406.9m 13 deals, $2.1b 35 deals, $10.3b High technology (12) Health care (9) Real estate (9) Industrials (8) Financials (5) Financials ($10.5b) High technology ($3.2b) Real estate ($2.9b) Health care ($2.2b) Energy ($1.4b) 2010 163 (▲143%2) $43.5b (▲60%2) $267.1m 60 deals, $6.7b 109 deals, $17.5b High technology (35) Health care (21) Financials (20) Industrials (17) Energy (14) Industrials ($22.0b) High technology ($4.9b) Financials ($4.1b) Energy ($3.5b) Real estate ($2.0b) 2011 FH3 78 $28.8b $369.5m 35 deals, $6.8b 53 deals, $23.8b High technology (21) Health care (13) Energy (10) Consumer products & services (6) Real estate (6) Health care ($5.6b) Energy ($5.5b) High technology ($5.1b) Consumer products & services ($3.6b) Retail ($1.9b) 44 deals, $23.9b 31 deals, $4.9b 3 deals, $103.0m
Top sectors (capital raised)
Stock exchanges: NYSE NASDAQ AMEX (number of deals, capital raised)
17 deals, $25.1b4 18 deals, $1.7b 1 deal, $3m
35 deals, $19.1b 30 deals, $8.1b 1 deal, $2m
82 deals, $34.7b 76 deals, $8.7b 5 deals, $94.5m
Based on IPO activity on US exchanges (NYSE, NASDAQ and AMEX) 1Percentage change from 2008 and 2009 2Percentage change from 2009 and 2010 32011 FH covers IPO activity from 2011 January to end of June 4Includes Visa’s $19.7b IPO (largest US IPO ever). The average deal size excluding Visa is US$199.2 million 5Private investments refers to backing by PE firm or by VC firm or by both Source: Dealogic, Thomson Financial, Ernst & Young
As we look out a year or two from today, the IPO outlook is likely to continue to remain very active — will your portfolio companies be ready for any opportunities that arise? Successful management teams and investors have a dual focus — both on execution of their established business plans and building value — but also in this still-challenging environment, it is important not to lose sight of exit readiness. Venture-backed companies will need to be thoroughly prepared before exposing themselves to the ever-increased scrutiny of the public markets. Today’s capital markets expect companies to have long-term growth potential, and the ability to scale (both revenues and margins). showing the market that it has weathered the recession gives a company another dimension of readiness. Our experience, supported by substantial ernst & Young research, is that IPO success begins with readiness preparations 12 to 24 months prior
to the IPO “event.” The question is not whether an IPO is on a company’s immediate agenda, but how a company can be prepared to take advantage of the open IPO window — and operate successfully as a public company — when its business plan eventually requires such an infusion of capital to take it to the next stage of growth.
are your portfolio companies prepared for the ipo Value Journey?
ernst & Young audits more IPO-bound companies than any other public accounting firm. Bringing together the collective experience and network of the firm, we have determined through inquiry and research that companies who outperform the market, both at the time of the initial transaction and in terms of post-offering performance, are typically those who prepare early for their IPOs. Market outperformers treat the IPO as a long-term transformational process
that brings change to every aspect of the business organization and corporate culture. As board members and advisors, venture investors have an important role in guiding their companies through this value journey. The changes that are undertaken as a part of the IPO readiness agenda also help to enhance value should a merger or acquisition be the ultimate outcome. Our research indicates that focusing on the following 10 key areas plays an important role in the success of a company’s IPO.
Keeping your options open: alternatives to an ipo
While a public offering brings prestige and liquidity to a company, the private capital markets may be an effective and less costly vehicle for raising capital and realizing an optimal company valuation — and significantly more companies realize an exit through an M&A transaction every year than through an IPO. Evaluate other possible transactions that could be attractive alternatives to an IPO — consider “multitrack” strategies or pre-IPO transactions to enhance the offering’s value. Determine your company’s potential M&A valuation versus its public company valuation. Ensure your company can scale to meet the company’s growth projections.
companies that invest early to prepare for their ipos are rewarded with an increase in multiple } Reduce execution risk } Start early to reduce the risk that your company is not adequately prepared for the IPO transaction and life thereafter as a public company. } Increased awareness } Increase awareness throughout the company as to the rigor and focus required to execute a successful IPO } Drive business performance } everage the leading practices of L executives of top-performing IPOs. Embrace critical success factors to drive not only the IPO valuation, but overall business performance
Multi-track your Way to a capital infusion
A multi-track approach simultaneous to an IPO can help a company improve the chance of financing success and achieve the highest possible company valuation. Multi-track options can include: sale to a private equity firm; sale to a strategic buyer; partnerships, joint ventures and strategic alliances; and alternative liquidity options, such as Rule 144A placements or private exchanges and cross-border listings. Often, potential buyers will show interest in a company that has indicated it will go public has strengthened its infrastructure to do so and has a realistic prospect of doing so. Establishing and following a rigorous IPO readiness agenda typically drives value and speeds deal completion in other types of financing and M&A transactions.
preparing for the ipo Value Journey
An IPO is not the end game, but rather a transformation from a private company to a public enterprise. Begin acting like a public company as early as possible: develop a formal comprehensive written plan and timeline. Consider integration of a transaction strategy, formalizing policies, procedures, reporting and communications. Allow adequate time to build the necessary legal, financial, technological and risk management infrastructure. There must be time to address key financial and reporting issues, including accounting for stock option issuance and revenue recognition. Finally, proactively address the four functional phases of the IPO preparation process: due diligence, drafting, SEC review and marketing.
timing the Market
Market timing is often regarded as a key success factor for an IPO. If timed perfectly, the company can price its shares to yield an optimal valuation and the highest possible returns for its investors, for months and years after the IPO. Throughout the process, it is important for the company to communicate realistic timeline expectations to key stakeholders. The company should be prepared to quickly enter into the registration process when the window of opportunity is available.
A multi-track approach simultaneous to an IPO can help a company improve the chance of financing success and achieve the highest possible company valuation.
A company’s IPO valuation is driven by market confidence in the ability of its management team to execute on its business plan and deliver strong investor returns. We suggest that board members and management teams challenge whether they are ready for the public market instead of asking if the markets are ready for them. Solicit input from a variety of external advisors, including investment bankers, attorneys, auditors and others, in assessing transaction options and timelines. As a board member, you should also help them develop a Plan B. If the markets are unfavorable or if there is a delay in the offering process, it might be necessary to delay the IPO. As a result, the company should be prepared for delays and have an alternate financing strategy to execute, if an IPO cannot take place. Throughout the IPO process, many companies explore multiple options simultaneously to increase the likelihood of a capital infusion.
companies public. The selection of the extended team of financial and tax advisors, auditors, attorneys, underwriters and other key advisors carries significant weight in the IPO process and can assist the company and its team through bumps in the journey. Each of these professionals and their teams should have extensive experience in taking companies through the initial public offering process. Having the right external team aligned with your company and its goals can assist the company through the IPO journey anticipating questions and issues before they are raised externally. Finally, the investment community looks for a CEO that can articulate the company’s vision and strategy, and can continue to execute the business plan, while forging relationships with the external stakeholders. The CFO must also own the financial results and communicate those results effectively to the investor audience. The CEO and CFO will need to co-navigate through the pre-IPO process, with the CFO becoming the primary liaison with the investor community in the after-market.
building the business process and infrastructure
The ultimate decision to go public or pursue an alternative method of capital infusion must reflect a comprehensive understanding of the markets, financial reporting process, technology and related potential areas of exposure. IPO candidates must weigh the decision to go public by understanding the risks and regulations associated with life as a public company. Now is the time to assess the capability of your company’s internal infrastructure. Do you have the proper procedures in place to support the transformation to a public company? Are there appropriate systems and controls in place to produce timely quarterly statements? Often, companies that are newly public find the quarterly close process to be challenging, but it is an essential element in meeting public investors’ expectations. We recommend that companies prepare their financial statements as if they were already public for several quarters prior to the IPO. Information systems also need to be aligned with the company’s business objectives and should support critical reporting requirements. Information technology will be crucial to helping the public company capture, organize, report and assess relevant information
building the right team
The market looks for companies that have a management team with the right experience and a going-public track record. As a board member, it is important that you work with the board and the CEO to evaluate the management team, to determine whether all members have the skill sets necessary, and a commitment toward the end goal of running a publically held company. Strong IPO performers typically begin the process of strengthening the management team a full one to two years in advance of the IPO so that the team is in place and functioning (well together before the public launch). Also, ensure that the company has a strong set of external advisors that have deep experience in taking
quickly. Management should be able to make informed decisions, monitor and analyze progress against corporate goals, and answer questions from the analysts quickly. Establish the appropriate balance within the organization to ensure focus on the transaction does not supersede business execution. Determine who will run the company while the key executives are out selling the transaction.
possessing the right credentials, board members must be able to meet a substantial time commitment of 200 hours or more per year. Under the umbrella of SOX oversight, companies must draw a definitive line between the scope of directors’ duties and the responsibilities of executive management. Additionally, the company should develop appropriate succession plans and executive depth.
establishing corporate governance
Public companies require a different level of guidance and compliance than a private company. The process of assembling a strategic board of directors is even more complicated and critical for today’s IPO-bound companies than it was in the past. With heightened corporate governance standards for public companies and increased liability exposure, a board must have a mix of audit, governance, compensation and compliance specialists, as well as experienced executives. Typically, small-cap company boards should target a composition of five to six outside directors with a minimum of three independent committees (audit, compensation and governance/ nominating). In addition to being independent and
Managing investor relations and communications
A company’s debut in the public markets requires an investor-relations function that can sustain the market’s interest, communicate with shareholders and attract new investors and sell-side coverage. The investor-relations professional should also be able to manage regulatory matters and risks around external messaging that are within the company’s control. A company on the IPO journey should hire a skilled investor-relations expert to help build and guide the strategic communication plan. That individual should prepare an internal and external communication strategy and be able to effectively communicate that plan to the capital markets. Once the company has
gone public, it will be important to continually retell the company’s story and fine-tune the investment value proposition, including, where appropriate, providing supportable guidance on milestones and financial performance.
delivering on the promises
Once a company goes public, the real work begins — keeping the promises made on the road show. It is time to execute the business plan and effectively use the proceeds of the public offering. Management credibility is one of the most important drivers of public company success and longevity in the investment arena. Newly public companies should clearly define the parameters and metrics that management believes are appropriate to track the business in order to give investors and analysts a blueprint to follow. A public company’s management team will always be surrounded with issues outside of its control, including stock market volatility, the economy and industry fluctuations. It is important to focus on factors within the company’s control — managing the business, meeting revenue numbers and creating value. Do not underestimate the importance of strong financial reporting, planning and analysis functions to support the message to the investors. In our view, the most successful IPOs — both in terms of the transactions and post-offering performance — are conducted by companies that view the IPO as a transformational process touching on all aspects of the enterprise and allowing enough time for changes to become ingrained in the organization before operating as a public company. As board members and advisors, venture investors have an important role to play in guiding their portfolio companies through this valuecreating journey. What’s more, the changes undertaken as part of an IPO readiness agenda also help to drive value in a dual-tracking process where a merger or acquisition is the ultimate outcome.
conducting a successful road show
A critical part of the IPO journey is the road show. It is possibly the most exhausting event for the CEO and CFO. The road show commitment is typically 8 to 10 days in the us with an additional 1 to 2 days in Europe or Asia. These meetings can be one-on-one or group presentations, for 8 to 12 hours a day, and can be in multiple cities in one day alone. This is where management must sell the investment merits of their company’s story, as well as address the questions and issues raised by prospective investors. It is extremely important that the company’s business plan and messaging are consistent, realistic and sustainable over the long-term. Developing a welldesigned road-show presentation, “elevator” pitch, and talking points is the best opportunity to influence investors’ investment decisions.
attracting the right investors and analysts
It is important that the company establish a strategic plan for managing the ownership mix in the aftermath of going public as accountability shifts from a small investor pool to perhaps thousands of new investors. The company management team is responsible for continuing to drive post-offering performance. Companies should develop a strategic plan that actively engages and cultivates relationships with potential buy-side investors, who understand their business model through ongoing dialog and non-deal market visits. It is key for the message to resonate with the investors to ensure strong postoffering performance.
