venturecapital

More than 300 executives from start-ups, emerging companies and especially those developing mobile, internet applications will converge on New Delhi on the 25th of August for what is the definitive event for an IT start-up in India – the EMERGEOUT Conclave to understand “What it takes to build a successful mobile, internet company from India?”.

Learn from the industry thought leaders on new opportunities and interact with people who built and are building successful mobile, internet companies from India. Also many emerging company executives who attend to brainstorm their ideas, free wheeling discussions and networking all of which are especially pertinent for small to mid size companies trying to become game changers.

Technology, often disruptive in nature is at the heart of a start-up’s differentiators to make them game changers. No surprise then that EMERGEOUT has in the past been themed around Cloud Computing, and that the current theme is “The Mobile Internet & AppStore”.  This makes the event a must attend for the technology and business strategists.

Over the past four editions, the EMERGEOUT Conclave has become ‘the’ event on the calendar of a start-up CXO. Given the number of senior executives and CXOs the event attracts, in their wake come the Research Analysts, Bloggers and Media, who track and report on the sector.

Attending the Conclave gives a visitor a clear sense of where the action is in the emerging companies space and hear their stories, learn from companies building successful business cases. And in keeping with the ‘catch them young’ strategy, the Conclave brings in Investors looking for the next big idea and the next little company that will implement that game changing idea. Register now!

For Sponsors, its hard to find a more focused target audience. Nor a more responsive one…..the level of debate, interaction and buzz is not seen at too many other conferences!

EMERGEOUT has something for everyone — Now, you cant find an excuse for not attending. Join Us!

Like most of the blogosphere, I’ve been trying to use Flipboard since its extraordinarily well executed (or well hyped – I can’t tell yet) announcement.  But, like almost everyone I know, I can’t get it to authenticate Twitter or Facebook.  Two days ago I entered in my email address to reserve my place in line.  Today, at 9:55 AM AKDT I got an email titled “Your Flipboard is Ready to Customize” that said:

Hi there. We’re now ready for you to set up your Facebook and Twitter accounts on Flipboard. Try it out and let us know what you think. And thanks again for your patience and enthusiasm.

I went to connect up my Twitter and Facebook accounts.  Nope – doesn’t work.  At 10:34 AM AKDT I got an email titled “Apology, and Flipboard Confirmation”

We just sent you an email telling you that we were ready for you to set up your Facebook and Twitter accounts. We are sorry to say that our email system sent the wrong email. We were actually trying to send you an email confirming your place in line for you to setup your Facebook and Twitter sections.

You will receive another email when your reservation is ready. We are working around the clock to get you your invite and will send you your official invite soon.

Thanks again for your patience and support.

Oops.

By Justin Byers, Business Intelligence Analyst

Last week, entrepreneur turned venture capitalist and blogger Mark Suster had an excellent post titled, "Want to Know How VC's Calculate Valuation Differently from Founders?". In his post, he referenced the importance of deal terms to company founders and we wanted to expand upon that discussion. First of all, I do not know Mr. Suster, so any additional observations revealed within this post are simply the result of further analysis utilizing the tools and information available at www.vcexperts.com.

Whether it be "The Encyclopedia of Private Equity and Venture Capital", the "Glossary of Private Equity and Venture Capital", the "Valuation and Terms Database" (VAT), or the "Portfolio Company Analysis Tool" (PCAT), we at VC Experts like to pride ourselves on the data that we provide to the venture capital community. Our data is not bias to any particular side of the table, but in reality, makes both sides of the table more aware on how the negotiations of a deal are going to affect them.

One of our most utilized tools is the Valuation and Terms Database, or what we refer to as the VAT. TheVAT is a one of a kind database that provides the specific deal terms and valuations for thousands of private company financings. This is not exactly the type of data that you can find through a search engine on the internet. The data is compiled using publicly filed regulatory documents (both state and federal), such as the Amended and Restated Certificate of Incorporation. We make copies of these documents available with every set of deal terms that we post in the database.

Within the VAT, we report Liquidation Preference as the order in which the liquidation amounts will be distributed. (Ex: Senior, Pari-Passu, Junior, or N/A if there are no other rounds prior to the current. This is assumed that if Preferred is issued, then all Preferred Stock is Senior to the Common Stock unless stated otherwise.)

We report the Liquidation Multiple which dictates how much of their money the investor will get before any other holders get anything.

