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Private Company Financing Trends
Summer 2008

Is Clean Tech Just an Investment In This Issue
Bubble About to Burst? Feature Articles
By Josh Green, General Partner, Mohr Davidow Ventures
Is Clean Tech Just an Investment
Bubble About to Burst?
The two questions that I am asked most While helpful, these definitions remain By Josh Green, Mohr Davidow
often are “What is clean tech?” and “Why broad and abstract. The total size of each Ventures ................................................Page 1
isn’t clean tech just another bubble that is market exceeds tens of billions of dollars,
about to burst?” In this brief article, I will and in some cases, hundreds of billions of The Fuss About IFRS
endeavor to answer these questions. dollars. These are the largest markets on the By Packy Kelly, KPMG ............................Page 1
planet, and the challenge is to identify high-
At MDV, we define clean tech as being growth opportunities within them.
multiple independent value chains tied From the WSGR Database:
loosely together by the increasing cost of We believe that there are fundamental Financing Trends ................................Page 2
energy and the challenge of climate change. structural shifts currently occurring in these
Starting Up: Sizing the
Greentech Media recently grouped clean value chains caused by the rapid and
Stock Option Pool ..............................Page 8
tech into the following eight value chains: sustained increase in the cost of energy, a
cost that used to be immaterial to many Does My Start-Up Qualify for
• Power generation • Water industrial processes. While these costs may Venture Debt Financing? ................Page 10
• Energy storage • Materials swing wildly going forward, we believe that
• Energy infrastructure • Recycling and waste the era of cheap energy is over. Whether it Top 10 Intellectual Property Tips
• Transportation • Services is the ever-increasing demand/supply for Early-Stage Companies ............Page 12
imbalance or the adoption of cap and trade
Selecting and Protecting a
Company Name ................................Page 14
continued on page 5 . . .

The Fuss About International Financial Reporting Standards
By Packy Kelly, Partner-in-Charge, Western Area and Silicon Valley Venture Capital Practice, KPMG

During the last 12 months, the buzz in financial reporting by companies based in having to reconcile to U.S. generally accepted
financial-reporting circles has been about many countries outside of the United States. accounting principles (U.S. GAAP). Previously,
International foreign private issuers were required to report
Financial Reporting IFRS came to the either in accordance with U.S. GAAP like
Standards (IFRS). forefront in the U.S. in domestic filers or provide a reconciliation of
Many entrepreneurs
If globally adopted, IFRS’s December 2007, when IFRS financial information to U.S. GAAP
are asking what impact will be felt well the Securities and financial information. As a result, IFRS are
are IFRS and what before a company plans its Exchange Commission now acceptable alternatives to U.S. GAAP for
do they need to (SEC) issued a final rule foreign private issuers for their filings with
initial public offering.
know about them. permitting foreign private the SEC.
IFRS comprise a issuers to file financial
high-quality, statements in accordance On the heels of this action, discussion ensued
comprehensive, broadly accepted set of with IFRS as issued by the International about whether domestic companies should be
accounting standards currently used for Accounting Standards Board (IASB) without given this same opportunity. In ongoing
continued on page 6. . .
Private Company Financing Trends
Summer 2008

From the WSGR Database: Financing Trends
For this report, we have compiled a range of 300

data on financing transactions for the first six Number of Venture Deals by Series*
months of 2008, with the objective of 253 253 1st Half 2007 vs. 1st Half 2008
identifying relevant trends in activity and
valuation levels for the U.S. venture capital
industry in general. The first half of 2008 is

Number of deals
notable as a turbulent period that has severely 1H 2007 1H2008
buffeted the national and world economies. 150
Against this backdrop, we have compared the
first half of 2008 with the comparable period 100
in 2007. Surprisingly, the U.S. venture capital 81 78
68 67
industry has shown remarkable resilience 56 58
50 44 48
during this time, based on indications within
our database. We offer some observations
and interpretations of this information that 0
Total number Number of bridge Number of Number of all Number of Series C
may be useful to our audience of of deals financings Series A deals* Series B deals and later deals
entrepreneurs and investors.
*The number of Series A deals reflected in this chart includes financings led by
angel investors as well as institutional venture capital funds.
For purposes of the charts in this report, our
database includes all venture financing 2,500
transactions in which Wilson Sonsini Goodrich Total Amounts Raised by Series† †
& Rosati represented either the company or 2,089 1st Half 2007 vs. 1st Half 2008
2,000 1,968
the issuer (although we do not include venture
debt or venture leasing transactions, or
facilities involving venture debt firms). For
Deal value ($M)

data involving averages, we use a truncated 1H 2007 1H2008
average, discarding the two or three highest
and lowest figures to exclude the effect of 1,000
transactions that are, in our judgment, 850 881

unusual. 599 598
Total activity levels for the first and second
halves of 2008 and 2007 were flat; there were 91 134
a total of 253 financings reported in the first 0
Total value of Value of all bridge Value of all Value of Value of Series C
half of both years. When broken down by all deals financings Series A deals Series B deals and later deals
quarter for the first half of 2008, our internal
data indicates a 17% decline in the second The value of all Series A deals reflected in this chart includes the value of financings led
by angel investors as well as institutional venture capital funds.
quarter—115 financings in the second quarter
compared to 138 financings in the first quarter The total value of all deals reflected in this chart, as well as the value of Series C and
of the year. By aggregate amount of invested later deals, has been revised to exclude a single financing in the first half of 2008
capital, the first half of 2008 decreased to involving an investment of $300 million. This exclusion was made so that the data in this
chart is consistent with the data we used in calculating the average pre-money valuation
approximately $2.0 billion compared to an and the average amount raised for Series C and later deals shown on the next page.
aggregate of $2.1 billion in the first half of
2007 (but see the footnote relating to the
The data in our reports is derived from financing transactions for the period from
exclusion of an unusual financing transaction).
2004 to the present in which Wilson Sonsini Goodrich & Rosati represented
We believe that the economy in general either the company or the investor. This data consists of more than 400 financing
continues to be a factor in the modest decline transactions in 2004, more than 600 transactions in each of 2005 and 2006, and
in activity level. In addition, the complete more than 800 transactions in 2007. Data is reported on financings throughout the
disappearance of the IPO market for venture- United States, without distinction by geography.