For further information on IPO readiness or to contact an Ernst & Young IPO leader near you, visit www.ey.com/us/strategicgrowthmarkets
About the Authors
Jacqueline A. Kelley (firstname.lastname@example.org), Partner, is the Americas IPO Leader, Ernst & Young LLP. Bryan Pearce (email@example.com), Partner, is the Americas Director, Entrepreneur Of The Year® and Venture Capital Advisory Group, Ernst & Young LLP.
Growth Equity: A Lawyer’s Perspective
By Al Browne, Partner in Charge, and eric Grossman, Partner, of Cooley LLP Whether you call it “venture-heavy” or “LBO-light,” growth equity investing is on the rise, and these transactions present legal advisors with a unique set of issues when structuring and defining the terms of the deal. During the first quarter of 2011, later-stage investments represented 36% of deal activity — more than three times the later-stage deal volume during the first quarter of 2010 — and many of those later-stage deals are growth equity investments. Transactional lawyers who are used to advising clients based on market custom and practice will find that growth equity investments, while containing many of the familiar terms of traditional financing transactions, have unique terms and investor expectations that must be carefully considered in every deal.
the growth equity portfolio company
Companies that pursue growth equity capital are, relative to recipients of venture capital, generally more mature businesses that have successfully built a product and have sales and substantial customer traction. They have generally taken the product development and product acceptance risk out of the equation — no small accomplishment. Typically, these companies have an operating history, multiple offices (sometimes overseas) and historical financial performance that is, at least to some extent, predictive of future financial performance. They are raising capital not to further R&D, but instead to grow sales and geographic footprint, execute on an acquisition strategy, hire talent or, often most importantly, for stockholder liquidity.
... because there may be a disguised compensation element in a founder stock purchase (or, more typically, repurchase), it is most convenient to structure the liquidity component as a primary investment by the investor in newly issued stock, followed by a repurchase of the founder stock by the company with the investment proceeds. This allows the company to withhold applicable taxes on the compensation element.
Unlike venture investors who often search for disruptive technologies, growth equity investors rarely expect that their investments will be transformative. Investors in these companies are hoping that their participation in the business will help accelerate sales and create new market opportunities. As a result, the equity return targets are generally more modest for the growth investor and management. A 3x to 5x return is a good growth equity return. Modest financial engineering — such as sales team optimization, modest restructurings and tax optimization — can impact returns in a meaningful way. In some respects then, the mindset of the growth equity investor is similar to that of the classic private equity investor: they both target later-stage businesses and are hoping to make a reasonable return for their limited partners without fundamentally disrupting an industry. But there are meaningful differences between a growth equity target and the classic private equity leveraged buyout target. Growth companies
are often managed by the same founding team who launched the business, thus instilling the company with a scrappy entrepreneurial culture. The founders have typically “bootstrapped” the business over several years, and the operations are already very lean. More often than not, the growth equity investor is hoping to preserve the culture that has made the company successful, while, at the same time, helping the company scale its corporate infrastructure. Private equity-backed LBOs, on the other hand, are often built on financial engineering and restructuring managed by professional executive teams, which remain rare in the context of the growth equity portfolio company.
Growth equity sits squarely at the intersection of venture capital, on the one hand, and private equity, on the other. As more and more venture capitalist firms expand into later-stage deals and growth equity, they bring their transaction norms and customs to those transactions. At the same time, traditional LBO and private equity firms are expanding into technology and growth equity, and they, too, are bringing their terms with them. This results in a mélange of “market” practices that defy easy categorization of the more evolved venture or private equity markets. As a result, principals at growth equity firms and private companies often seek guidance from their law firm when setting the “market” terms of a transaction. The following is a list of some of the typical issues and terms that attorneys at Cooley have experienced in growth equity transactions.
structuring stockholder liquidityprice paid for seller stock in liquidity transactions — and by Whom?
Often it is the founding team driving for partial liquidity in a growth equity deal. The team has been at it for a while, have commonly bootstrapped their way to this point and want to take a few “chips off the table” as an interim reward as they drive to push the company to new heights and its ultimate exit. Structuring stockholder liquidity transactions for founders/management can be tricky. Commonly, the per share price paid for founder common stock is the same as the price per share paid by the investor for new preferred stock. Tax issues raised by this approach include: (a) whether the common stock
Undoubtedly, careful tax analysis needs to be front and center when initially structuring a growth equity deal with a liquidity feature.
purchase price is equal to or greater than fair market value; (b) if greater than fair market value, how to treat the excess amount paid (typically as compensation or less typically as a dividend); and (c) the effect on postinvestment option pricing. Further, because there may be a disguised compensation element in a founder stock purchase (or, more typically, repurchase), it is most convenient to structure the liquidity component as a primary investment by the investor in newly issued stock, followed by a repurchase of the founder stock by the company with the investment proceeds. This allows the company to withhold applicable taxes on the compensation element. However, there can be another important consideration in choosing between a primary and secondary transaction. If the company effects the founder stock repurchase, this may undermine so-called “qualified small business stock” status for both the new stock purchased by the investor and for stock purchased within the last few years by the sellers (and stock purchased during the last year by non-participating investors). Given the current favorable tax treatment of qualified small business stock, this can be a significant downside to structuring the liquidity transaction as a repurchase by the company. Undoubtedly, careful tax analysis needs to be front and center when initially structuring a growth equity deal with a liquidity feature. Further complicating the picture at the corporate board level is the board’s fiduciary obligation to the company’s stockholders. Prudent boards will often insist that liquidity opportunities be offered to all stockholders equally. However, this requirement is rarely in the interest of the growth equity investor who typically prefers to limit liquidity to a select group. While practice varies, we have found that the growth investor typically prevails in this debate and that — more frequently than not — repurchases are effected only with a select group or groups of stockholders. Finally, recently enacted Dodd-Frank legislation is now influencing the structuring debate. For those advisors to funds who rely on, or who intend to rely on, the venture capital fund advisor exemption to registration under the Investment Advisers Act, a pure secondary purchase will potentially be less desirable as the acquisition of portfolio securities via secondary purchase will only be available with respect to a limited bucket (20%) of total committed capital before jeopardizing said exemption. Accordingly, at least within this group of funds, we expect to see even more of these transactions structured as a primary share issuance coupled with a repurchase of shares.
recapitalizations — Fiduciary and tax considerations?
Growth investors frequently look to invest in companies that have previously gone without taking outside institutional capital — so-called “bootstrap” companies make for ideal growth equity targets. However, it is common for growth equity investors to cash out early institutional or angel investors who are looking for liquidity. This may involve some form of recapitalization. In some cases, recapitalizations are tied to “down round” financings. It is in that context that companies and investors alike are especially mindful of the myriad fiduciary issues implicated by a down round, especially in transactions involving “insiders.” While the fact pattern around a recapitalization in the growth equity context is typically less dire, companies and investors need still be mindful of the fiduciary implications of a recapitalization. A good corporate governance process is key, and the board of directors will need to consider whether the transaction results in disparate treatment of stockholders and carefully manage those issues. Recapitalizations can be effectuated in a variety of structures. A merger with management rollover is one such structure that can come with certain advantages for management. There are numerous tax considerations involved in a management rollover. While management will desire and expect a “tax-free” rollover, this is not always easy to accomplish. Also, if management’s existing equity is held in stock options rather than outstanding stock, there can be tax implications if management wishes to exercise those options and “roll” the stock received on exercise. If management has a significant tax basis in their existing stock and also receives significant cash in the transaction, what appears on the surface to be a qualifying tax-free rollover may in fact be a rollover where little or no tax is actually deferred. Finally, there can be significant tax benefits, and significant tax complexity, when using an LLC as the investor’s acquisition vehicle and issuing LLC interests to management as their rollover equity. The LLC equity may be a regular LLC interest or may be designed as a “profits interest” in certain cases.
representations and Warranties, purchase price adjustments, indemnification and escrows
Growth equity deals typically feature a more robust set of representations and warranties than early-stage deals, reflecting both the more substantial operations of the target business and the fact that growth equity deals, particularly those featuring a liquidity component, frequently contain fully negotiated indemnification provisions akin to an M&A transaction. Risk allocation and the clawback of proceeds are key deal points in these transactions — unlike early-stage deals in which the representations and warranties are largely symbolic (and of little practical import). To expand on this point, while there are obviously representations and warranties in early-stage investments, company and investor alike largely live by the rule that VCs rarely bring claims against their portfolio companies. In contrast, representations and warranties about later-stage companies are critical. Take, for example, representations about the company’s financial statements — VCs may not place much value on historical revenue generation or cash flows for an early-stage company, but for a growth equity deal in which valuation methodology is more sophisticated and often based on performance multiples, the historical financial statements take on a heightened importance. *** Indemnification is a key deal point for both sides in a growth equity deal, as the growth investors generally model their investment and returns based on sound assumptions and wish to seek recourse to the extent that is not the case. The company/ existing stockholders want to make sure that their investment proceeds are secure and their risk is known and appropriately bounded. This is related to the point above. In a typical venture-stage deal, the only remedy if the representations are not true is a breach of contract claim. As we mentioned, it is quite unusual for a venture investor to actually litigate a claim against one of its portfolio companies as it might do more harm to the investment than good. So there is really little “bite” in venture-stage deals for breaches of representations and warranties; the representations are usually viewed as a way to draw disclosure rather than serving a risk-allocation function. In contrast, because
Growth equity deals typically feature a more robust set of representations and warranties than early-stage deals, reflecting both the more substantial operations of the target business and the fact that growth equity deals, particularly those featuring a liquidity component, frequently contain fully negotiated indemnification provisions akin to an M&A transaction.
of the more critical role played by the representations and warranties in growth deals, growth investors approach indemnification as a buyer would in a private equity or acquisition transaction with fully negotiated “caps” and “baskets” and the panoply of other customary indemnification points typical of M&A transactions. As is customary in sale transactions, a logical extension of a robust indemnity is concern over the availability and ease of recovering proceeds in the event an indemnification claim is made. Accordingly, it is common for these liquidity deals to include an escrow setting aside typically 10% to 20% of deal proceeds to backstop the indemnity obligations of the existing stockholders and the company. Further, in growth equity deals, past financial performance is not just of heightened relevance in the context of representations and warranties and postclosing indemnification claims. Frequently, in growth equity transactions, the valuation metrics used by the growth investor have direct import into the transaction documents. In those transactions, in addition to specific representations and warranties, it is very
typical to see dollar-for-dollar post-closing valuation and purchase-price adjustments based on shortfalls in working capital, eBITDA and other specific financial metrics.
As growth equity continues to emerge as a distinct investment class, we expect that the industry will begin to standardize more than it has in the past on specific deal terms. For example, it would not be surprising to us — particularly in light of the recent legislation — if the industry standardized on effecting liquidity transactions by means of a primary share purchase coupled with a stockholder redemption. However, due to the inherent complexity of these transactions, we would also expect that there will always be substantial limitations on the industry’s ability to define and converge on a standard set of terms. We look forward to seeing it unfold.
About the Authors
Al Browne is the partner in charge of Cooley LLP’s Boston office and the chair of the firm’s growth equity practice group. Al specializes in mergers and acquisitions; late-stage venture capital and growth equity transactions; cross-border transactions; and complex intellectual property transactions, particularly in the software industry. His clients include strategic and financial buyers and sellers in public and private acquisitions, among them private equity-sponsored leveraged buyouts and take-private transactions. Al also has significant experience in counseling boards of directors in connection with mergers and acquisitions and related governance and anti-takeover matters. Eric Grossman is a partner in Cooley LLP’s Reston, Virginia, and New York offices and a co-founding member of the firm’s growth equity practice group. Eric focuses his practice on private equity, growth equity and venture capital investments; leveraged buyouts; mergers and acquisitions; cross-border transactions (with a specific focus on India); and counseling emerging-growth companies with respect to general corporate and securities law matters.
Fair Value, Who Cares? and Why They Should!