Below is an example from an actual Restated Certificate of Incorporation in our database where you would/could find the details of the Liquidation Preference and the Liquidation Multiple.

Here we see that the Series D Preferred has a Senior Liquidation Preference with a 1.5x Liquidation Multiple.

1. First, the holders of the shares of Series D Preferred shall be entitled, before any distribution or payment is made upon any Common Stock or Junior Preferred, to be paid an amount per share of Series D Preferred equal to 150% of the Series D Original Issue Price (as adjusted for any stock dividends, combinations, splits, recapitalizations and the like with respect to such shares after the filing date hereof plus all accrued and unpaid dividends on the Series D Preferred for each share of Series D Preferred held by them).

One term, which many consider to be the most "influential" on an exit or liquidation event, is the Participating Preferred Stock. This term has become more popular in recent financings across the U.S.. Participating Preferred Stock allows the preferred stock to participate in any remaining assets on an "as-if converted basis" alongside the common stock. In short, after the Preferred Stock receives their initial preferences and multiple, they can then participate with the Common Stock in any remaining assets. This could be an unlimited amount based on the number of shares, unless there is a Participation Cap present.

Below is an example from an actual Restated Certificate of Incorporation where you would/could identify the Participating Preferred Stock.

Here we see there is no cap stated on the participation.

1. Third, after the payment of the full Series D Liquidation Preference and Series B Liquidation Preference pursuant to Section 3(a) and 3(b) above. the remaining assets of the Company legally available for distribution in such Liquidation Event (or the consideration received by the Company or its stockholders in such Acquisition or Asset Transfer), if any, shall be distributed ratably to the holders of the Common Stock and Series Preferred on an as-if converted to Common Stock basis.

To better illustrate the impact that these terms have on the returns and equity stake in a company, we are going to use our Portfolio Company Analysis Tool to display some very simple examples.

Example Company

• Raising a $1 MM round at a $3 MM pre-money resulting in a $4 MM post-money
• Using a hypothetical $4 MM exit value to demonstrate the returns and true price per share of the holders at the time of the investment
• What are the results of Conventional Convertible Preferred Stock vs. Participating Preferred Stock?
• What are the results of a 1x Liquidation Multiple vs. a 2x Liquidation Multiple?

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Using Conventional Convertible Preferred Stock and 1x Liq. Multiple for the Series A Preferred:

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Note the expected distributions of 75% Founders & 25% Investor #1.

Also note the share price per share are $3 for each the Founders and Investor #1.

Using Participating Preferred Stock with a 0 Participation Cap and a 1x Liq Mult for the Series A Preferred:

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Note the change in distributions to 56.25% Founders & the 43.75% Investor #1.

Also note the price per share at issue versus the price per share at the proposed exit. Using the Analysis Date as the investment date allows us to see the true impact. The shares of Preferred are issued at $3 and already worth $5.25, whereas the Founders shares are worth $2.25 per share.

Using a Conventional Convertible with a 2x Liq Mult for the Series A Preferred:

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Note the change in distributions to 50% Founders and 50% Investor #1

Also note the price per share at issue versus the price per share at the proposed exit. Using the Analysis Date as the investment date allows us to see the true impact. The shares of Preferred are issued at $3 and already worth $6, whereas the Founders shares are worth $2 per share

Using Participating Preferred Stock with a 0 Participation Cap and a 2x Liq Mult for the Series A Preferred:

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Note the change in distributions to 37.50% Founders & to 62.50% Investor #1.

Also note the price per share at issue versus the price per share at the proposed exit. Using the Analysis Date as the investment date allows us to see the true impact. The shares of Preferred are issued at $3 and already worth $7.50, whereas the Founders shares are worth $1.50 per share.

In summary, each party involved in a venture capital financing should be concerned with their individual return at liquidity. Deal Terms, while often overlooked, are a powerful aspect of each financing a company undertakes. Are you getting the best terms for your company or clients?

Alignment. 

You hear this word thrown out frequently in business conversations.  It is a wonderful thing to aspire to, but very hard to achieve.  Perhaps even harder to achieve in entrepreneurial settings between the venture capitalist and the entrepreneur, where the stakes are so high and the ever-present risk of dysfunctional behavior leading to a "Start-Up Soap Opera".