Private Company Financing Trends
Summer 2008

backed private companies in the second 90
Average Pre-Money 77.0
quarter of 2008 and the continued sober
80 Valuation and Amount
outlook for the U.S. public equity markets in
Raised by Series*
technology represent a challenge for 70
1st Half 2007 vs. 1st Half 2008
companies seeking working capital, as well as 60.4
a concern for investors who traditionally have 60

relied upon the domestic public equity 50

markets for liquidity.
1H 2007
In our database, there are diverging trends in 1H2008
first-round financing transactions involving the 22.0
sale of Series A Preferred to institutional 20
investors. This is a particularly important 9.3 10.6 9.7
12.2 12.7
component of the venture industry, since 5.7 5.6
1.9 1.8
these financings are an indicator of innovation 0
and growth. Although the total number of Pre-money Amount raised Pre-money Amount raised Pre-money Amount raised Bridges amount
Series A Series A Series B Series B Series C Series C raised
Series A Preferred financings has declined and later and later
modestly in the first half of 2008 compared to
2007—78 compared to 81 financings, a 4% The period-to-period increase in pre-money valuation is dramatically true for later
decline—the average pre-money valuation rounds of financing involving the sale of Series B Preferred or Series C Preferred
negotiated by early-stage venture-backed and later. In the Series C Preferred and later rounds, the increase in the size of the
companies engaged in institutional Series A- financing and the pre-money valuation are even more pronounced, as investors
round financings increased 15%—from $9.25 continue to support their company portfolios.
million to $10.62 million—when comparing
the first half of 2007 to the first half of 2008. *The data shown in both charts on this page is based on averages that (i) exclude data resulting
from financings led by angel investors, and (ii) exclude a single financing in the first half of 2008
This increase in pre-money valuation may be involving an investment of $300 million, which we considered anomalous for purposes of the charts.
attributable to a basic imbalance in supply
and demand, i.e., the substantial amount of
money available for investment by the venture
industry against a relatively smaller number of 100
companies that merit venture capital. Pre-Money Averages by Series*
2005, 2006, 2007, and 1st Half 2008 77.0
Finally, we note that the number of bridge
financings—financing transactions involving
the issuance of promissory notes convertible 60 2005 56.8
into the first/next round of equity—increased

2006 48.2
by 55% in the first half of 2008 in comparison 40
1H 2008
with last year, from 44 to 68 transactions.
25.9 28.2 24.6
Bridge transactions are useful as a temporary 21.3
financing tool for a number of reasons,
8.3 10.0 9.6 10.6
including the speed with which they can be
completed, the senior protection they offer to 0
investors, and, in the case of initial start-ups, Series A Series B Series C and later

avoidance of the need to establish any
company pre-money valuation as the basis for For purposes of comparison, the chart above compares pre-money valuation
the investment. averages for the first half of 2008 against averages for each of the full years of
2005, 2006, and 2007, broken out by stage of financing.

continued on page 4. . .

Private Company Financing Trends
Summer 2008

From the WSGR Database: Financing Trends (continued from page 3)

160 25

140 Series A Preferred Pre-Money Valuation Series A Preferred Amounts Raised
Ordered by Size 20 Ordered by Size





40 Average $5.6M
20 Average $10.6M

0 0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57

The first equity financing round is a critical include on this page two charts reflecting pre- others— are likely to be far more important
step for every start-up company seeking to money valuations and amounts raised for a than external economic factors on the pre-
launch its business plan, and entrepreneurs total of 57 Series A financing transactions for money valuation that forms the foundation for
characteristically have placed great emphasis the first half of 2008, in each case with values an investment.
on the pre-money valuation of their company in the data ordered from lowest to highest.
as the foundation on which the investment is The point of both of these charts is to illustrate As the community of entrepreneurs and
made. For this reason, industry statistics on the enormous range of values in the data that venture investors continues to closely monitor
average pre-money valuation, the average provide the basis for the average reflected in economic and political developments for the
dilution to the founders and early employees the charts. Thus, even in times of economic balance of 2008, our data supports the belief
that results from the investment, and related turbulence, key factors relevant to the intrinsic that activity levels for venture investments in
statistics are scrutinized with great interest. value of a business—such as the experience the broad technology arena continue at a
However, it is important to realize that of the management team, the disruptive vibrant pace.
statistics based on averages provide only nature of the technology, the size of the
general insights into industry trends. We markets, and the barriers to entry, among

FYI . . .
In an article published by the San Jose Mercury News on July 8, 2008, the Cleantech Group,
a San Francisco-based research firm, reported that worldwide funding for clean
technologies reached $2 billion for the second quarter of 2008, an all-time record, up 58%
from the same period in 2007, and up 48% from the first quarter of 2008. It also reported that
Silicon Valley continues to be the leading source of investment into the various technologies
in the clean tech segment.

Private Company Financing Trends
Summer 2008

Is Clean Tech Just an Investment Bubble About to Burst? (continued from page 1)