By steven Nebb, CFA, Director, and David L. Larsen, CPA, Managing Director, of Duff & Phelps LLC Primarily because of historical bias, during the past decade and especially during the past several years, venture capitalists have repeatedly been heard to say: “Fair value reporting for the Venture Capital (VC) industry is meaningless; LPs don’t need it; GPs don’t want it; regulators don’t understand it.” However, a more critical examination of a wide range of reporting and governance issues demonstrates that fair value is not only required by most LPs, but provides key benefits to both LPs and GPs. Part of the stigma associated with fair value is a lack of understanding of what fair value means for the VC industry. some incorrectly believe that FAsB instituted fair value rules for the VC industry in 2006 with the issuance of the much-maligned sFAs 157. Yet sFAs 157 (now AsC Topic 820) does not require any asset or any liability to be measured at fair value. Fair value, for the investment industry, has its origins with the 1940 Investment Company Act. Further, investment 1 company accounting, which originated with the AICPA Audit and Accounting Guide for Investment Companies in the 1960/’70s requires investments to be reported at fair value.
What is Fair Value?
Most discussions about fair value still begin with a description of what fair value represents. With liquid securities, fair value is a concept that is much easier to understand since the definition becomes somewhat formulaic: market price times number of
US investment company accounting requirements are now promulgated by FASB Accounting Standards Codification (ASC) Topic 946.
shares owned, or a value that has direct benchmark indications from other market transactions. However, when considering illiquid investments, fair value represents a more qualitative and ambiguous concept. Even in such instances, fair value is still strictly defined. Accounting guidance establishes the definition of fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants 2 at the measurement date.” The guidance adds that to the greatest extent possible, valuations should be based upon observable market data from reliable sources. For VC investments, there is often limited or no reliable market data. each investment is unique (no comparable companies or transactions) and involves sensitive details that many times would be harmful to the investor if disclosed. As a result, VC investors must use supportable unobservable inputs, often using a manager’s own assumptions, about how a market participant would transact. Historically, VC fund managers have reluctantly embraced fair value concepts, using cost or the value of the last round of financing as their best estimate of fair value in between financing events. The use of cost to estimate fair value was driven by three key factors: 1. A historical convention that identified “conservatism” as a positive attribute; 2. Draft 1989 NVCA guidelines (which were never ratified or adopted), which encouraged the use of cost; and 3. An investor (LP) base made up of individuals rather than entities that had less strict fair value reporting requirements. Furthermore, because the development of an emerging business or technology requires financings more frequently, investors attempt to manage their exposures to certain risks by funding development at discrete points in time. Multiple financing events potentially generate an opportunity to assess implied values in Last Round of Financing (LRF) transactions. However, caution should be applied when considering LRF as indications of fair value since implying value for existing investments using LRF requires material assumptions that may or may not be appropriate. Because of this, the ability to use LRF as an indicator
of value does not mitigate the need for alternative methods and procedures for estimating a robust fair value.
Why Fair Value?
Because many VC fund managers have partially convinced themselves that fair value is not estimable, is not cost-effective to estimate or is not needed by their investors, it is important to dispel such myths and once and for all acknowledge that while imperfect, estimating fair value is not only possible, but necessary for most investors and helpful to most managers. Our experience with our VC clientele is that while a current period valuation of a VC investment requires significant judgment, the focus on a valuation framework that considers the analysis of all meaningful factors and inputs beyond LRF, and the effort to document these considerations, does indeed help the fund in its strategic planning and in communication with its investors. It also provides a meaningful method for monitoring its investments and satisfying the funds governance requirements. Additionally, we find that most of our clients are already doing what is necessary in some form to satisfy these goals, but the lack of a formalized process or documented methodology has not allowed them to take full credit for the work performed. One other important consideration that should not be ignored is the fact that investment companies are not required to consolidate underlying investments because they report fair values. However, if a fund did not report its investments at fair value, arguably, from an accounting point of view, underlying control investments would be required to be consolidated, making internal and external reporting significantly more complex and less meaningful.
evidence of Fair Value
If there are real difficulties in estimating the value of an emerging company, how then do venture capitalists determine the valuation at which they will invest at various points in time? Many valuation practitioners and auditors like to refer to market studies that have been conducted over the past couple of decades as support for indications of value. These studies demonstrate the step-up in value between major rounds of financing typically consisting of 25% to
FASB ASC Topic 820-10-35-1
One other important consideration that should not be ignored is the fact that investment companies are not required to consolidate underlying investments because they report fair values. However, if a fund did not report its investments at fair value, arguably, from an accounting point of view, underlying control investments would be required to be consolidated, making internal and external reporting significantly more complex and less meaningful.
100%+ increases in value as companies progress through the stages of development. However, this is only true for investments at specific points of time that successfully secure financing and is only meaningful on an aggregate level, not necessarily applicable to a single investment. In working with our VC clients, we have observed numerous examples of a portfolio company being able to meet significant milestones only to have forced recapitalizations or down-round financing available to it. The question then becomes, why does this happen? The illiquid nature of the VC market sustains pricing inefficiencies. Ultimately, the supply and demand of VC capital and the bargaining power of entrepreneurs and ownership syndicates does change, and at times will not be correlated with the performance of the underlying company. This environment clearly muddies the waters for determining values. However, what this truly means is that when estimating the fair value of an investment, considerations beyond LRF or company performance are meaningful. The assessment of what could be termed “nonperformance risk” is the risk that a portfolio company with negative cash flow will be unable to raise additional capital when needed. This factor is material for VC investments that are capital intensive in one form or another, and are expected to generate negative cash flow over the development period of two to five years. In situations where capital becomes unavailable, the company is typically sold, possibly at a loss, recapitalized at a valuation significantly lower than the post-money valuation implied by the progress of the firm or is shut down. Ultimately valuations should consider the inputs used to derive value, the intangible assets of the business. These intangibles include intellectual property and know-how, long-term growth potential, management team talent, financial strength of existing investors, perception of VC market interest, progress toward milestones and competitive landscape. For earlystage, venture capital-backed companies that require additional capital, these intangibles may impact positively or negatively their ability to raise capital in the current venture capital environment. The resulting non-performance risk for companies that need to raise money to reach cash flow breakeven or a successful exit continues to be substantial, and may outweigh many or all other valuation considerations. While changes in value are certainly not linear, it should be clear that value does not magically increase or decrease on the day a new financing event takes place. Since VC investors are instrumentally involved with their portfolio companies, they likely are aware of how a company is progressing toward its milestones, and they typically have timely knowledge of trends in the VC capital market that lead to an understanding of the willingness and ability of the market to fund the next stage of development for a company. Therefore, while significant judgment is required, it should be evident that an estimate of value can be derived at times other than on the day of a financing event.
Why investors (lps) need Fair Value
One of the most troubling features of the GP/LP interactions is the seeming inability of both sides to fully understand the needs of the other. This failure to
communicate has given rise to more specific Limited Partner Agreements, requests for side letters, ad hoc data requests and LP initiatives such as the ILPA Private equity Principles. Any institutional LP (LPs that produce GAAP-based financial statements and invest on behalf of others — fund of funds, pension funds, endowments, etc.) has need for timely, periodic, robustly estimated net asset values (NAV) supported by a rigorous measurement of the fair value of underlying investments. LPs don’t always articulate the reasons they need fair value reporting. LP needs include, but are not limited to, the following: • Fair value is the basis investors (LPs) use to report periodic (quarterly/yearly) performance to their investors, beneficiaries, boards, etc. • Fair value is the best basis for LPs to make “apples to apples” asset allocation decisions. • Fair value is an important data point in making interim investment (manager selection) decisions on a comparable basis. • Fair value is often necessary as a basis to make incentive compensation decisions at the investor level.
• Limited partners need consistent, transparent information to exercise their fiduciary duty. fair value provides such information on a comparable basis for monitoring interim performance. An arbitrary reporting basis such as cost does not allow comparability. • Most investors are required by relevant GAAP to report their investments on a fair value basis. Not all LPs articulate their needs as described above. some may even tell GPs that they prefer “cost. In many cases, this failure to communicate occurs because “deal” team members of LPs speak with “deal” team members at the GP and may not fully articulate all of the needs of the investor. Additionally, reporting fair value for financial instruments is required to be consistent with other financial reporting requirements. In particular, the recognition of the fair value of contractual rights for future cash flows typically resulting from earn-outs or 3 contingent considerations at fair value is required.
Established by FASB Statement 141 (revised 2007), Business Combinations (FASB Accounting Standards Codification™ (ASC or Codification) 805, Business Combinations.
Based on the uncertainty embedded in many earlystage companies, it is not suppressing that many M&A transactions increasingly include earn-outs or some form of future consideration. Since other reporting entities (buyers) must report the contractual payments at fair value, it is logical that the seller should also recognize this contractual asset at fair value as well. LPs must have fair value-based NAV and, therefore, managers need to include the fair value of all investments, including contractual payments, in their calculation of NAV. Determining the acquisitiondate fair value of contractual rights (contingent consideration) may entail the estimation of the likelihood and timing of achieving relevant milestones and/or the development of expected or scenariobased projections relevant to sales- or profitabilitybased payments. The good news is that these types of assumptions and inputs are the same details that are considered by the manager in making the decision to sell its investment in the first place (and only need to be adjusted for buyer/negotiation considerations). Essentially, the reporting of fair value for contractual rights becomes an extension of the processes already performed by fund managers.
such as the use of independent third-party valuation experts to augment and validate the investee fund’s procedures for estimating fair value. Ultimately, the investor is required to assess, understand and conclude that the GP has delivered a NAV derived from a rigorous estimate of the fair value of underlying investments.
Why is Fair Value Meaningful?
Whether it is from the GP’s perspective, or an LP’s requirement, fair value is ultimately the contemporaneous measurement basis that allows the VC industry to deliver on its obligation to be fair, ethical and to effectively communicate critical information needed by multiple interested parties. Arbitrary valuations, such as cost, or inaccurate valuations can undermine effective asset allocation for investors, resulting in the inability of an investor to properly manage its investment strategy or possibly increasing the risk of fulfilling its fiduciary duty to its beneficiaries. Industry best practices centered around robust fair value determinations provide GPs with effective strategic tools for making appropriate comparisons and for monitoring interim performance of their investments, in addition to satisfying fiduciary obligations. Because fair value requires a systematic approach for estimating value and supporting assumptions, appropriate procedures that generate fair value will provide additional focused information to monitor portfolios regularly. An incomplete development of policies, procedures and processes that measure fair value may expose fund managers to significant reputational and legal risks and, ultimately may adversely affect their marketing and fund-raising efforts. In the current market environment, fund managers must now be aware that investors should, both in their initial due diligence process and in periodic reviews, discount managers that have not adopted appropriate valuation practices that generate robust indications of fair value. Additionally, auditors and regulators will scrutinize funds that don’t have well-defined and documented valuation process and governance policies.
limited partner Valuation Needs
As noted above, limited partner investors have a number of reasons for needing and using fair value derived NAV. LPs must value their interest in an underlying fund at regular intervals to support their financial reporting process. The recent accounting guidance (Asu 2009-12) outlines when and how an LP may estimate the fair value of an interest in a fund using the reported fund’s NAV. Based on the guidance, reliance on a reported NAV is only appropriate to the extent that the investor has evidence that the reported NAV is appropriately derived using proper fair value principles as part of a robust process. In order to do this, the most frequent ways to assess the robustness of reported NAV are: 1. To conduct thorough pre-investment due diligence and to leverage this diligence in ongoing monitoring procedures; 2. To assess the fund’s fair value estimation processes and control environment, and to monitor any periodic changes; and 3. To review the fund’s policies and procedures for estimating fair value, including considering factors
What’s a Vc to do?