Ever since I began the research for my book, I have been spending time thinking about why VC-entrepreneur alignment is so elusive.  And so when the Kauffman Foundation asked me to give a presentation to their recent class of young VCs, I decided to take the opportunity to develop a few thoughts that teed up the key issues.

In short, I concluded that despite all the aspirational rhetoric about VCs becoming more "entrepreneur-friendly", there are structural reasons why VCs and entrepreneurs are not always aligned.  In negotiating term sheets, performing the inside-outside financing dance, discussing exit scenarios - and many other elements of the start-up journey - misalignment between VCs and entrepreneurs is common, natural and inevitable.

VCs and entrepreneurs have a hard time dealing with these areas of misalignment because they are human beings.  And like nearly all human beings, they have a hard time facing conflict dead on.  Conflict makes us uncomfortable.  No one wants to be the "bad guy/gal" and so try to gloss over real differences or sweep them under the rug. 

I argue instead that VCs and entrepreneurs should explicitly acknowledge these areas of misalignment and talk about them openly and directly.  Only by naming these points of conflict and appreciating the other side's point of view, can you really begin to develop the solutions to these points of conflict.  As Mark Pincus of Zynga told me when I interviewed him for Mastering the VC Game, "Don't be a victim.  Don't look at the [conflicts and drama] personally, look at them structurally."

Anyway, here's the presentation I gave the Kauffman folks the other day that laid some of these issues out.  I still consider it a work in process (like everything I do!), so let me know what you think.

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Whenever First Round Capital holds a party, we sometimes get emails from a few of our guests asking if they can bring another person with them.  Maybe a VC friend of ours wants to bring another partner with him.  Maybe it’s an entrepreneur who wants to bring a new executive hire.  Maybe it’s someone who works at Facebook and wants to bring a co-worker.  Unless we’re dealing with a venue that has a limited space, we typically are fine with the extra guests.  It’s a great way to expand our network – and meet new, interesting people.  The few times we weren’t able to accommodate those requests typically were due to hard constraints (either budgetary or the size of the venue).  And when we don’t have room, we tell that to the person who asked – and they typically are very understanding. 

I just read my friend, Roger Ehrenberg’s, latest blog post on syndicating seed rounds – and totally agree with his main conclusion (that rounds tend to work best if there is a lead investor to represent the interests of the syndicate).  But the most meaningful part of Roger’s post, in my opinion, is when he writes about how a syndicate gets chosen.  Specifically, he writes: ‘One can have a reasoned discussion concerning capacity, etc., but fundamentally if an entrepreneur wants a particular investor in I am going to make room – period.’   I could not agree more.  I think that the entrepreneur should be the “decider” on the syndicate – not the lead investor.  The lead investor should help establish terms, provide feedback and input on potential co-investors, and bring other investors to the table if asked/needed – but the lead investor should not force a syndicate on the entrepreneur.  

If I’d react badly to a guest trying to force me to let another guest into my party for a few hours (ie, “the only way I’ll come is if you let this stranger in”), I can only imagine how badly I’d react if I was an entrepreneur that was forced  to spend the next 5+ years with someone I don’t want.  In my view the lead investor should offer feedback and offer introductions – but ultimately should follow the founder’s lead on syndicate composition.  If the founder wants certain angels to participate – done.  If the founder thinks that a certain fund could add value – done.   

Just like I think that financing rounds should be based on company math (as opposed to venture math), I think the syndication decision belongs with the founder (as opposed to the investor).  The founder should be free to choose the investors that increase the company’s odds of success.  And building a syndicate is the entrepreneur’s opportunity to figure out who the founder wants to spend time with, who the founder respects, and who the founder thinks can help the company the most.  

Oftentimes the first strategic discussion that a lead investor gets to collaborate with a founder on is the discussion around the syndicate.  And while I'd clearly expect a reasoned conversation to occur, I believe that an early stage investor is funding a company because they believe in the entrepreneur's ability to make strategic decisions and to optimize for success.  And ultimately, it should be the investor who follows the founder's lead when it comes to syndicate composition (and not the other way around).

By Michael Davis-Wilson of Fenwick & West LLP

Introduction

In recent years, the private sector's efforts to develop responses to environmental challenges have focused strongly on technological solutions. For many businesses in this field, patent protection for innovative technology is a key element of their business strategies. But as global economic conditions make it more difficult to mount capital intensive ventures, and as competition stiffens in many subsectors, patents on traditional technology may not be as rewarding an investment as they have been. In this new environment, we are likely to see more investment in logistical and structural innovations, and consequently in patents on business methods.