regimens to deal with climate change, higher though it will undoubtedly have its ups and lighting are particularly interesting at
conventional energy costs are a fact of life downs. Technological advancements are this time.
causing significant dislocation. Individual carefully measured and monetized with
businesses and entire industries must account questions such as: “How much will this We believe that clean tech is an exciting new
for this new reality, and in some cases, this process increase productivity, decrease costs, arena in which Silicon Valley can once again
means changing their way of doing business and increase my bottom line?” Unlike Internet change the world. With the new reality of
for the first time since their industries began companies during the bubble, clean tech higher energy costs and greater awareness of
over 100 years ago. performance is being objectively measured. our environment, technological advances are
The markets for clean tech products already regarded as having great value. This makes it
How will this change be accomplished? In one exist, so there is an existing standard against a perfect scenario for tried and true
word: technology. Without technology coming which performance can be judged. This is not entrepreneurs to have a positive impact on our
to the rescue, much as it did for information to say that there will be no downward cycles planet and build an attractive business.
technology and life sciences, these industries for clean tech. Similar to other technologies,
will be forced to pass along higher costs and we expect that clean tech will go through its Josh Green is a general partner at Mohr
become less own periods of being in Davidow Ventures, and has more than 25
competitive. It will be favor and out, and some years of experience working with
technology that frees value chains may companies from start-up phase to large
them from this Clean Tech can be defined as experience severe and public company. MDV partners with
dilemma, and also technology enabling massive extended downturns. entrepreneurs and takes a hands-on
enables them to meet transformation of the planet’s However, it is important approach to architect and help build
the important societal largest industries. to note the possibility successful companies. MDV’s team and
goal of combating that while one value the firm’s extended network of industry
climate change. Thus, chain may be in a down experts bring years of real-world
clean tech can be cycle, others may be in experience to accelerate each
defined as technology enabling massive an up cycle. This distinguishes it from company’s time to market and optimize
transformation of the planet’s largest information technology and life sciences. its long-term success. The firm has $2
industries. While all of the value chains enjoy current billion under management.
opportunities, we think that high-efficiency
Technology is also the reason that we believe solar, energy efficiency, building materials, Josh may be reached at 650-854-7236 or
that clean tech will not be a bubble, even algae as a feedstock, storage, water, and

FYI . . .
In a release published July 19, 2008, by the National Venture Capital Association and
PricewaterhouseCoopers, it was noted that venture capitalists invested $7.4 billion in 990
deals in the second quarter of 2008, compared to activity levels for the first quarter that
witnessed $7.5 billion invested in 977 deals. According to Mark Heesen, the president of the
NVCA, “The relatively stable level of venture investment this [second] quarter across a
broad swath of industries and all stages of development evidences that there are no
shortages of opportunities for innovative companies.”

Private Company Financing Trends
Summer 2008

The Fuss About IFRS (continued from page 1)

deliberations, a consensus appears to be
emerging that a single set of high-quality IFRS U.S. GAAP
global standards should eventually be used by
all listed companies. Last month the SEC
communicated that it will issue a proposed Revenue Recognition
“roadmap” that identifies measures of • Revenue recognition is based mainly on a • Unlike IFRS, there is extensive guidance
progress that will be monitored between now single standard that contains general specific to industry, such as Statement of
and 2011, when the SEC plans to consider principles that are applied to different Position 97-2, Software Revenue
requiring U.S. public companies to file their types of transactions Recognition, and type of contract
financial statements using IFRS as issued by
the IASB. The roadmap will be proposed in a Share-Based Compensation
release that addresses when and how the
requirement to use IFRS might be phased in • Share-based compensation is measured at • Like IFRS, share-based compensation is
and includes a proposed rule that would, if fair value and recognized over the service measured at fair value and recognized
adopted, permit certain large U.S. public period over the service period
companies in industries composed mainly of
IFRS-reporting entities to use IFRS as soon as • Awards with graded vesting are accounted • Awards with graded vesting may be
in their 2009 financial statements. for as separate arrangements accounted for as a separate arrangement,
like IFRS; or ratably over the longest
The origins of IFRS date back to the founding vesting tranche, unlike IFRS
of the International Accounting Standards
Committee (IASC) in 1973, and the core Research and Development
standards were completed in 1998. In 2001,
the IASB assumed standard-setting • Internal research expenditure is expensed • Unlike IFRS, both internal research and
responsibilities from the IASC. The IASB is as incurred, and internal development development expenditures are expensed
based in London and comprises 14 members. expenditure is capitalized if specific as incurred
In 2002, the European Commission mandated criteria are met
that European Union-listed companies adopt • Special capitalization criteria apply to
IFRS on or before January 1, 2005. In addition, • The capitalization criteria are applied to all direct-response advertising, software
several other major economies, including internally developed intangible assets developed for internal use, and software
Brazil, China, India, Korea, and Canada have developed for sale to third parties, which
commenced IFRS convergence plans. differ from the general criteria under IFRS

A switch to IFRS could impact how U.S. Property and Equipment
companies report their financial position and
results of operations. In recent years, the IASB • Property, plant, and equipment may be • Unlike IFRS, the revaluation of property,
and the Financial Accounting Standards Board revalued to fair value if fair value can be plant, and equipment is not permitted
(FASB), the standard-setter for U.S. GAAP, measured reliably
have been collaborating on many standard-
setting projects with a goal of achieving • All items in the same class are revalued at
greater convergence of the requirements of the same time and the revaluations are
IFRS and U.S. GAAP. While some progress has kept up to date
been made, many differences remain. IFRS
comprise a less extensive body of literature
than U.S. GAAP, with limited industry-specific The information in this table is intended to illustrate some of the similarities and differences between IFRS and U.S. GAAP
guidance and less-detailed application and is not intended to be a comprehensive analysis. For a more complete discussion, please see KPMG’s publication IFRS
compared with U.S. GAAP, available at

Private Company Financing Trends
Summer 2008

guidance. As a consequence, there are more A move of listed companies to IFRS has Packy Kelly is the Partner-In-Charge of
circumstances where application of IFRS potential implications for emerging privately the Western Area and Silicon Valley
requires an exercise of judgment that should held companies. The most obvious impact is in Venture Capital practice for KPMG.
be supported by contemporaneous analysis and respect to those companies that aspire to Packy has more than 15 years of
documentation. complete a public offering of their securities experience providing auditing and
through a listing on the U.S. exchanges. These accounting services, including IPOs for
A high-level comparison of some aspects of companies will need to prepare their financial start-ups. Packy’s professional
the guidance provided by IFRS and U.S. GAAP statements in accordance with IFRS when experience includes serving venture-
in a few areas of interest to emerging going public if they become the required backed companies and working on IPOs.
technology companies is presented on the framework for SEC registrants. He has been the lead engagement
previous page. partner for several technology
Other impacts will be felt well before a companies. Packy holds a B.S. degree in
Significant benefits are expected from the use company plans its initial public offering. accounting from Fairfield University, an
of a single global set of high-quality Financial-statement data of comparable MBA from Columbia University, and an
accounting standards, including improved publicly traded companies are often used to MBA from the University of California,
comparability of the financial statements of analyze the performance and valuation of Berkeley. He is a member of the
foreign and domestic companies and easier emerging companies and key financial- American Institute of Certified Public
access to global markets. But conversion statement measures can be impacted by the Accountants.
presents a number of challenges and can change. Also, financing and commercial
require considerable cost to realize these contracts can include provisions tied to Packy can be reached at 650-404-5244 or
benefits. The task is not limited to financial financial statement elements as determined
reporting but extends to many aspects of the under U.S. GAAP. If these contracts are
business including training, information modified by counterparties to reflect financial
technology, internal controls, compensation reporting by companies reporting under IFRS,
arrangements, commercial agreements, and privately held companies that continue to
communications with internal and external follow U.S. GAAP need to pay particular
stakeholders. Conversion also may have wide- attention to their contractual arrangements.
reaching effects on the financial professions Because of these potential impacts and the
in the areas of training, licensing, and tendency for emerging companies to emulate
academic curriculum. the public companies in their sector,
entrepreneurs may become more acquainted
with IFRS in the near future.