The determination of fair value, for VC investments, requires a significant level of informed judgment, rather than a rigid application of a mechanical process. Therefore, fair value requires thoughtful involvement from all stakeholders, including fund managers, institutional investors, auditors, valuation experts and regulators. The valuation process should not be a “make work” exercise. Best practice dictates that the information needed to make, monitor and improve investments is the same information used to value investments on an interim basis. Generally, there is no need for a fund manager to develop extensive policies, but leveraging or enhancing existing processes to develop and use a comprehensive and integrated valuation framework that is clear, consistent and pragmatic will provide effective documentation and communicate the fund’s efforts in monitoring its investments and reporting fair value robustly. This typically means that the valuation process is an extension of the fund’s, already developed, diligence, monitoring and strategic decision-making processes. A well-developed and documented valuation process can provide the basis for demonstrating to investors that the fund manager is compliant with fair value measurement principles. The specific components of a thorough process should include a governance structure, well-documented valuation policy and clearly defined roles and responsibilities, including independent personnel who are extremely knowledgeable about valuation methodologies. The elements of the valuation policy should cover specific approaches and valuation methodologies appropriate for various types of investments at various stages of development, and should include details regarding typical assumptions and sources of data that would be part of each valuation methodology. Additionally the policy should address the internal documentation procedures to support valuations (models and templates) and a delineation of circumstances that permit a manager to rely upon specific or different models. The valuation policy and supporting documentation should be periodically reviewed and updated. Having established valuation policies and procedures will allow a manager to communicate and discuss its approach to fair value and satisfy an
investor’s need to understand the processes and controls related to deriving value. It should be emphasized that fair value does not represent what a fund manager ultimately expects to receive for exiting an investment, but the amount that would be received in an orderly transaction as of the valuation date. This concept troubles some VC managers because they would not, and likely could not, sell the investment at an interim date. The “orderly transaction price” determination is hypothetical and requires the exercise of informed judgment. This means that fair value does not have to assume that the underlying business or investment is saleable, the investor or shareholders intend to sell in the near future or the likely transaction would have to be a forced sale or liquidation. In assessing fair value, fund managers should be able to answer the following questions in a consistent manner to explain how the investment is being valued. 1. How correlated is the investment to public market data? What objective data may indicate whether value is moving in a logical direction? This should be from a perspective that adjusts for outliers that may significantly impact reported trends. 2. What other recent transactions has the fund been involved with (or know the details of) that support the current fair value of an investment? Are there similar deals that provide an indication of the fair value of the subject investment? This may include transactions of the subject company securities, comparable company transactions, or sector and industry transactions involving companies in similar stages of development. 3. Are there any potential issues with obtaining the next round of financing for an investment (compared to original expectations)? What’s the likely impact of less/more demand to fund the portfolio company? 4. Does the fair value indication represent a price [as of the valuation date] that you would be willing to invest in the same portfolio company (with the same existing terms)? Would more investment for a higher or lower percentage interest be appropriate? Does it make sense to invest less money for the same percentage interest because the company has satisfied some development hurdles (milestones) and has less need for capital at the current stage? Will the company need more capital than originally
expected because the burn rate is higher, more uncertainty developed in the market or negative results require more development effort? 5. Is it possible to sell an interest in an existing portfolio company at the same price as you could have sold it previously? This question may help limit the hypothetical nature of a fair value transaction since it contemplates the comparison of a hypothetical transaction in the past to a current hypothetical transaction. 6. What has changed with the portfolio company in relation to the company’s position at entry, during the LRF and with the expectations of the business over the holding period? It’s more important to understand why things have changed than to simply recognize that things are different. An understanding of why changes have occurred should be helpful in
assessing the potential impact the changes will have on the success of the business, which is the key to assessing the progress of value during the holding period of an investment. 7. Have the current market and economic conditions affected the underlying opportunities, risks or probability of success of the portfolio company? Considering these questions and documenting the answers will be a good start at a well-thought-out and documented process for estimating the fair value of VC investments. Again, since these considerations are the same considerations that are used in making, monitoring and exiting an investment, they flow directly into the periodic (usually quarterly) valuation assessment. For example, a simplified way to consider valuing VC investments is using the following decision tree (for illustrative purposes only):
Policy Statement: All investments are recorded at fair value. All relevant information is taken into account to make the fair value determination.
Valuation Decision Tree
1. Barring contradictory information, the cost (excluding transaction costs) of an investment is deemed the “exit” price on the date of investment and is therefore used as its initial fair value. a. Fair Value is measured as the market price times the number of shares held less a possible discount. support for the discount generally model-based.
2. Are shares publicly traded in an active market? 2a. Is there a legal restriction?
b. if there is no legal restriction (attributable to the shares, not to the holder), fair value is determined as the market price times the number of shares owned. No discount is allowed even if the number of shares owned is large relative to the average daily trading volume.
3. Is there a comparable company from which fair value can be derived?
utilize comparable company valuation techniques to determine fair value.
4. Does the investee company have positive sustainable performance (for example, positive recurring EBITDA)?
Fair value may be determined as ebitda times a reasonable marketplace multiple for the company.
5. Has there been any significant change in the results of the investee company compared to budget, plan, etc? Has there been any significant change in the market for the investee company or its products or potential products? Has there been any significant change in the global economy or the economic environment in which the investee company operates?
a. if the change is positive, there is an indication that value has increased. determine fair value using objective data from the company, investment professionals and other investors b. if the change is negative, there is an indication that value has decreased. determine the value decrease to be recorded based on objective measures and manager experience. c. if no, the value of most recent round of financing may be the best estimate of fair value.
By utilizing the simplified illustrative decision tree, many early-stage venture investments would fall into step 5. Therefore, for some period of time after investment, assuming none of the changes outlined in step 5 have occurred, fair value is often measured by using the value of the last round of financing. However, as knowledge is gained about the progress on a meaningful milestone, or it is clear that more or less funding will be needed (burn rate) to get to the next stage (probability of success), or that funding is or is not likely to occur at typical terms (performance risk), fair value has diverged from the last round of financing, and fund managers have a duty to acknowledge and report that fact in the normal reporting process to the fund’s investors.
since the issuance of the PeIGG guidelines in 2003, the release of the IPeV Guidelines in 2005, FAsB’s issuance of statement 157 in 2006, the financial crisis of 2008 and subsequent revisions and application of the preceding, fair value measurement has been a topic of concern in the VC industry for almost a decade. Rather than being vilified, fair value should be embraced as the best (albeit imperfect) basis for measuring investments at interim periods, resulting in the fulfillment of a multitude of needs for both investors and managers.
About the Authors
David L. Larsen is a Member of FASB’s Valuation Resource Group, a Board Member of the International Private Equity and Venture Capital Valuations Board (IPEV), led the team that drafted the US PEIGG Valuation Guidelines, and is a Member of the AICPA Net Asset Value (NAV) Task Force. Mr. Larsen serves a wide variety of alternative asset investors and managers in resolving valuation and governance-related issues. Steven Nebb serves as the project lead for numerous Alternative Asset managers and investors, including large global private equity, venture capital, and Business Development Companies. He provides advisory support to many limited partnerships and corporate pension plans regarding fund management, financial reporting requirements and general valuation of investments, and has significant experience in performing valuations of intellectual property, private equity, illiquid debt, and complex derivatives for a variety of purposes, including fairness opinions and transaction advisory, financial reporting, tax, litigation, and strategic planning.
The Case for LLCs for Venture Capital Financings
By Richard small, Partner of edwards Angell Palmer & Dodge, with contributions made by Karl Fryzel Venture financings are almost exclusively structured as investments in C corporations. Is it finally time for venture professionals to modify this time-honored deal structure and to begin investing in limited liability companies? In my mind, it is. Going back, I have tried to figure out how we got to where we are now and why we are stuck here. The first venture financing deal that I worked on was in 1982. As company counsel, I remember being impressed by the investment documents prepared by counsel for the investing venture funds. The investment agreement, charter, shareholder agreement, voting and co-sale agreement and registration rights agreement were tightly drafted, carefully integrated and appeared to cover seemingly every contingency with precision and clarity. There were some memorable provisions as well. In that deal, the preferred stock antidilution terms had 1 a full ratchet. That took some time to understand, and once understood, I never fully accepted the concept. I still do not. If one looks at the NVCA Model documents, the core elements of the documents presented to our client in that deal in 1982 have remained largely intact. Over the years, the forms have been refined, enhanced and finetuned. Other forms, such as indemnification agreements for directors, have been added. In short, the forms
A full ratchet is the abbreviated term for ratchet antidilution whereby the conversion ratio of a convertible preferred stock is adjusted to the price that any shares issued at a lower price subsequent to the original issuance of the shares of convertible preferred are issued. The effect can dramatically increase the number of shares of common stock into which the preferred stock is convertible for the benefit of the holder of such preferred stock to the detriment of holders of other stock. See www.nvca.org.
Specifically, I would submit that there are now significant, multiple reasons for venture firms and their professionals to break from tradition and start using a modified limited liability company structure as the investment structure.
continue to be tightly drafted, carefully integrated and cover every known contingency. The forms and related commentary are very useful tools for practitioners and benchmarks for what is accepted practice in many cases. As with everything in business, however, changes take place, and maybe it is time to rethink how venture deals are structured and documented. Specifically, I would submit that there are now significant, multiple reasons for venture firms and their professionals to break from tradition and start using a modified limited liability company structure as the investment structure. I appreciate that many venture professionals are cringing and have now stopped reading. Those who have not stopped reading, please keep an open mind about what follows. C corp on the eve of an IPO is easily doable. In addition, during the term of the investment, all of the complicated tax allocations that no one wants to understand or explain to multiple equity holders are largely irrelevant since no income flows to the LLC during operations and no tax distributions need be made. The only time these allocations come into play is when there is a dividend recap (a phenomenon present in the buyout world) or an exit event, and the allocations are generally straightforward at that time. Before getting to the case for the LLC structure, it is worth observing that other investment professionals whose deal structure and documentation are similar to those of the venture investors, and who once exclusively used the C corp structure, have modified their practices over time. In the parallel universe of the buyout world, LLC structures are being utilized frequently for portfolio company investments. As we all know, buyout professionals award employee equity, take companies public, deal with multiple investor groups with differing securities and different priorities, and sell companies in tax-free and taxable transactions. LLC-based documents for these deals are being refined and enhanced (much the same way corporate documents have been refined over time) and continue to be refined. Parties have gotten familiar and comfortable with and many believe (myself included) that all of the matters in the NVCA forms can be covered (and some of these matters can be covered in a better way) in the LLC
the proposed structure
The proposed structure is a passive Delawareorganized LLC holding company whose sole activity is to hold one or more wholly owned operating C corp subsidiaries. Employee equity is awarded at the holding company level (often in a more tax-advantaged manner 3 than option grants as described below); uBTI/eCI is avoided since no operating income flows to the LLC during the term of the investment as the income is trapped at the C corp level; converting the LLC to a
Many of the typical investors in a venture capital fund are tax-exempt investors, such as pension funds and college endowments, and foreign persons. The investment gains from portfolio investments for such investors are generally not subject to tax in the United States. There are exceptions to this treatment. For tax-exempt investors, the major exception is UBTI, which is “unrelated business taxable income.” UBTI is generally income from a trade or business. See Sections 511, 512 and 513 of the Internal Revenue Code. Therefore, income from a trade or business conducted by a pass-through entity, such as a limited liability company, would be taxable in the hands of the tax-exempt investors in the venture fund. Similarly, foreign investors are subject to tax on such trade or business income, which is known as ECI, or “effectively connected income,” i.e., income effectively connected with a U.S. trade or business. See Sections 864, 871, 881 and 882 of the Internal Revenue Code. Many venture capital funds place limits or outright prohibitions upon investments by the fund that will generate UBTI or ECI.