Sound off on this buzz in the Comments Section.

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Most recent "green" businesses are technologically oriented; the sector is commonly called "cleantech" for a reason. Even after a substantial decline from its 2008 peak, the Cleantech Group reports that nearly a billion dollars was invested in clean technology ventures - particularly solar technology, biofuels, and advanced batteries - in the first quarter of 2009 alone. However, some commentators argue that too many resources are being devoted to the search for technological solutions to environmental challenges. These critics suggest that the quest for a technical fix (and, perhaps, for a "magic bullet") distract from the possibility of finding structural solutions. It might ultimately be more effective to rework some of the processes that we use in our lives and our businesses than to try to do the same old things, only with less carbon-intensive fuels.

That sort of structural innovation has largely been left, so far, to the public sector. Consider, for example, the city of Berkeley's recent Berkeley FIRST program. This program seeks to address one obstacle to the deployment of residential solar energy systems - namely, the fact that property owners may hesitate (or may be unable) to invest substantial sums in a system that will pay off over the long haul, out of concern that they may not be able to recoup that investment if they want to sell their property in the short or medium term. Berkeley FIRST finances the installation of solar panels through a tax obligation that runs with the property; this couples the costs of solar infrastructure over time with its benefits.

Of course, structural schemes that depend on allocating property rights will necessarily be primarily the domain of government. However, schemes that enable better deployment and more efficient use of resources can be and are developed in the private sector. San Francisco startup Virgance operates a project called Carrotmob, which coordinates environmentally minded consumers to shop en masse during special events at stores that have committed to use some portion of the event proceeds on green improvements. Coordination of private action thus creates opportunities for investment in efficiency. This kind of private structural innovation, however, appears to be the exception rather than the rule.

In part, this imbalance may be due to the fact that, especially in the Bay Area, there is substantial infrastructure for technological innovation. There are many well-established resources for anyone seeking to mount a new technological venture - investors experienced in evaluating technology opportunities, a deep pool of talent accustomed to developing new technology, and a sophisticated patent system offering property rights in any useful innovations which emerge from the new venture. Those patent rights can then be leveraged into a return on investment in a variety of ways. Structural and logistical innovations, by comparison, are terra incognita. But the same essential model remains viable. In the words of Diamond v. Chakrabarty, 447 U.S. 303 (1980), patent protection extends to "anything under the sun made by man," even in less technical fields. The business method patent allows innovators who create not a new machine or a new molecule, but a better way of doing things, to recoup their investment in innovation.

Cleantech companies have largely neglected the business method patent in the past, which the exception of a cluster of patents addressing methods of trading carbon credits issued under cap-and-trade schemes. It seems very likely that this will change in the future. Because relatively little effort has been devoted to structural innovation in the past, there may be more unexplored opportunities for innovation in that realm than in crowded fields like biofuels or solar technology. Furthermore, the credit crisis poses a serious problem to cleantech firms whose technology requires large installations, and thus large capital investments. Some firms, unable to fund planned capital expenses, have been able to pivot to a different business model in which they license technology rather than deploying it themselves, but other firms have not survived. Businesses that focus on structural and logistical efficiency may prove less capital intensive than more traditional technology companies, and thus better suited to the current environment.

A significant obstacle to cleantech innovators considering business method patents, however, is the Federal Circuit's recent en banc decision in In re Bilski, 545 F.3d 943 (Fed. Cir. 2008). In that case, the court upheld the Patent and Trademark Office's rejection of a patent for a method for hedging commodity risk, holding that a process is only eligible for patent protection if it passes the "machine-or transformation" test: that is, it either is tied to a particular machine or apparatus, or transforms a particular article into a different state or thing. The full implications of this decision may not be seen for some years; commentators and practitioners are divided on whether Bilski substantially narrows the potential scope of business method patents, or simply presents a new set of drafting challenges for patent prosecutors.