FYI . . .
In an article published by The Wall Street Journal on July 1, 2008: “In the second quarter [of
2008], no companies backed by venture capitalists went public via an initial public offering in
the U.S., the first time that has happened since 1978, according to the National Venture Capital
Association. There were just five venture-capital-backed stock offerings in the first quarter,
compared with 31 in the fourth quarter of 2007.”

Private Company Financing Trends
Summer 2008

Starting Up: Sizing the Stock Option Pool
By Doug Collom, Partner (Palo Alto Office)

One of the most important aspects of plan is the reserve, or pool, of common stock As a very rough rule of thumb, the following
organizing a start-up company is setting up a that is set aside for incentive purposes. chart suggests equity incentive levels for early-
capital structure that will support the key stage companies by employee title/position:
growth objectives of the company. The equity The usual questions that arise in connection
capital of an early-stage company must be with the creation of a stock plan are: Post-Series A
structured with a view toward motivating • How big should the stock pool be? And Preferred
early-stage employees, facilitating outside what factors should be considered in CEO 5-10%
investment, and establishing strategic and establishing the size of the stock pool?
commercial relationships with partners that Vice Presidents 2-3%
will complement the growth plan. In the • Can we implement the stock plan after CFO 1-2%
context of the first objective, founders of a we have completed our outside
new enterprise should understand the factors financing? Director-level <1/2%
that relate to the creation of a stock option • What is the convention for vesting of Other <1/4%
pool for the hiring and retention of employees. employee stock?
The need to hire and retain employees is a The percentages above are calculated on the
Sizing the Stock Pool
universal requirement of early-stage basis of the company’s fully diluted capital
companies with growth-oriented business Bottoms-up analysis—expected headcount structure, i.e., the sum of both the outstanding
plans. In the technology and biotech sectors, growth and levels of equity. The size of the shares and the full amount of the reserve of
equity participation among the employee stock pool should correspond to the expected common stock included in the stock pool.
ranks at all levels within the enterprise is employee headcount growth of the company
In light of these rough guidelines for equity
commonplace, and manager and key as set out in the company’s business plan.
incentive levels in the post-financing company,
employees expect to receive equity as a Although business plans frequently contain
we hypothetically may assume the usual
significant part of their overall compensation. projections that extend out three years or
pyramidal corporate organization that over a
The founders usually address this expectation more, reasonable business forecasting with
12-18 month period will end up with one CEO,
by creating a stock plan that sets aside, or any accuracy realistically only extends to a
two or three vice presidents, half a dozen or
reserves, a pool of common stock to be used horizon that is roughly 12-18 months distant.
so director-level employees, and an additional
for the grant of stock options or restricted In addition, and as a corollary to the
number of rank-and-file employees. If
stock (i.e., stock subject to vesting) to headcount growth anticipated within this
competitive levels of equity compensation are
employees, consultants, and other service timeframe, the founder will need to identify
awarded to each position, the aggregate
providers. the required manager
number of shares so granted typically ends up
and employee
For purposes of roughly in the 20% range of the fully diluted
background, founders’
In the technology and positions—by title and
capital of the company.
expected contribution
stock normally biotech sectors, equity
to the company— It should be noted that in the table above, the
constitutes the first participation among the included within the actual aggregate percentage of stock
issuance of common
employee ranks at all levels headcount. This allocated to management and employees is
stock by a newly information must then
within the enterprise is usually impacted by the number of founders
organized company. be translated roughly and their role within the company. For
Once this commonplace. into expected levels of example, a founder of a company who also
organizational step has equity compensation serves as its CEO typically will own
been completed and ranked by title and substantially more than the 10% equity to be
the company is ready to begin hiring its first position, and then aggregated to approximate expected for a non-founder CEO. Founders’
employees, a stock plan is adopted as an the likely equity incentive requirements of the stock normally is not included in the stock
administrative vehicle for the grant of equity company. This bottoms-up approach is pool, nor do early-stage companies as a
incentives—such as stock options and probably the best determinant of the size of general rule anticipate granting additional
restricted stock—to employees, directors, and the stock pool. stock to founders beyond their original equity
consultants. A key provision of every stock
position in the company.