Some buyout firms that do not have tax-exempt or foreign investors use full pass-through entities, i.e., a single LLC and no corporate operating subsidiary, or a LLC at every level. This can be particularly useful at exit in allowing buyers to avail themselves of tax basis step-ups for asset purchases or for purchase of LLC interests (and appropriate elections) while maintaining one level of tax for the sellers. Occasionally, one will see an LLC structure for state law purposes electing to be taxed as a C corporation for federal income tax purposes. This permits the entity to avail itself of many of the more flexible attributes of the Delaware Limited Liability Company Act, but not the benefits from granting profit interests. Finally, some firms have developed complicated LLC-based structures that avoid UBTI and ECI altogether.
structure. In short, many buyout professionals now prefer the LLC structure. Before getting into the positives of an LLC structure, one point needs to be dealt with. The principal rationales that I hear for the continued use of the C corp structure are familiarity, efficiency and standardization. These rationales may be rationales of default and habit. True, we are all familiar with corporate-based forms and the detailed statutory pattern that supplies many of the default rules; we all understand that parties to a venture financing want as little deviation as possible from the forms in most deals; and we all appreciate that keeping expense down and moving quickly through the deal process from term-sheet signing to final closing are highly desirable. All that said, with the exception of a truly straightforward Series A round with one or two investors who have worked together in the past and know each other’s preferences, there is complexity in these deals. For example, if we add into the deal picture a warrant from a venture lender (with antidilution provisions), a license/equity agreement with a research university (also with antidilution protection but different language and preemptive rights), multiple rounds of preferred, pay-to-play provisions and so on, we have a fair level of complexity and nuance. That complexity needs to be worked through, and working through the complexity takes time and expense to be done correctly.
complete the picture, the selling corporation does get a corresponding ordinary deduction in the same amount as the income allocated to the option holders by reason of the option cash-out. Admittedly, this deduction can have value, and sometimes buyers will pay for this value. In other cases, neither buyer nor seller can utilize this deduction, and sometimes buyers are simply not willing to pay for this deduction. The point is that the management team holding options is bearing an unnecessarily large tax burden that can be easily and painlessly avoided with an LLC structure. The burden can be substantial dollars (millions of dollars in some cases) in additional tax payable by the option holders. Consider the LLC approach to employee 5 equity. In this structure, employees are awarded outright profits interests (meaning a direct ownership LLC interest in profits, losses and distributions of the LLC and not an option) that, as of the date of grant, can have a fair market value of zero (or if not zero, can be structured by setting a distribution threshold described more fully later in this section). The value for this purpose is determined under a special liquidation analysis sanctioned by the IRS. To determine this value, it is assumed that the LLC’s business is sold for fair market value and then liquidated, paying all LLC members in accordance with the LLC agreement’s distribution waterfall. For example, a profits interest granted at the time of a venture firm’s investment should have a zero value because, if the business held by the LLC were sold immediately after the investment, all the sale proceeds would be paid to the venture investors in respect of their preferred securities, and the LLC units held by management would not receive any distribution. The management units can participate in the growth in value of the business subsequent to the grant of the interest. For this reason, profits interests also have a real
5 If recipients of profit interests are employed at the operating subsidiary, the employee-owner problem is avoided. The IRS takes the position (see Revenue Ruling 69-184) that a partner in a partnership (or member in an LLC) cannot also be an employee of the partnership or LLC. Thus, the former employee holding a profits interest will have to report income on a partnership Form K-1 rather than the more familiar Form W-2 for wage withholding. Other consequences follow, such as estimated tax payments, self-employment taxes, potential changes in fringe benefits and potential tax return filings in every state (and foreign country) in which the LLC conducts business. These burdens are eliminated by the employee continuing to provide services to the operating subsidiary corporation while holding the profits interest in the LLC holding company.
Why an llc structure?
Employee equity. On the subject of employee equity, I confess, up-front and fully, that I am not a believer in traditional stock options, given the alternatives. My biggest problem with options occurs at the time of a liquidity event. Assume a sale of a venture-funded company for cash is in the works. In connection with the sale, unexercised options will be cashed out for the spread between the transaction price and the option exercise price. This spread is ordinary income to the option holder. There is no avoiding this result. Upon learning this, option holders often scramble, without success, to explore ways to convert ordinary income into long-term capital gains. It cannot be done. It is just not possible because the underlying stock cannot be acquired by option exercise and held for more than 12 months within the transaction time frame. To
advantage over restricted stock issued by a 6 C corporation. At the time of sale, the parent LLC sells the stock of its operating corporate subsidiary. There is one level of tax based upon the gain at the LLC level, which gain is passed through to the LLC members. If the stock being sold has been held for more than one year, which is inevitably the case, the proceeds, distributed to the equity holders (including management) are taxed at long-term capital gains rate at the current federal rate of 15%. Another feature of the profits interests is that these interests can be granted after the original investment has appreciated in value (or at the time of the original investment, if the value of the interest is greater than zero) without any cost or tax to the management recipient at grant. At each grant date subsequent to the initial investment, it will be necessary to perform the same liquidation analysis described above. Once the business appreciates, it will be necessary to set a distribution threshold for the profits interests granted so that these interests will have a zero value at the date of grant. For example, if on the date of grant, each LLC unit would receive $1.00 of cash on a liquidation of the business, then the profits interest unit can only share in future liquidating distributions after all previously issued units have received $1.00 per unit. To summarize, the receipt of a profits interest is not a taxable event to the employee, no matter when in the life cycle of the business it is granted, and distributions of sales proceeds can qualify for capital gains treatment. In addition, the interests can be granted with customary performance and time vesting provisions, and the interests are not subject to the burdensome
6 A particular advantage of profits interests as compared to restricted stock is the ability to issue profits interests at any time in the life cycle of a portfolio company without tax to the recipient. In the case of restricted stock, the value of the shares will increase as the company matures and that means the price to be paid for the shares by the service provider must increase or the service provider incurs a substantial tax on the compensation income once the restriction lapses, or is treated as lapsed pursuant to a special election made under Section 83(b) of the Internal Revenue Code. In the case of profits interests, the IRS has issued special safe harbor valuation rules permitting the recipient to treat the value of the interest as zero so long as the interest is subordinate to the market value of all other equity outstanding on the day of grant. The value of the outstanding equity is determined by assuming that the business is sold and then liquidated in accordance with the provisions of the governing documents. See Revenue Procedures 93-27 and 2001-43 and IRS Notice 2005-43 and Prop. Reg. Section 1.83-3(l).
tax rules of IRC section 409A. The ordinary income problem of options being cashed out described above is eliminated. The subject of profit interests is, however, under review 8 by Congress. I have other problems with options but, admittedly, these problems are more annoyances and less significant. When options are granted, unless the aggregate exercise price is nominal, the mindset of the issuing company and the option holder is that the options will likely never be exercised prior to the issuing company going public. Option holders do not like to write big checks for emerging company equity as there is a fair amount of risk. Put another way, option holders like upside potential but not downside risk. Option holders do, however, leave the employ of the issuing company before an exit event occurs. Options may be fully or partially vested at that time, and a limited time period will likely exist post termination of employment for the optionee to exercise the vested options or to have the options lapse. Option holders must decide whether to exercise or not. So the question is — what disclosures should be made to the employee seeking to exercise, and how does the company cost-effectively protect against the scenario when the option holder exercises but the business ultimately does not do well, and the exercise payment made by an option holder is lost. Federal
7 Section 409A of the Internal Revenue Code can impose severe adverse tax consequences on certain deferred compensation arrangements of employees and other service providers. Stock options are subject to these rules. For example, if the exercise price of a stock option on the date of grant is not fair market value, then the spread, i.e., the difference between exercise price and fair market value, will be taxable when the option is vested and a penalty tax of 20% in addition to the regular tax on the compensation income may be imposed. To ensure that the exercise price is equal to fair market value, the portfolio company may need to obtain an outside appraisal to substantiate the value. On the other hand, pursuant to current IRS guidance, a profits interest is not subject to the provisions of Section 409A. See IRS Notice 2005-1. In recent years, several bills have been introduced in Congress proposing to enact a new section 710 of the Internal Revenue Code that would treat the net income attributable to an “investment services partnership interest” (commonly referred to as a “carried interest”) as compensation income except to the extent such income is attributable to a partner’s invested capital. These same rules would apply to members of a limited liability company. “Investment services partnership income” is intended to include allocations of income to partners/ members who perform investment management services on behalf of passive investors in a partnership/LLC. However, the language of the legislation is broad enough to include any carried interest in an LLC that owns a portfolio company where the employee of that company receives a carried interest in the LLC holding company as equity compensation for performing services for the portfolio company. It is hoped that if this legislation is enacted, Congress will clarify that these types of carried interests are not “investment services partnership interests” for purposes of Section 710.
and state securities laws (specifically the antifraud rules) apply to the option exercise. Not providing any information or providing incomplete information to the exercising option holder carries risk of an antifraud violation. Private companies are simply not geared up to provide complete, accurate and ongoing information to option holders who may wish to exercise. All of this is avoided with the outright grant of profit interests since no exercise (and no parting with funds) is ever required. Again, this point is not by itself enough to change practices, but it is another consideration in the analysis. the trados challenge. Oversimplified, the Trados case stands for the proposition that:
Naturally, there is more to the case than this summary, so some additional background is in order and needed to appreciate fully the Trados problem. Trados was a software company funded principally by four venture firms. These firms held in various proportions several series of preferred stock in Trados constituting a majority of the preferred. Much of the preferred was a participating preferred so that after the preferred holders received their preference, they would also share along with the common. The four venture firms held the right to appoint four of the seven board members and appointed active principals from their funds to the board. Two board members were Trados executives (CeO and CTO). The remaining director was an outsider. Trados’ directors made a decision to sell the company in 2004. They engaged an investment banker, JMP Securities, and conducted, by all accounts, a real and substantive sales process. At some point during the process, it became clear that the sale proceeds would be less than the aggregate liquidation preference payable to the preferred holders. The board therefore adopted a carve-out plan for management. Under the plan, management would receive a graduated portion of the sales proceeds. To set the stage, the common was out of the money, and I would assume that management options were likewise out of the money as well. So again, this is a pretty common scenario for a venture-funded company
• Holders of preferred stock in a Delaware corporation • Holding a majority of the outstanding voting stock • With the right to designate a majority of the members of the corporation’s board of directors • With no party holding any veto rights over a sale of the corporation • Cannot easily or freely sell the corporation at a time at which the preferred holders receive all of the sale proceeds and the common holders receive no sale proceeds;
9 In re Trados Inc. Shareholder Litigation, No. 1512-CC, 2009 WL 2225958 (Del. Ch. July 24, 2009).
going sideways. Ultimately, an agreement was reached with a buyer for a sales price of $60 million (less than the aggregate liquidation preference payable to the preferred holders) for Trados to be divided up amongst the preferred and management. The company was sold. The common holders brought suit. The key claim asserted by the common holders was that by selling Trados at a price at which the preferred holders received all sales proceeds (other than carve-out proceeds) and the common holders received zero proceeds, the board violated its fiduciary duty of loyalty to the common stockholders. The Trados board sought to dismiss the case. The Delaware Chancery Court, however, declined to dismiss the case for the following reasons. First, the court determined that the duties of the Trados directors ran to the common stockholders, not the preferred stockholders, if the interests of the common stockholders and the preferred stockholders were not aligned. Here, they were not aligned or, more accurately, they were partially aligned but only in the case, not present here, in which the common was “in the money” and both common and preferred were to share in sales proceeds after the preferred’s preference was paid. second, the directors were not independent (four directors were principals of firms that held preferred stock and received sale proceeds, and two directors were executives who were receiving carve-out plan proceeds), and the directors arguably violated their duty of loyalty. Further, since the directors were interested, they were not protected by the business judgment rule 10 and the case proceeds to trial. This gets us to the truly troubling point about the decision, and this involves the duties owed by the board to the common stockholders about a company sale decision at a time where the common holders are receiving nothing. There is language in the case to the effect that, since the common holders were not
10 To reiterate, the Delaware Chancery Court has not found that the directors of Trados did in fact violate their duty of loyalty. The court simply refused to dismiss the case on this point. Dismissal is always highly desirable. All discovery is avoided; expenses are minimized, and disruption to the business is likewise minimized. The board’s argument to dismiss was as follows. A robust sales process was run by a professional banking firm. The company was sold to an unaffiliated third-party buyer. Nothing unusual or untoward. The technical path to dismissal for the board was to bring itself under the business judgment rule, which provides that, absent conflicts or self-dealing, board judgments if carefully reached are not to be second-guessed. The case therefore should be dismissed at the outset. End of discussion. The court in Trados refused to dismiss for the reasons discussed above.