The Bilski court did explicitly state that processes that transform or manipulate abstractions like legal relationships or business risks, like the hedging method claimed in Bilski, are ineligible for patent. Another recent Federal Circuit decision, In re Comiskey, 499 F.3d 1365 (Fed. Cir. 2007), which rejected a patent for a method of arbitration, further supports the conclusion that purely financial or legal processes may no longer be patentable subject matter. This rule may imperil the aforementioned carbon trading patents; carbon credits, ultimately, are simply legal entitlements to emit greenhouse gases, and processes that manipulate them would seem to fall within Bilski's exclusion.

Many green innovations that might be candidates for a business method patent, however, involve moving around or transforming actual things. As an example, consider U.S. Patent Application No. 20070008181 (filed Apr. 21, 2006), which teaches a system to reduce fuel and time wasted while drivers search for parking by connecting parties with spaces to offer with parties in need of a parking space. Although such a method largely manipulates data, that data represents physical spaces and vehicles. Methods that manipulate data representative of physical objects were specifically distinguished in Bilski from the purely abstract transactions barred by the machine-or-transformation test. Thus, these kinds of methods, which squeeze opportunities for improved efficiency out of everyday activities, ought to remain viable patent opportunities, even in a post-Bilski world.

Another concern that may hold back potential patentees is the possibility of backlash. Patents that cover innovations of significant public value are often deeply resented. This problem is compounded when a patent's subject matter is not the sort of thing one traditionally thinks of when one thinks of patents - software, business methods, etc. Exclusive rights in a better battery are more intuitive than exclusive rights in a better way of collecting and recycling used cooking oil. Indeed, inventor expectations may be as much of an obstacle as public relations. It's hard to imagine a cleantech business method patent that could invite as much controversy as a patent on a life-saving but expensive drug, but some innovators might themselves balk at preventing others from using their logistical innovations.

Cleantech and patents are natural allies. The fundamental challenge of cleantech is to find better and more efficient ways to do all the things that we need to do; the patent system exists to provide incentives for everyone who devises a better way to do things, regardless of the form that better way takes. In these difficult times, cleantech firms will need to use that synergy to the fullest, exploring new forms of innovation and new ways of profiting from their investments.

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Michael Davis-Wilson, Associate, mdaviswilson at fenwick dot com

Mr. Davis-Wilson served as Editor-in-Chief of the Berkeley Technology Law Journal from 2007-2008. During law school, he also served as a judicial extern to the Honorable James Ware of the United States District Court for the Northern District of California.

Full Bio

Fenwick & West LLP

Fenwick & West is a national law firm that provides comprehensive legal services to technology and life sciences clients of national and international prominence. We have approximately 300 attorneys, with offices in Silicon Valley, San Francisco, Seattle and Boise.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional.

? 2010 Fenwick & West LLP. All Rights Reserved.

In 2008 I was invited by Pamela Samuelson, who I met through several Silicon Flatiron events, to be on an advisory board at the Berkeley Center for Law & Technology.  I attended the one meeting that we had and a subsequent symposium and wrote about it in the post Entrepreneurial Companies and the Patent System.  As with most things like this, I found it fascinating, stimulating, and frustrating all at the same time and hoped that I’d contributed something useful to the discussion.

I read the paper titled High Technology Entrepreneurs and the Patent System: Results of the 2008 Berkeley Patent Survey when it came out at the end of June 2010.  I thought it was a solid paper although there were some things that I struggled with which is typical for me in any academic paper, especially when I get bogged down in arguing with myself while trying to parse the footnotes.  But I was optimistic that as the authors started talking about the article, some thoughtful and constructive discourse would result.

I was appalled when I started seeing soundbites emerge from at least one of the authors of the paper from weak conclusions buried in the midst of the data.  My partner Jason took one of them on when he wrote his post 76% of Venture Capitalists Believe that Software Patents are Important (NOT!) In this post I think Jason does an excellent job of dissecting the data and explaining why this is not only an incorrect conclusion from the data, but a terribly misleading soundbite.

Fortunately, Pam Samuelson (one of the other co-authors) has set the record straight with her excellent summary of the Berkeley Patent Survey on her post on O’Reilly Radar titled Why software startups decide to patent … or not. Her essay is very digestible and focuses specifically on the issue of software patents and what she believes they reported in the paper.  She reached the following conclusions which she states in her intro:

• Two-thirds of the approximately 700 software entrepreneurs who participated in the 2008 Berkeley Patent Survey report that they neither have nor are seeking patents for innovations embodied in their products and services.
• These entrepreneurs rate patents as the least important mechanism among seven options for attaining competitive advantage in the marketplace.
• Even software startups that hold patents regard them as providing only a slight incentive to invest in innovation.