Private Company Financing Trends
Summer 2008

This bottoms-up approach to calculating the pools in the range of 11% to 20%, expressed allowance for an appropriately sized stock
size of the stock pool also may correspond as a percentage of the fully diluted capital of pool as part of the start-up’s stock before the
loosely to the timeframe within which the company. (It should be noted that the investment. Investors don’t want their
companies may need to raise the next round percentage of stock actually allocated to ownership position in a company to be diluted
of financing. It is not unusual for the board of management and employees in fact may be by an employee stock pool, after having spent
directors of a company—which typically substantially higher, since common stock the time to negotiate the pre-money valuation
includes representatives of the venture issued to the company founders is typically of the start-up as the foundation of their
investors—to evaluate the stock reserve not included in investment. This
remaining in the pool at the time of each calculating the size of convention is a virtually
round of financing, and to replenish the pool the stock pool.) Founders and investors non-negotiable aspect of
as necessary to address the hiring and alike discover quickly that a venture capital
retention requirements of the company. As a general investment, with the
observation, the employees with below- result that investors and
Top-down analysis. The chart below is based percentage of stock market levels of equity are founders alike will pay
on companies that engaged in a Series A that is allocated to the careful attention to the
financing in 2006 and 2007 and for which stock pool of the more likely to look
anticipated headcount of
Wilson Sonsini Goodrich & Rosati has acted early-stage company, elsewhere for employment. the company over a 12-
as a stock transfer agent. It illustrates the particularly in the 18 month period, and to
amount of stock allocated to the stock pool of technology and competitive levels of
early-stage companies immediately following biotech sectors, is relatively immutable, even compensation to be provided to the managers
the completion of the first institutional round in the face of multiple financing rounds and and employees within the headcount. This
of investment. Of the 95 companies included the dilution to the overall capital structure that analysis usually leads to an agreement on the
in the database, the Series A Preferred each financing entails. This is because the right size of the stock pool in advance of any
financing transactions in almost all cases principal factor driving the level of equity proposed investment.
were led by institutional venture capital incentives granted to management and
investors (as distinguished from angel employees is “competition in the street”— Vesting Conventions for Employee
investors or strategic corporate investors). i.e., what it takes to offer a competitive Stock Incentives
compensation package to employees for hiring
The chart indicates that a clear majority of and retention purposes. Founders and Investors have a strong interest in the vesting
start-up companies established their stock investors alike discover quickly that requirements of their portfolio companies,
employees with below-market levels of equity since vesting ties directly to employee
are more likely to look elsewhere for retention, as well as the “burn rate” of
Percentage of Stock Allocated to common stock used as equity incentives—and
Option Pool after Series A Financing hence the potential for increased dilution.
30 Dilution, Timing, and the Stock Pool
Stock vesting for equity incentives granted to
Founders are quick to figure out that it would employees is typically tied to a four-year
25 be to their advantage if the 20% reserve of regime. We looked at the vesting schedules in
No. of companies (sample size was 95)

common stock in the pool could be established our sample of 95 companies. Within this base,
20 after the completion of the first round of approximately 82% required four-year vesting,
equity financing. If this could be arranged, and only 4% required vesting over a term of
15 then the dilution to the company’s capital five years. Companies in the sampling that
structure resulting from the creation of a stock appeared to require vesting less than four
pool would be spread equally between the years in most cases provided credit to early-
founders and the investors, before any stage employees for personal time spent on
employees were actually hired. the business prior to their joining the
company, or prior to the actual formation of
Not surprisingly, the investment community the company—thus adhering to the
has figured this out, too. And not surprisingly, conventional four-year vesting term at least in
6-10% 11-15% 16-20% 21-25% 26-30% 31-35% it is a virtually universal convention that every philosophy.
Percentage Brackets venture capital term sheet requires an

Private Company Financing Trends
Summer 2008

Does My Start-Up Qualify for Venture Debt Financing?
By John Mao, Partner (Palo Alto Office); Andrew Hirsch, Partner (Palo Alto Office); Christine Foster, Associate (Palo Alto Office)

What is Venture Debt Financing? financing, and (iv) the timing of a company’s Key Considerations in Structuring Venture
next significant milestone in its business plan. Debt Financing
Venture debt financing typically provides
capital to private venture-backed companies in With all of this in mind, a company is often in Runway extension. If a venture debt financing
the form of secured term loans that are often the strongest position to negotiate and obtain does not extend a company’s runway, it may
referred to as “growth capital loans.” The venture debt financing immediately after not be achieving the primary goal of such
runway provided by the proceeds of a venture closing a round of equity financing, when its financing. There are a number of different
debt financing can provide a company with cash resources are highest and its prospects structural elements of a venture debt
more time to meet a product/technology are most promising. For later-stage financing that must be analyzed to ensure that
milestone a regulatory milestone, or another companies, there may be a greater focus on a company is receiving the maximum benefits
commercial benchmark, which ultimately can financial metrics and business milestones of the financing within the parameters of the
result in a higher valuation in the company’s where the purpose of the venture debt marketplace, including:
next round of equity financing and less financing is to bridge to positive cash flow or
dilution to a company’s existing stockholders. a liquidity event. • length of the term of the loan facility until
In some instances, the resulting cash maturity;
resources can defer the need to raise A typical venture debt financing can range in
additional equity capital before the company size from $1 million to $15 million and usually • interest-only periods that defer the
reaches a cash-flow break-even point or a matures in 24 to 42 months. These financings amortization of principal;
liquidity event such as an acquisition or an are secured by a lien on all or substantially all
initial public offering. of the assets of the company, although • amortization schedules;
sometimes intellectual property is excluded.
Companies that utilize venture debt financing Venture lenders are compensated for the • payments made in advance versus in
are often pre-revenue or cash-flow negative, credit risk associated with these transactions arrears;
so the credit analysis and determination of through a mix of interest-rate yield on the
whether a company principal of the loans • the impact and utility of delayed draw
can obtain a venture and warrant coverage. mechanisms;
debt financing A company is often in the Typically, venture
commitment are quite lenders will receive a • final payments that defer payment of a
different than those strongest position to negotiate warrant to purchase portion of the interest yield;
of a traditional bank and obtain venture debt capital stock of the
financing. Venture financing immediately after company. These • subjective defaults, including insolvency
lenders typically rely warrants enable the defaults and material adverse effect
upon subsequent
closing a round of equity holder to purchase a defaults that can result in the acceleration
rounds of venture financing. number of shares of of the outstanding loans; and
capital equity the company’s capital
financing as the stock equal to a • any financial covenants that might
primary source of repayment for their loans. negotiated percentage of the principal amount effectively “cash collateralize” outstanding
As a result, venture lenders’ primary focus is of the loans being provided, divided by the loans or otherwise trigger a default prior to
upon: (i) a company’s relationship with its price per share paid by other investors that maturity, resulting in the acceleration of
venture capital investors and the reputation of have purchased such capital stock. The range such outstanding loans.
those investors, (ii) the timing of the most of warrant coverage is determined primarily by
recent equity financing and the amount of the the stage of a company’s development, the
remaining cash proceeds, (iii) a company’s type of lender providing the venture debt, and
cash-flow projections and the anticipated competitive market forces.
timing of the need to raise additional equity