The Delaware LLC statute permits parties to an LLC Agreement to modify and even eliminate fiduciary duties. If fiduciary duties are eliminated, the only duty that the LLC members and managers owe to each other is the covenant of good faith and fair dealing, but not the duty of loyalty which caused the problem in Trados.
receiving sales proceeds in the sale that occurred, the common holders would always be potentially better off not having the company sold until they were “in the money.” That is self-evident. So the tough question is: what does a board controlled by venture-firm designees have to prove at trial that validates a board’s decision to sell at the time when the common is “out of the money.” That question is left largely unanswered, and in my mind puts the corporate board in a very tough position when confronted with a situation like that in Trados. I would bet that most, if not all, venture investors have experienced a Trados scenario or will experience a Trados scenario at some time in their careers. How can an LLC structure solve this challenge? The Delaware LLC statute permits parties to an LLC agreement to modify and even eliminate fiduciary 11 duties. If fiduciary duties are eliminated, the only duty that the LLC members and managers owe to each other is the covenant of good faith and fair dealing, but not the duty of loyalty that caused the problem in Trados.
11 Delaware Limited Liability Company Act Section 18-1101(e).
The duty of good faith and fair dealing has been described by the Delaware Supreme Court as follows: “Delaware’s implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, that later adversely affected one party to a contract. Rather the covenant is a limited and extraordinary legal remedy. As the Chancellor noted in his opinion, the doctrine ‘requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the 12 bargain’.” Accordingly, proving a breach of this duty places an exceptionally high burden upon a complaining shareholder to meet. In my opinion (and going out on a limb because there is no case on this point), a properly drafted LLC Agreement which eliminates fiduciary duties would deal with the Trados problem fully and cause the problem to disappear. structure of an exit. Assume that it is time to sell a venture-funded company, and assume that the Trados problem is not present. The company has been in existence for eight years. It was originally funded by angel investors and has gone through several rounds of institutional funding. It now has 75 shareholders, 50 option holders, and 2 venture lender warrant holders. In the corporate structure, it is impracticable to structure the sale as a sale of stock and have all 75 holders read, accept and sign the acquisition agreement. So the transaction is structured as a merger. If care has been taken at every step, the principal stockholders can likely “drag” along and require all stockholders to approve the merger and join in post-closing indemnity obligations on a pro rata basis. Options can be cancelled and cashed out. It is not unusual, however, for the following to be at work. Some stockholders may not have executed each amendment to the Shareholders Agreement or the Agreement itself; there may not be a drag-along or waiver of dissenters’ rights in the relevant agreements; there is no certainty that a waiver of dissenters’ rights executed many years before the liquidity event is enforceable; some stockholders may object to the representations or post-closing indemnity obligations set forth in the Merger
Agreement; some stockholders may be sufficiently upset with the proposed deal and their investment, and upon learning about the transaction, may even seek to enjoin the transaction after signing and prior to the closing. Buyers generally do not want to hear about any of this. Most buyers want a clean and uncomplicated acquisition of all of the stock of the target company and want to spend no time or money on dissenters’ rights, option holders’ rights or like matters pre-closing or post-closing. Compare these challenges to how a sale transaction can be effected by a parent LLC of a corporate subsidiary. The managing board (controlled by venture investors) of the parent LLC votes to sell the corporate subsidiary; no stockholder meeting (or its equivalent) is required; no drag-along needs to be invoked; no dissenters’ rights are in force; no options need to be cashed out. The only parties to the agreement are the LLC parent and the buyer, and the agreement and actual closing can occur simultaneously if closing conditions are satisfied at the time of signing. In addition, the parent LLC would be making the representations in the agreement, providing a further level of protection to individual shareholders. Bottom line – no or fewer headaches with equity holders. Flexibility of process. suppose you (venture investor) wish to fire the CEO. The CEO is a member of the board of the entity you have invested in. Technically, this requires a board vote, which can be done either by unanimous written consent or done at a meeting (with notice properly given or waived). suppose you believe that the CEO will not sign a written consent, will not waive notice of a meeting, will insist upon a meeting, and in the worst case, may seek to enjoin the meeting and enjoin his or her planned termination. Suppose you just want to tell the CEO that he or she is fired and do not want to discuss or deal with corporate process or formalities. I appreciate that I may be overstating the problem here. That said, I have had clients tell me that they want to, and are prepared to, fire the CEO, and that they want to follow all the proper corporate procedures, but at the same time, they do not want to give notice and hold a formal meeting to effect the firing of the CEO for any number of valid reasons. Again, consider how the firing can be effected with a properly drafted LLC structure. Action can be taken by the managing board, with less than unanimous written consent (presumably the board members other than the
12 Nemec v. Shrader, 991 A.2d. 1120, 1125, 1128 (Del. 2010).
CeO). No meeting is required; no notice of a meeting is required; no requirement of unanimity for the consent to this action is applicable. Obviously, this is not a big point, but it does point out the greater flexibility of operations that LLCs provide over a traditional corporate structure. down rounds. Down rounds are a fact of life in the world of venture investing. No one likes them, whether current investors, former investors or current or former management. There are ways to structure down rounds that provide protection to venture funds and board members from claims of breach of fiduciary duty of loyalty — outside fairness opinions; offering the downround security to all stockholders; running a process seeking new investors and having such investors set the value for the new round by arm’s length negotiations; approval of terms of the round by disinterested board members or a special committee. All of these approaches are equally applicable to a down round done by an LLC or by a traditional corporation. LLCs can avail themselves of an additional layer of protection. The protection is mentioned in the discussion of the Trados case. Claims by disgruntled equity holders in connection with down rounds are based upon violation of fiduciary duties (specifically the duty of loyalty). Again, these fiduciary duties can be modified or even eliminated by agreement in the LLC structure. Does this mean that venture board members are totally out from under such claims and the problem disappears? No. In my mind, a fiduciary duty waiver does not give a controlling investor complete latitude to conduct a down round at any price on any terms
13 Delaware Limited Liability Company Act Section 18-404(d).
with impunity. It does mean that additional, meaningful protection is available and the burden for a party to pursue a successful claim is exceptionally high, as noted above. information restrictions. The Delaware statutes on information that a stockholder or LLC member can obtain as a matter of right are similar but not identical. Suppose you have a former employee who has exercised options and left the company on bad terms, or suppose you want such a former employee to know as little as possible about the affairs of the company. Suppose also you do not want employees to know about the equity awards of other employees. The Delaware LLC statute, by agreement, permits 14 limiting the availability of this information. The Delaware corporate statute does not permit such limiting. There are likely other reasons to add to the above discussion in favor of choosing the LLC structure that investment professionals and practitioners have gained through their experience. In addition, I am hard pressed to think of any aspect of a venture-financed transaction that cannot be covered just as well by the LLC structure. Admittedly, there may be some additional complexity and some learning. For those not familiar with LLCs, some work is inevitably required to gain the appropriate level of familiarity. Once understood, the benefits from LLCs noted above are real. And finally, for those inclined, you can still have a full ratchet.
14 Delaware Limited Liability Company Act Section 18-305(g).
About the Authors
Richard Small is the Partner and Co-Chair of Edwards Angell Palmer & Dodge’s Private Equity & Venture Capital Group. Richard’s practice is heavily concentrated in leading attorney teams in sophisticated transaction work for private equity and venture investors, specifically mergers and acquisitions, divestitures, leveraged recapitalizations, debt and equity financings, joint ventures, mezzanine financings and venture capital investments (early and late stage) as both company counsel and investor counsel. He has also represented numerous management teams in connection with such transactions. Karl Fryzel is a Partner in the EAPD Tax Department and provided significant insight and guidance on tax-related issues.
Tapping Winning Talent
By Jeff Markowitz, Managing Partner, and Brad stadler, Partner, of Heidrick & struggles Every company wants to find the right executives, but for venture capital firms or their portfolio companies, this is absolutely critical. Such organizations tend to be relatively small, which can make the impact of a single executive even greater. A proven track record in the industry is practically a must. The right hire can change the trajectory of a company, while a key role left unfilled for too long, or filled with the wrong leader, can cause tremendous challenges. Venture-backed companies have always had to deal with the challenges of hiring entrepreneurial, inspired and driven leaders on a time-sensitive schedule, usually under the intense scrutiny of a board of directors. However, changes in the market are making that task increasingly difficult. There is a critical shortage of proven C-level executives with experience in key technology-related market sectors. Many of these executives are already working in fulfilling jobs and being aggressively recruited by multiple companies. Given this shortage, even experienced venture-backed organizations are finding recruitment more challenging. These difficult conditions call for them to refine their hiring processes — often engaging with an executive search firm — to increase their chances of identifying and securing the most experienced and dynamic leaders. We often recommend that a venture-backed organization use its existing internal network for a period of time to help calibrate and understand current market conditions and then, if that is unsuccessful after three or four weeks, engage an experienced executive search firm.
There is a critical shortage of proven C-level executives with experience in key technology-related market sectors. Many of these executives are already working in fulfilling jobs and being aggressively recruited by multiple companies.
success starts with a strategy
A successful hiring process requires up-front planning. Everyone on the search team needs to be on the same page relative to exactly what is needed and how high to set the bar. Begin by developing a clear understanding of the expectations, skills, experience and personal attributes the position requires, and then refer to this when meeting candidates. Often it is helpful to grade candidates on a handful — say, three or four — of key requirements to remain focused. Take the time to compose a unique and compelling position specification describing what is special about the organization and the role. Nine out of ten talent specs are generic; candidates take special notice when they are specific to the needs of the company. Given the high bar, there is typically not much room for compromise. Focus only on candidates about whom the search team is excited. As soon as it appears that a candidate does not meet the stated experience and characteristics for the position, it is time to move on. A “something is better than nothing” attitude is not a winning strategy, nor is it one a venture-backed company can afford. One way to streamline the process is to have promising candidates meet with several experienced interviewers in close succession to provide multiple points of feedback. This enables a company to rapidly gain clarity about which candidates make the grade. A venture-backed company’s strategy should deliberately incorporate multiple decision points, to ensure it saves all its energy and efforts for candidates who meet or exceed the profile and have the greatest potential to excel. Decisiveness is critical in today’s recruitment market. Reaching a consensus quickly — whether it’s a yes or a no — is essential to ensure wise use of an organization’s resources. When our clients decide that they really like a candidate, they need to go out of their way to build a rapport, spending time with the candidate and allowing him or her to get to know them and their business well. For example, during a recent search, we presented a candidate who lived hundreds of miles away from the company. When it became clear that this candidate was the frontrunner, the founder flew to visit with him twice, each time to spend a couple of hours talking about the company. The founder, of course, had other personal and professional demands, but he understood the importance of building a strong connection and ultimately securing the best talent possible. The outcome? This made a significant impression on the candidate and, although there were local companies trying to attract him, he felt a much stronger bond with the founder and ultimately accepted the position.
Keep candidates engaged and listen well
We urge our clients to take every opportunity to engage with candidates. This may seem obvious, but a one-hour meeting simply isn’t enough to get to know someone who could dramatically impact the success of the business. Reaching out on a regular basis and hearing their feedback can provide valuable insight into the candidates, and to our clients. One simple, yet often overlooked, technique for keeping candidates actively engaged is to listen well. Take the time to ask for their opinions on various business issues and the payoff will be twofold. This allows the company’s key personnel additional opportunities to get to know the candidates and find out how they think and their approach to solving the issues. And as the candidates start thinking about the business, they become more mentally engaged.
When a company decides that a candidate is the right leader for the position, we urge it to move aggressively to reach closure.