Pam is balanced in her intro as she concludes by saying “While the three findings highlighted above might seem to support a software patent abolitionist position, it is significant that a third of the software entrepreneurs reported having or seeking patents, and that they perceive patents to be important to persons or firms from whom they hope to obtain financing.”

The juiciest conclusion is about halfway through the essay and is “One of the most striking findings of our study is that software firms ranked patents dead last among seven strategies for attaining competitive advantage identified by the survey.”  Another one was “We were surprised to discover that the software respondents reported that patents provide only weak incentives for engaging in core activities, such as invention of new products (.96) and commercialization (.93).”

I’m glad Pam took this on and put this out there.  I look forward to more studies she does from this research set.

This week’s special guest are Jeff Clavier from SoftTech VC and Rob Hayes from First Round Capital.  Among other things, you get to hear Jeff define the Three Asses Rule and Rob explain what happens after you finish the TechStars program.  As a special bonus, there’s a cute clip of me near the end watching the incredible record tennis match between Isner and Mahut.  And some funny running footage.  And a glider.  And Ari Newman and how sandpaper and rubbing alcohol intersect with the fundraising process.

“People Product Market” The Founders | TechStars Boulder | Episode 10 from TechStars on Vimeo.

I recently had the opportunity to chat with Vincent Carbone, the COO and co-Founder of Brightidea. The company is one of a small group of vendors pitching solutions that help companies link ideation with managed innovation. I was looking forward to this conversation for two reasons, the first being that Brightidea is a successful 11 year old company that has never taken venture financing (I expect that will change) and as it relates to product R&D, especially for digital products, ideation is contributing to the software tools sector becoming exciting again.

Ideation has always been a funny word to me… it just sounds made up so let’s talk about what ideation is. To greatly simplify the entire market, let us agree that ideation is the process of innovation that begins with collection and sorting of ideas that result in new products or product extensions, validation of the feasibility of ideas, and then integration into a product development process that culminates in a marketing process to create demand for new or improved products. Brightidea calls this “innovation management”… whatever we agree to call it we intuitively recognize that it is a process that every service and product company engages in.

I think it is also appropriate to talk about the distinction between two market segments for ideation products and the distinct requirements that each has. Marketing organizations want ideation that is more appropriately described as a lightweight idea submission and voting mechanism that encourages marketplace engagement, and generally speaking it is also true that marketing driven ideation isn’t primarily concerned with the R&D process even though there is an explicit benefit gained that affects R&D.

I don’t think it’s wrong that marketing driven ideation isn’t primarily oriented to R&D because the process of engaging customer and prospect constituencies drives many benefits that don’t require integration of R&D, like customer satisfaction, marketplace segmentation, new customer group identification, and social commerce through product suggestions keyed off idea submission. I think one of the reasons why streamlined idea submission products are emerging inside community offerings is that marketing organizations see the value of these services in the context of a community effort.

R&D driven innovation management is by definition more structured and while the front end user experience is identical what is happening in the backend is much different. For starters many industries have complex requirements for idea documentation to meet auditing and legal requirements, which is no small requirement on it’s own. Companies also don’t work around the notion of ideas, they work with projects and the management of projects is highly structured with many data points of action and integration.

What begins for many companies as idea brainstorming quickly evolves to a structured process of idea collection, ranking, scoring, and then integration in structured product pipelines where separate process loops interact to manage a portfolio of activities and prioritize according to resources. In short, what starts out as a very simple concept quickly becomes complex because the underlying business function itself is complex and involves many people and disparate activities.

Brightidea is clearly capable of handling the product R&D side of the market and their customer list is a testament to their success in doing just that. I am not suggesting that Brightidea is ill-conceived for the marketing driven side of the market but I’m also not convinced that that is where they should compete. One of the most difficult strategies to pull off in any market is straddling a high price point that serves a direct sale marketplace and a lower cost self-service on demand model that is based on the same product.

Enterprise software vendors have been struggling with price point spread for the last 10 years, therefore I’d say that if you have a business based on direct sales then you go all in on that and tailor price points and product offerings to support the economics of direct selling. Companies like Salesforce.com are successfully dealing in both markets, direct and self-service, but it’s important to recognize that they didn’t start out focused on direct selling and their early leadership driving SaaS resulted in a wave of highly valuable free promotion that they successfully used to lever up their direct business.