Private Company Financing Trends
Summer 2008

Economics & scope of collateral. A number of • the exercise price of the warrants and its cons associated with each type of lender;
different factors should be considered in impact on the warrant coverage;
negotiating the economic terms of venture • a venture lender’s sources of capital and its
debt financing transactions and the scope of • whether the warrants survive a liquidity ability to control its sources of capital;
the collateral securing such financings, event; and
including: • the reputation of specific venture lenders
• the scope of the collateral and whether and their track record when dealing with
• the impact of a company’s stage of intellectual property is included in the their borrowers in difficult times; and
development upon the pricing of the collateral securing the loan.
transaction; • a venture lender’s legal documentation and
Sources of capital. Understanding the its philosophical approach to documentation
• the actual all-in yield on the interest reputation of venture lenders in the venture that can impact both up-front expenses and
component of the loans, taking into account debt financing markets, their typical deal the relationship between the venture lender
commitment fees, interim interest structures, and the stage of development of and its borrower throughout the term of a
calculations, and final payments; companies and industries that they typically venture loan.
fund is critical due diligence in this process. In
• prepayment penalties; particular, a prospective borrower should
• whether the warrant coverage is fully
earned up front or vests with the extensions • the distinctions between commercial banks
of loans; and venture lending funds and the pros and

FYI . . .
In a July 1, 2008, poll taken of the membership of the National Venture Capital Association
that elicited 662 responses, 43% expressed their belief that the IPO window for venture-
backed companies would not open for at least 12 months, an additional 32% believe that it
will be one to two years before the window reopens, and 5% believe that it will be more
than two years before the window opens.

Private Company Financing Trends
Summer 2008

Top 10 Intellectual Property Tips for Early-Stage Companies
By Peter Eng, Partner (Palo Alto Office)

For an early-stage technology company, a everyone hired by the company, including disclosure as regular utility patent
strong intellectual property strategy is crucial founders, employees, consultants, and other applications, provisional applications can be
to attracting investment dollars. Because of third parties. The agreements should assign IP hastily prepared without sufficient technical
small or non-existent revenues, the early- rights to the company, including IP created detail. The subsequent public disclosure of an
stage company’s IP tends to represent a during the working relationship. Non- invention that relies upon an inadequate
significant portion of its valuation. disclosure agreements also should be provisional application may irrevocably cause
Accordingly, here are some tips to protect a executed to prevent leakage of confidential the loss of potential patent rights.
company’s IP: information and to prohibit misappropriation or
misuse of IP. Tip #5 – Develop and Pursue a Patent
Tip #1 – Leave the Past Behind Strategy
Tip #3 – File for Patents before Deadlines
When joining or forming a new company, A well-positioned patent portfolio can provide
founders and other employees should make a Early-stage companies may lose their ability to an early-stage company with strategic
clean separation from prior employers. If a seek a patent by waiting too long. There is a advantages. Aside from protecting core
founder developed IP one-year grace period technologies, a patent portfolio can be used
while employed by a to file for a patent for offensive purposes to block competitors, to
former employer or as Starting a company by using following a public generate revenue through licensing, or to
a graduate student, disclosure or sale of encourage favorable cross-licensing
that former employer a prior employer’s computers, an invention under arrangements. For example, by obtaining
or university may resources, or proprietary U.S. patent law. In patents on incremental innovations around a
have ownership rights information may lead to contrast, most foreign competitor’s core technology, a company can
to the IP. Moreover, if countries require that block the competitor from improving on its
the new company
serious problems with IP a patent application original invention. An early-stage company
relates to the former ownership and even litigation. be filed before public should continually evaluate its business
employer’s business, disclosure of an strategy and work with IP counsel to modify
it is even more invention (absolute its patenting strategy as the company evolves
important to terminate the prior relationship novelty). Companies therefore should think and business conditions change.
as cleanly as possible. Starting a company by globally and file for a utility or provisional
using (or even appearing to use) a prior patent application before the release or public Tip #6 – Manage Infringement Risks
employer’s computers, resources, or disclosure of their technology in order to
proprietary information may lead to serious preserve their U.S. and international patent Under U.S. patent law, treble damages may be
problems with IP ownership and even options. awarded when the infringement is found to be
litigation. willful or in bad faith. When an early-stage
Tip #4 – Avoid Pitfalls of Provisional company becomes aware of a problematic
Tip #2 – Get It in Writing, Get It in Writing, Patent Applications third-party patent, there is a duty to
Get It in Writing reasonably investigate whether the company
Provisional patent applications enable is infringing. Seeking competent legal advice
Employers do not always, by default, own the inventors to establish an early priority date for from counsel is essential to mitigating the risk
IP developed by their employees. With some their inventions. They are also a favorite of enhanced damages for willful infringement.
forms of IP such as patents, the creator among entrepreneurs because they are Courts consider the failure to seek and follow
presumptively owns the IP that is developed perceived as a low-cost solution to protect IP. the advice of legal counsel when deciding on
absent a written agreement. Without proper Unfortunately, provisional applications may the issue of willful infringement, making it
written agreements, a company may not have give the unwary a false sense of security that critical that early-stage companies consult
clear title to the IP created by its employees or could lead to loss of patent rights. For with their IP attorneys before undertaking or
consultants. Therefore, early-stage companies example, although provisional applications continuing activity that is potentially
should diligently execute agreements with have the same legal standards of technical infringing.