Even when a topic may be a challenge for the company, assume serious candidates will find out about it eventually when they do their due diligence. We have seen countless companies use this to their advantage by broaching an awkward topic and genuinely discussing it with the candidate. Candidates appreciate this transparency and hearing about issues from the business directly rather than through their personal connections. This is the chance for the company’s leaders to show that they’re genuine, sincere in their interest, and also likely to be good, honest and direct communicators going forward. In addition, remember to look at the process from the candidate’s point of view: if several days pass without contact, candidates begin to wonder where they stand and may begin to pull back. If, on the other hand, a company’s key personnel go to great lengths to spend time with the finalist candidate, that sends a strong message that the company is serious and encourages the candidate to be serious about the company. Ultimately a candidate’s connection with the company leads to a successful hire.
then get to yes
When a company decides that a candidate is the right leader for the position, we urge it to move aggressively to reach closure. In today’s market, the slightest pause could well mean losing the candidate to another opportunity. Under no circumstances should a company make an offer before the candidate is ready to commit. To help break the impasse and move the process forward, it is important to get inside the candidate’s head and understand what is keeping him or her from being ready to commit. Companies have to make sure the candidate wants the job before extending an offer. Whether it’s a recruitment firm, a board member or someone within the company who has forged a close relationship with the candidate, multiple people — in a carefully orchestrated manner — may want to reach
out to try to understand what additional information the candidate needs to get to a position of wanting the job. During periods when the demand for talent exceeds supply, a company may need to tap into deeper and wider networks to find the gifted leaders it requires. The problem with relying on personal networks today is that they are no longer sufficiently extensive to supply enough talent for all the positions that are open. An experienced executive search firm — bolstered with deep talent resources, detailed industry data, and
superior client service — can help venture-backed technology companies develop a strategic hiring plan and then identify and recruit high-performing candidates for their most critical positions.
Contact Jeff Markowitz, Managing Partner, Heidrick & Struggles Global Venture Capital Practice, at firstname.lastname@example.org or Brad Stadler, Partner, Heidrick & Struggles Global Venture Capital Practice, at email@example.com.
About the Authors
Jeff Markowitz is the managing partner of the global Venture Capital Practice for Heidrick & Struggles. He was most recently a partner and member of the executive committee at a national recruiting firm. While there, Jeff was both the first employee on the ground, and built that firm’s Silicon Valley office into the leading search practice serving the venture capital industry nationally. Jeff focuses on senior level executive searches within all areas of technology, including both private and public companies. Brad L. Stadler is a partner in the global Technology and Venture Capital & Private Equity practices at Heidrick & Struggles. He specializes in CEO and VP level searches in the areas of software and internet. Brad joined the firm following the acquisition by Heidrick & Struggles of IronHill Partners, a national retained executive search firm which he founded. IronHill had grown into one of the leading technology specialist firms in North America, with offices in New York, Pennsylvania, Massachusetts and California. IronHill was a leader in the venture capital market specializing in CEO and VP-level searches in many areas, including internet, software and cleantech.
Venture Fund Wind Downs to Achieve Strategic Objectives
By Laurence Allen, Managing Member of NYPPeX, LLC Increasingly, venture firms are implementing plans to wind down funds by December 31 to achieve strategic objectives such as eliminating the expense of another audit. In general, funds with little remaining economic value are top candidates to wind down and include U.S., European and Pacific Rim portfolios. Motivations to wind down venture funds include: • Opportunistically respond to historically high prices in the secondary market • Respond to revised seC custody rules for private funds (expected to increase audit expenses) • Better allocate limited human resources • Reduce fund administration expenses • Respond to investors requesting liquidation of a fund (to reduce their time and expense to monitor funds with little remaining economic value) • Prevent term extension • Generate cash distributions to investors • Monetize incentive fees to general partners A general partner’s fund wind-down checklist should include: • Obtain an independent secondary advisor’s secondary market valuation • Identify key objectives and portfolio divestiture strategy • estimate cash proceeds from the portfolio divestiture • Create provisions for limited reps and warranties for the purchase and sale agreement (to avoid contingent liabilities to dissolved legal entities)
• estimate final liquidation costs (include legal, audit and a reserve) • File Articles of Dissolution in the jurisdiction where legal entity was established • File final tax return • Close bank accounts • send final payment to limited partners from reserve account and issue 1099s Below are selected venture fund wind downs that illustrate secondary market prices and motivations of venture firms (for informational purposes only).
Contact Laurence Allen, Managing Member at firstname.lastname@example.org or Sean P. Finnegan, Vice President at email@example.com at NYPPEX, LLC.
Fund’s Strategic Objective 1. Monetize Incentive Fee 2. Eliminate Costs 3. Prevent Term extension
(A) Portfolio Cost Basis ($ millions) $53.9 $14.3 $24.5
(B) NAV ($ millions) $121.3 $14.3 $8.0
(C) Secondary Price (% NAV) 88.9 53.1 56.2
(C x B)/A Final Investment Multiple 2.00x 0.56x 0.18x
About the Author
Laurence G. Allen serves as the Managing Member of NYPPEX, LLC, a global securities firm that provides a wide range of liquidity solutions to general partners, limited partners and governments, which include advisory, transfer administration and principal investments. Mr. Allen has over 26 years of experience in financial services and has served on advisory boards for a variety of organizations, which include the Wharton School and the U.S. Congressional Business Advisory Council. Mr. Allen received his MBA in Finance and BS in Economics with honors from the Wharton School at the University of Pennsylvania.
Preventive Medicine for Patent Portfolios:
Getting More Out of IP Due Diligence
Copyright 2011 by Kristin H. Neuman, esq., and elias schilowitz, esq., of Proskauer LLP
It is common for venture capitalists to perform intellectual property (IP) due diligence on a target company or opportunity, but after the “patient” is examined and the checklist complete, few use the work-up as an opportunity to make the patient healthier over the long haul. This article addresses key strategies for getting more value from IP due diligence and using the results to strengthen patent portfolios and freedom to operate positions. IP due diligence is performed in connection with a variety of transactions, from mergers and acquisitions, securities offerings and loan securities, to VC and earlier-stage investments. A key difference that sets VC investments apart from other transactions is that VC-related diligence takes place at an earlier stage in the life of the target enterprise when there is still time to fix problems, strengthen IP positions and practices, and enhance the overall value of the enterprise. For this reason, it is important to approach IP due diligence with the following in mind: (a) use experienced IP attorneys and other professionals to perform the diligence; (b) design a strategy for the investigation that is precisely tailored to the target and the business environment in which it operates; (c) determine whether the patent claims are strong and well aligned with the target’s business goals; (d) probe below the surface of the recorded patent assignments to scope out ownership conflicts; and (e) strategically assess the prospects for third-party patent infringement (freedom to operate). even if the patient receives a clean bill of health at the end of the work-up, be proactive about using the results and intelligence from the investigation to further strengthen the portfolio so that it can remain vigorous and valuable for years to come.
If outside counsel will be retained to perform the due diligence investigation, make sure that a seasoned IP lawyer is actively leading the team, preferably someone with experience in all three pillars of the body patent — patent prosecution, licensing and litigation.
assembling the right team
If outside counsel will be retained to perform the due diligence investigation, make sure that a seasoned IP lawyer is actively leading the team; preferably someone with experience in all three pillars of the body patent — patent prosecution, licensing and litigation. Too often, diligence work is pushed down to junior attorneys and professionals who have not yet acquired the experience and instincts to spot issues that really matter in terms of business strategy and enterprise value. A lawyer has to have lived in the trenches for a while before he or she can effectively analyze the data, spot the key issues and make an accurate assessment of IP health. If a seasoned lawyer is not actively involved, the telltale spot on the x-ray may be missed, the investment may be made, and later, regrettably, the patient may be too sick to deliver the promised or hoped for results. essential to realizing a return on investment. For other industries, patents are less important. For example, in the aerospace materials business, money is made by winning bidding contests and securing government contracts. Patents are not a factor in this process. Thus, in the aerospace world, patents are “nice to have” if there is a private sector market for the product, but they are usually not a “must have.” It is also important to have a good understanding of the territorial scope of the target’s current and future business goals. There is no worldwide patent or patent system. Patents are territorial. Thus, if the target’s business is limited to a particular geographic region, then the IP due diligence can be limited to that region. But if foreign markets are important, then the diligence should expand beyond the U.S. Typically, a patent portfolio will include filings in the U.S., the economic leaders of the European Union, and Japan. More and more, it is important to have filings in emerging markets, such as China, India and south Korea.
tailoring the Work-up to the patient
A good doctor takes a full patient history before starting an examination to establish meaningful background and context. The same applies to IP due diligence. It is important for IP professionals to take the time at the beginning of the diligence project to understand the core fundamentals of the target’s business and the competitive environment in which it operates. Only then can the diligence project be designed and tailored to produce meaningful and valuable information. For example, if the target is a biotech, pharmaceutical or medical device company that will invest millions or even billions of dollars in developing and launching its products, then patent protection and a strong, exclusive market position are
the patent portfolio review
Look for Good Alignment of Patent Claims to the Target’s Business Objectives
The patent portfolio review starts with the task of assembling a schedule of all patents and pending applications purportedly held by the target. This is usually accomplished with assistance from the target and by independent confirmation based on searches of well-known patent databases.
In the U.S., a patent provides its owner with the right to exclude others from making, using, offering for sale, selling or importing the subject matter of the patent claims. 35 U.S.C. § 271(a). Further, a patent owner may prevent others from actively inducing the combination of components outside of the U.S. in a manner that would infringe the patent if such combination occurred within the U.S; and if the claims cover a process, the patent owner has the right to exclude others from using, offering for sale, selling, or importing products made by the process. 35 U.S.C. §§ 271(f) and (g).
Once the schedule is assembled, then the meaningful work begins. Triage the patent assets into categories of importance based on their relation to the target’s business goals. Determine which patent assets relate to current or first-generation product offerings, secondgeneration product development, third-generation, and so on. Then, based on a balance between prudence and cost, skilled IP lawyers should study the claims of the critical categories of patent assets to determine how closely the claims are aligned to the target’s business goals and whether the claims are strong enough to keep competition away. Generally, it is important to have a variety of claims covering different categories of patentable subject matter (such as compositions of matter, articles and methods of manufacture, and methods of use) because each of these categories has a different set of strengths and weaknesses when it comes time to assert the patent claims against competitors. Similarly, the claims should be of varying scope. Broad claims, while tantalizing, are more vulnerable to validity attacks by competitors. In the litigation context, the most valuable claim in any patent is the claim that covers the competitor’s product and nothing more. For the more important assets in the portfolio, it is a good idea to obtain the results of any prior art searches conducted by the target, and any prior art analyses, conclusions, reports and opinions pertaining to the patentability of pending applications and the validity of issued patents. If the target has done little or no prior art searching, then, for mission-critical patent assets, the VC should consider commissioning a prior art search to get a better handle on the value of the portfolio. There are many patent search firms that can provide prior art search services for reasonable rates. However, it is very important that the results be analyzed by a skilled patent lawyer, preferably one well versed in the law of patent claim construction. Finally, if the VC decides to go forward with the investment, then the diligence lawyer should communicate his or her observations and conclusions in reasonable detail to the lawyers who will be handling the portfolio for the company going forward. If there were deficiencies or shortcomings in the nature and scope of the patent claims, now is the ideal time to remedy them through claim amendments, the filing of continuing applications, the preparation and filing of new applications, and in some cases, the
commencement of patent reissue and reexamination proceedings. Even in industries where speed to market is essential, companies can benefit from obtaining patent protection on their innovations. Indeed, filing for patent protection need not add additional time to market. In the United States, at least, a “provisional” patent application may be quickly prepared and filed before the product-release date. A provisional application is essentially a placeholder. It allows the inventor to file a simple description of the invention and how to make and use it. The inventor then has one year from the filing date of the provisional application to file a formalized patent application meeting all of the patent office’s requirements. While the provisional is on file in the patent office, it is treated as confidential and no one outside of the patent office may access it. The key benefit of a provisional filing is that it establishes a date of invention, giving the company priority over others who may try to copy the innovative product once it hits the market or is otherwise disclosed. Even if the product launches in the marketplace before a patent application is filed, the situation can be remedied in the U.S., at least, because an inventor has one year from the first public disclosure, sale or offer for sale to file a patent application. However, in many foreign countries, including those of the European Union, publicly disclosing an innovation surrenders the inventor’s ability to obtain a patent at all. As a result, if foreign patent protection could prove valuable, a company must file for patent protection prior to launching a product or otherwise disclosing the invention. Ideally, to maintain the health and vitality of the company’s patent portfolio over time, a system of reviewing the portfolio, aligning the patent claims to business objectives, and filing on new inventions will take place periodically over the life of the company. This is best done by appointing a patent committee made up of representatives from R&D, business development and legal who will continue to nurture the portfolio by ensuring that the company is harvesting new inventions frequently and effectively from all sources and by taking measures to continually feed and strengthen the core patent assets, while pruning away assets that are no longer important to the business, for example by selling or licensing those assets to other entities.