Private Company Financing Trends
Summer 2008

Tip #7 –Avoid Joint Ownership Tip #8 – Manage Risks of Contamination models change, and what seems like a logical
and Blocking restriction today may become problematic
Companies that collaborate in research and later. Companies should avoid such restrictive
development often believe that the resulting Contamination occurs when a company is covenants, as it is also very easy to forget
work is jointly owned and all parties share exposed to and integrates someone else’s IP about restrictive provisions and breach these
equally in the profits. However, joint into its own products without having the right contractual obligations.
ownership of IP is anything but simple. The to do so. Blocking can occur when the
rights and duties of joint owners vary for company is later prevented from using the Tip #10 – Preserve Exit Options in
different types of IP and in different countries, tainted technology or is otherwise forced to Agreements
and a failure to understand the complexities of obtain a license from the other party. Although
joint ownership could lead to serious contamination and blocking may be Whether the exit strategy is a merger, sale, or
unintended unavoidable dangers an IPO, early-stage companies should preserve
consequences. that arise when their future exit options when entering into IP
Furthermore, early- Investors view constraints on companies interact and agreements earlier on in the company life
stage companies conduct business, this cycle. Decisions that are made now may seem
a company’s business
should recognize that risk can be managed by reasonable or insignificant but could
joint ownership may operations pessimistically. proper documentation materially affect the company’s valuation or
arise by default due of technological even prevent the company from completing an
to the nature of the developments and exit down the road. For example, investors
collaborative activity, even if the inventors or carefully controlling the inflow and outflow of and acquirers considering a potential merger
authors do not physically work together, make shared information. In addition, companies or acquisition will look at ownership of the
the same degree of contribution, or intend to may further protect their technology by filing company’s IP assets when valuating the deal.
be co-owners of the resulting work. If the patent applications before sharing or Has the company obtained the necessary IP
parties want to avoid the complications of disclosing their IP under confidentiality assignments? Does the company hold a key IP
joint ownership, they should expressly address agreements. license that can be easily terminated or
this in a written agreement. cannot be transferred without the licensor’s
Tip #9 – Avoid Restrictive Covenants and consent? Are there any change of control
In addition, early-stage companies should Grant Backs provisions that would hamper the company
consider ownership issues before conducting after closing? These and other IP obligations
joint research with universities or accepting In a rush to get a business up and running, could become potential deal-breakers and
governmental funding. Companies should not early-stage companies often enter into should be anticipated as the company is
access university or government resources— agreements with provisions that restrict their forming and growing.
such as personnel, laboratories or freedom to carry on business in the future.
equipment—without first understanding the IP Investors view constraints on a company’s
policies governing their use. business operations pessimistically. Business

Private Company Financing Trends
Summer 2008

Selecting and Protecting a Company Name
By Aaron Hendelman, Partner (Palo Alto and Seattle Offices)

Among the most important tasks in the company that sells Internet ads) tend not to be is not permitted. This happens even if the two
founding of a new company are the selection, initially protectable. companies operate in vastly different lines of
clearance, and development of a company commerce; the sheer similarity of the name
name. Because ownership rights associated Founders often gravitate toward descriptive bars the second name. (On some occasions,
with company names are “first in time” (i.e., names because they want the public to however, consent of the earlier company or a
belong to the first to file), the sooner a immediately understand the company’s relatively minor alteration of the name, such
founder takes steps to select and protect a business. However, as “Ultigra, Inc.” to
company name, the better. choosing a descriptive “Ultigra Software, Inc.,”
name can hurt a Founders should consider might increase the
Founders should consider their company company’s long-term chances that the state
their company names as
names as carefully as they select key hires bottom line. For will allow the new
and develop core technology. A company’s example, it might be carefully as they select key name.)
name makes a critical first impression. Over impossible to stop hires and develop core
time, the name can pay extraordinary competitors from technology. A company’s Another set of legal
dividends or create unnecessary roadblocks. using the identical issues concerns
name. As a result, it name makes a critical first trademark law. The
As founders start brainstorming potential might require the impression. Secretary of State’s
company names, they should continually focus company to spend approval of a business
on a number of important questions: What is more money on name does not grant
the name’s desired effect? Should the name marketing to differentiate its descriptive name trademark rights or authorize a company to
say something significant about the company from a crowded field. Also, there could be use the name in commercial activities. (Nor
or its product, or is it merely meant to serve as additional expenses caused by the increased does registration of a corresponding Internet
a convenient handle? Will the name make a burden of “policing” other businesses eager to domain name result in any significant legal
clear impression? Will it be easy to pronounce use similar names. rights.) Even if a company incorporates under
and spell? What is the company’s long-term a name, its use of the name to brand products
marketing strategy? Will the name allow the Legal and Business Issues or services might create liability for trademark
company to grow and its product lines to infringement or dilution. The penalties can be
expand? Is it prone to (good or bad) Founders should understand that there are a severe, including an injunction, disgorgement
manipulation? Founders also should host of legal and business issues as part of of profits, monetary damages, and more.
understand that, legally speaking, some the company naming process.
company names are stronger than others. Trademark infringement occurs when a person
Made-up names (e.g., Exxon or Google) or As an initial step, a new company must or company uses a name or mark in a way
those that have no literal connection to the determine whether its name is available under that causes a likelihood of confusion with
company (e.g., Apple for a computer company) state laws relating to entity names. In the another person or company offering similar
are well positioned to establish strong case of a corporation or limited partnership, products or services. Thus, “McCoffee” may
intellectual property rights. Names that this involves checking with the office of the infringe upon the marks of McDonald’s
require a slight leap of logic or suggest a Secretary of State in the state where the Corporation by leading the public to believe
company’s products or services (e.g., Titanium company is formed and where it must qualify that “McCoffee” is a product or an affiliated
for a travel-bag company, connoting strength to do business (usually where it has offices, company of McDonald’s. A company also may
and durability) are protectable trademarks and resident employees, or a sales force). be liable for trademark dilution by using the
often strike the right balance between famous mark of another company even if there
The state office checks its records to ensure
developing strong brands and educating the is no competitive overlap or likelihood of
that there is no other corporation or limited
public about the company. On the other hand, confusion. For example, the name “Pentium
partnership with an identical or closely similar
names that merely describe what a company Petroleum Corporation” may well dilute the
name; if one is found, the new name generally
does (e.g., Online Advertising, Inc., for a PENTIUM trademark of Intel Corporation.