Probe below the Surface for Conflicting Ownership Interests
All IP due diligence includes analysis of the target’s ownership of its IP assets. Does the target own what it thinks it owns? This task usually entails a search of the assignments recorded in publicly available databases at the United States Patent and Trademark Office (usPTO), the World Intellectual Property Organization (WIPO) for international applications filed under the Patent Cooperation Treaty (PCT), and other national patent offices. The search will uncover all recorded assignment instruments that convey ownership interests in the asset of interest. By analyzing the results of the search, a skilled professional will be able to trace the chain of ownership to confirm that there is a clean chain of title from inventor to the target. All too often, however, the diligence stops there. For the important core patent assets, the diligence process should delve beneath the surface to uncover any conflicting ownership interests that are not discoverable from a review of the public chain of title. This is highly important because under U.S. law, at least, joint inventors each own an interest in the invention and in any patent flowing from it, which, absent an agreement to the contrary, entitles each joint inventor to use or license its interest in the patent without having to obtain approval from or account
to the other inventor(s), and further, all co-owners of a patent must voluntarily join in a suit to enforce the 2 patent. Accordingly, joint ownership surprises can lead to disastrous results, such as an alleged patent infringer locating an unnamed joint inventor and obtaining a license from the joint inventor to continue 3 to practice the patent. In other cases, patent rights have been lost entirely when an unnamed group of inventors challenged the original ownership rights and 4 prevailed. The earlier inventorship/ownership issues are discovered, the more flexibility there is for resolving the matter in an acceptable manner. If the discovery occurs at a late stage when the value of an invention is fully realized, it can be more difficult to negotiate an acceptable resolution. If the issue goes to court, and through the passage of time, documents and witnesses go missing, it may be impossible to prove inventorship, with the result that ownership rights could be severely compromised or lost.
See, e.g., Schering Corp. v. Roussel-UCLAF SA, 104 F.3d 341, 41 USPQ2d 1359 (Fed.Cir. 1997); Ethicon Inc. v. United States Surgical Corp., 135 F.3d 1456, 45 USPQ2d 1545 (Fed. Cir. 1998). Ethicon Inc. v. United States Surgical Corp., 135 F.3d 1456, 45 USPQ2d 1545 (Fed. Cir. 1998). E.g., Yeda Research and Development Co. Ltd. v. Imclone Sys. Inc., et al., 443 F. Supp.2d. 570 (2006).
Generally, it is important to have a variety of claims covering different categories of patentable subject matter (such as compositions of matter, articles and methods of manufacture, and methods of use) because each of these categories has a different set of strengths and weaknesses when it comes time to assert the patent claims against competitors.
Prior to the time that the first assignment is executed from inventor to company, there are events that typically occur that can result in conflicting ownership claims to the patent rights. In many cases, especially in the field of life sciences, the invention arises from the collaborative efforts of several individuals, sometimes resident at more than one institution. The collaborations can be formal or informal. An interview with the named inventors should be conducted to inquire about early collaborations and the potential for unnamed co-inventors. In addition, the diligence lawyer should collect all written agreements that might contain conflicting ownership provisions. Unfortunately, such provisions can lurk in a number of different types of agreements, from funding and grant agreements to nondisclosure agreements, consulting agreements, material transfer agreements, sponsored research agreements and license agreements. If the invention and/or patents were licensed from a university or other research institution that relies on government grants, special care should be taken to ensure that the institution adequately secured an assignment of the inventors’ rights in the invention and that the inventors did not, knowingly or unknowingly, assign their rights in the invention to another entity. Earlier this year, the Supreme Court addressed the issue of patent ownership in the context of federally funded inventions under the Bayh-Dole Act in the case 5 of Stanford University v. Roche. Affirming the basic tenet of patent law that “rights in an invention belong to the inventor” unless and until the inventor assigns the rights to another entity, the court held that the BayhDole Act is not a panacea for lax assignment practices in that it “does not automatically vest title to federally funded inventions in federal contractors or authorize contractors to unilaterally take title to such inventions.” The technology of the patents-in-suit was developed by researchers at Stanford and Cetus Corporation. Cetus is known for its development of PCR, a DNA amplification technique that revolutionized the field of biotechnology. Together, Stanford and Cetus developed PCR-based methods and kits for quantifying HIV in patient blood samples. Dr. Mark Holodniy, a research fellow at Stanford, was at the center of the controversy. When Holodniy joined Stanford, he signed a Copyright and Patent Agreement (CPA), which stated that he “agree[d] to assign” his inventions resulting from his employment to stanford. Because Holodniy had limited PCR experience, his supervisor at Stanford directed him to conduct some research at Cetus to learn PCR and develop an assay for HIV. At Cetus, Holodniy signed a Visitor’s Confidentiality Agreement (VCA) that stated that he “will assign and do[es] hereby assign” his inventions made “as a consequence of his access” to Cetus. Later, Roche bought Cetus and all rights that Cetus obtained through agreements like Holodniy’s VCA. After about nine months at Cetus, Holodniy returned to Stanford, where he continued to work with his colleagues there on the development and validation of an HIV assay. Stanford filed a series of patent applications covering the invention, and in the process, acquired written assignments from all of the named co-inventors, including Holodniy. Roche, on the other hand, began marketing the technology in HIV kits that it currently sells worldwide. Stanford eventually sued Roche for patent infringement. The Federal Circuit reviewed the terms of the dueling assignment clauses and concluded that the CPA
Board of Trustees of the Leland Stanford Junior University v. Roche Molecular Systems, Inc., et al., 131 S. Ct. 2188, 180 L. Ed. 2d l, 2011 U.S. Lexis 4183 (U.S. 2011).
If the invention and/or patents were licensed from a university or other research institution that relies on government grants, special care should be taken to ensure that the institution adequately secured an assignment of the inventors’ rights in the invention and that the inventors did not, knowingly or unknowingly, assign their rights in the invention to another entity.
constituted nothing more than a promise to assign rights to Stanford in the future, whereas the VCA effected a present assignment of Holodniy’s future inventions to Cetus. Consequently, Cetus immediately gained equitable title to Holodniy’s inventions, which converted automatically to legal title in the patent application as of its filing date. Because Cetus’s legal title vested first, Holodniy’s subsequent assignment to Stanford during patent prosecution did not transfer title to stanford. stanford argued that the Bayh-Dole Act negated Holodniy’s assignment to Cetus because it empowered Stanford to acquire title to the invention. The Federal Circuit disagreed, and held that Stanford lacked standing to sue Roche for patent infringement because “it is well settled that all co-owners normally 6 must join as plaintiffs in an infringement suit.” The Supreme Court reviewed the case and affirmed the decision of the Federal Circuit. Accordingly, VCs should exercise heightened scrutiny when evaluating IP assets from federal contractors. As Justice Breyer remarked,
6 Board of Trustees of the Leland Stanford Junior University, et al. v. Roche Molecular Systems, Inc., 583 F.3.1 832, 8480, 2009 U.S. App. LEXIS 21465, *37 (Fed. Cir. 2009)
“a potential purchaser of rights from the contractor, say a university, will not know if the university itself possesses the patent right in question or whether, as here, the individual, inadvertently or deliberately, has 7 previously assigned the title to a third party.” Incidentally, the decision in Stanford v. Roche undercuts the position firmly adhered to by all or nearly all universities that patent rights springing from federal funds cannot be assigned by the university to a third party such as a company with plans to commercialize the invention. Until this day, the most that a company could expect to get from a university was an exclusive license. Now, with the Supreme Court’s pronouncement that the Bayh-Dole Act “does not automatically vest title to federally funded inventions in federal contractors or authorize contractors to unilaterally take title to such inventions,” there is room for companies to negotiate directly with university inventors for assignments of their inventions.
the Freedom to operate review
IP due diligence usually includes some level of investigation of the relevant patent rights of competitors to avoid exposure to liability for patent infringement. This investigation can range from simply reviewing the freedom to operate (FTO) opinions of the target company’s lawyers to a full-blown, worldwide search and analysis of all relevant patents. The former approach takes a lot on faith, whereas the latter approach can be extraordinarily expensive and time-consuming. Accordingly, a middle ground often involves searching and reviewing the relevant patents held by those competitors of the target who have the wherewithal to assert their patents and potentially block the target from activities that fall within the scope of the asserted patents. The FTO patent search can be carried out by a professional search firm or directly by diligence counsel. In either case, it is important that patent lawyers with sound knowledge of the law of patent claim interpretation analyze the results of the FTO search. If a potentially problematic patent is found, the target company has many options. It can drop the product altogether, attempt to alter the product so that it is no longer covered by the patent claims (“design
Board of Trustees of the Leland Stanford University, 131 S. Ct. at 2201, 180 L. Ed. at 19, 2011 U.S. LEXIS at *38.
around”), take a license under the patent, attack the validity of the patent in a patent office reexamination or opposition proceeding or before a court in a declaratory judgment action, or continue in the face of the patent. Licenses can usually be obtained on more favorable terms if they are negotiated early on in the product life cycle, before product success has been demonstrated, and before the company is highly invested in the product and its development and sales. If the company decides to continue in the face of the patent, it should first obtain an opinion of competent patent counsel that the patent is invalid and/or that the company’s product does not infringe. An exculpatory opinion of this nature is an important element in a defense against willful infringement and enhanced damages should the company ultimately be sued.
competitors. Finally, the results of the FTO study, coupled with the patent portfolio review, may produce actionable business development opportunities. For example, after reviewing a competitor’s patents and related products, it may become apparent that the target has patents or patent applications that are not important to the business and are potentially better utilized by the target’s competitor. This provides an opportunity to sell or license the assets for revenue, or to flag the assets for potential cross-licensing.
VC-related diligence often takes place at a relatively early stage in the life of a target enterprise when there is still time to fix problems, strengthen IP positions and practices, and enhance the overall value of the target enterprise. For this reason, it is important to employ the following value-driven elements in IP due diligence: (a) use experienced IP attorneys and other professionals to perform the diligence; (b) design a strategy for the investigation that is precisely tailored to the target and the business environment in which it operates; (c) determine whether the patent claims are strong and well aligned with the target’s business goals; (d) probe below the surface of recorded patent assignments to scope out hidden ownership conflicts; and (e) strategically assess the prospects for thirdparty patent infringement (freedom to operate). At the end of such an investigation, there will be many opportunities to use the results and intelligence from the investigation to further strengthen the patent portfolio so that it will remain vigorous and valuable for years to come. Even in the patent world, an ounce of prevention is worth a pound of cure.
Use the Results of the FTO Review to Enhance the Health of the Company
The results of a strategic FTO review present the company with a wealth of actionable intelligence that can be utilized to the company’s advantage in many ways. As mentioned above, potentially vulnerable products or product lines can be re-engineered to steer clear of third-party patents. In addition, the intelligence gained from the FTO review provides potentially valuable information about the technological direction and priorities of key competitors. Sometimes, the FTO reveals technological areas of “white space” where no one has staked out claims, in which case, the target may choose to devote resources to creating and developing innovations in that space. Likewise, the FTO results may reveal that the target has the opportunity to obtain dominant patent claims that would cover niche progressions being made by its
About the Authors
Kristin H. Neuman is a Senior Counsel in the Patent Law and Intellectual Property Groups at Proskauer, resident in the New York office. Her practice includes intellectual property litigation, strategic intellectual property counseling, patent prosecution and opinions, licensing and other intellectual property transactions, and intellectual property due diligence in support of corporate transactions. Elias Schilowitz is an Associate in the Patent Law and Intellectual Property Groups at Proskauer, resident in the New York office. His practice focuses on patent, trademark and trade secret litigation.
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