Private Company Financing Trends
Summer 2008

Therefore, it is vital to assess the potential Importance of Trademark Searches federal and state trademark registers and a
trademark law risks of a name before adopting large number of sources of unofficial
it as a company name. Prior to deciding on a name, founders should information about company and product
conduct an initial trademark investigation on names in relevant fields, such as newspapers,
It is important to realize that even if a new their own. At the very least, they should poke magazines, trade journals, business records,
company still has a low public profile, does around online for third-party names that would and domain-name registries. Counsel
not yet have products on the market, or does pose obvious problems. Internet search analyzes the report carefully for potential
not operate a website, it is not immunized engines and the U. S. Patent and Trademark conflicts and confers with the founders about
from legal challenges over use of its name. Office online database are useful tools for the availability of the name.
On occasion, companies have been sued for identifying companies that already may be
allegedly causing confusion through their using similar names. In addition, the Once a company is comfortable with the level
financing activities or for use of a pre-release availability of a corresponding domain name of risk of its chosen name, it is important to
code name for a new product. often is critical, so domain names also should find ways to protect the name as a
be checked. trademark. If the name will be used on
In a rush to get started, some companies products or in connection with the advertising
devise names in a hurry and do not clear them If the founders’ initial diligence does not or promotion of services, it often is a good
for trademark purposes. Often, they consider uncover any major risks, they should ask idea to file an application for federal
the name a place counsel to check the registration of the name based on the
holder until a later availability of the name company’s intent to use the trademark. This
time when they can Once a company is with the appropriate will help establish enforceable rights to the
invest the money and comfortable with the level of Secretary of State; if the name and, equally important, give early notice
effort to create a name is available, it to others who might otherwise overlook the
new name. risk of its chosen name, it is should be reserved company’s name when doing trademark
Unfortunately, this important to find ways to pending full trademark searches to develop their own names.
strategy is risky. protect the name as a clearance. Checking the
First, there is a availability and By taking important steps to best assess the
chance of liability. trademark. reserving the name cost availability and strength of its name, a new
Second, management only nominal fees. company can proceed more confidently,
may “fall in love” branding its products and services with
with the place-holder name and become Founders also should have counsel perform a assurance, and focusing its energy on
unwilling to give it up. Third, the company trademark availability search. Counsel developing its business.
may develop goodwill under the place-holder typically runs an initial trademark scan to
name that would be lost upon a name quickly eliminate names that have obvious
change. Fourth, the company may incur problems and, if clear, orders an in-depth
significant legal and administrative costs trademark search from an outside search
when it changes its name. company. The in-depth search examines

FYI . . .
According to a statistic published in a 2007 Global Insight Report and reported by the National
Venture Capital Association on July 1, 2008, companies that were once venture-backed but
are now public account for 10.3 million jobs and 18% of U.S. GDP.

Private Company Financing Trends
Summer 2008

Events Building Prize for 2008, the recipient of which
will be announced on November 6.
to this emerging industry including the
commercial viability of algae production,
current government and private initiatives,
California Clean Tech Open Phoenix 2008: evolving technologies, processing concepts,
The Medical Device and and venture and project finance.
In August, Wilson Sonsini Goodrich & Rosati Diagnostic Conference for CEOs
hosted a series of meetings and a special For more information, please visit
reception featuring representatives from the,
October 2-5, 2008
U.S. Department of Energy (DOE), which or contact Nancy Farestveit at
The Phoenician
announced a $100,000 contribution to the
Scottsdale, Arizona
California Clean Tech Open (CCTO). Co-
founded by Wilson Sonsini Goodrich & Rosati Phoenix 2008 will mark the 15th annual
partner Marc Gottschalk, the CCTO is an The Life Sciences Report
conference for chief executive officers and
annual competition for start-up clean senior leadership of medical device and Wilson Sonsini Goodrich & Rosati soon
technology companies. More than 250 diagnostic companies. The event will provide will issue the Fall 2008 edition of The
individuals attended, including Alexander an opportunity for top-level executives from Life Sciences Report, a newsletter
(Andy) Karsner, the Assistant Secretary of the large healthcare and small venture-backed providing an in-depth look at regulatory,
U.S. Department of Energy; David Rodgers, companies to discuss strategic alliances, intellectual property, and corporate
the Deputy Assistant Secretary for Energy financing, and other industry issues. securities issues facing life sciences
Efficiency; directors from five national
companies today. Articles in the
laboratory sponsors of the event; and CCTO For more information, please visit upcoming issue include:
mentors and participants., or contact
Tni Newhoff at • IRC 409A and SFAS 123R – What
In making its contribution, the Department of Should Companies Be Aware Of?
Energy joined the five national laboratories— Algae Biomass Summit
Lawrence Berkeley National Laboratory of • Small Business Federal Funding
California, Oak Ridge National Laboratory of October 23-24, 2008 Update
Tennessee, Argonne National Laboratory of Bell Harbor Conference
Illinois, National Renewable Energy Seattle, Washington • Federal Circuit Denies Regulatory
Laboratory of Colorado, and Pacific Northwest Safe Harbor Defense to Manufacturer
National Laboratory of Washington State—to The Algae Biomass Summit will survey the of Research Tools
encourage the development of net-zero-energy emerging industry exploring the use of algae • PhRMA Marketing Code Revisions
commercial buildings (buildings that supply as a feedstock for biofuels and other Significantly Affect Drug and Device
their own energy by combining energy- sustainable commodities. Participants will Marketing in California and Nevada
efficient designs with their own power from hear from entrepreneurs, investors,
renewable sources). The first act of their technologists, producers, scientists, and • From the Ivory Tower to the Consumer
collaboration is to sponsor the CCTO’s Green policymakers on issues of critical importance Market: Key Terms in Licensing
Technology from Universities
FYI . . . For more information regarding this
Wilson Sonsini Goodrich & Rosati ranked first among U.S. law firms report, or to be added to the mailing
list, please contact Marketing at
for the total number of issuer-side venture financings in the first
half of 2008 according to Dow Jones VentureSource.

Editorial Staff: Doug Collom, editor-in-chief (Palo Alto Office); Mark Baudler (Palo Alto Office); Herb Fockler (Palo Alto Office); Craig Sherman (Seattle Office); Yokum Taku (Palo Alto Office)
Knowledge Management Staff: Eric Little, Heather Crowell

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