I’ve been rambling on in this post about a lot of things not related to Brightidea and the reason I am doing that is that it is important to understand the market context that Brightidea, and others, are operating in. The fact that marketing and product groups operate independent of one another with few points of interaction simply doesn’t have to be that way but each group has unique requirements that pre-position them for different segments of vendors operating in this space. Any company pitching an ideation solution is going to be challenged to straddle marketing and product R&D opportunities, IMO.

The Brightidea product is impressive, at least as impressive as the 300 customers they count using it. The product suite is actually 3 products:

WebStorm: Idea submission and voting.

Switchboard: Scorecarding and routing of ideas.

Pipeline: This is project management at it’s core and integrates with tools like Rally as well.

I’ll close by saying that this market is one to watch and Brightidea is a company that has to be on the shortlist for large company selections of ideation tools. Their customer references are impressive as well as the metrics they track to determine the success of the ideas communities that they are creating. Even though this space is early (as if you could say that about an 11 year old company!) it is clear that by any measure Brightidea is a legitimate leader.

By Charlene M. Morrow and Todd R. Gregorian of Fenwick & West LLP

Introduction

In the opening weeks of 2010, Parliament in London took up a bill to consider whether company directors might be held personally liable in certain areas implicating health and safety of workers. This bill, scheduled for further consideration later this spring, does not address intellectual property. However, it reminds us to stay aware of a doctrine that already exists in U.S. law under which directors can be held accountable for corporate trade secret misappropriation.

Sound off on this buzz in the Comments Section.

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A plaintiff seeking to establish a director's tort liability typically faces a very high hurdle in the Business Judgment Rule (BJR). Directors are not personally liable in tort unless their action, including any claimed reliance on expert advice, was clearly unreasonable under the circumstances known to them at that time. Frances T. v. Village Green Owners Ass'n, 42 Cal. 3d 490 (1986). Even where the underlying facts raise suspicions about the reasonableness of the board's action, a prima facie showing of good faith and reasonable investigation, supporting application of the BJR, is established provided only that a majority of the board is comprised of outside directors and has received advice of independent consultants on the issue. Katz v. Chevron Corp., 22 Cal. App. 4th 1352 (1994); see also FDIC v. Castetter, 184 F.3d 1040 (9th Cir. 1999) (applying BJR in non-tort context after finding the two factors above, without further inquiry). However, one line of decisions applying the rule continues to present a potential danger for investors seeking an active role in the management of their investment. In PMC, Inc. v. Kadisha, 78 Cal. App. 4th 1368 (2000), the California Court of Appeal for the Second District articulated a new theory of officer and director liability that corporate officers or directors may be liable for the trade secret misappropriation of the company in which they are investing if:

(1) the officer or director purchased or invested in a corporation whose principal assets were the result of unlawful conduct;

(2) the officer or director took control of the corporation and appointed personnel to run the corporation; and

(3) the officer or director did so with knowledge of or, with respect to trade secret misappropriation, had reason to know of the unlawful conduct. --Kadisha thus created potential liability for investors taking a controlling interest in the management of the business, as their involvement may subject them to liability for past corporate wrongdoing. However, the key takeaway is that this rule only applies where there are facts suggesting the wrongdoing was a core part of the corporate strategy prior to the investment. --Kadisha involved a suit for misappropriation of trade secrets brought by majority shareholders of a corporation against former managers who had gone on to found a new company. The Kadisha plaintiffs, however, also sued previously unaffiliated investors in the new entity who had assumed roles as its officers and directors.

The appellate court rejected defendants' argument that they could not be liable for trade secret violations that predated their investment, finding that "misappropriation is not limited to the initial act of improperly acquiring trade secrets; the use and continuing use of trade secrets is also misappropriation." The court further explained that officer and director liability in tort generally requires a finding of actual participation by the officer or director in the tortious conduct, but also extends to knowing approval and consent to unlawful acts. The court went on to announce the three factors identified above, and found:

[P]laintiffs presented sufficient evidence to raise a triable issue whether, when defendants invested in [the new entity], became majority shareholders, officers and directors, effectively took control of the corporation, hired personnel to run it, and continued its operations, they knew or, with respect to trade secret misappropriation, had reason to know, that their codefendants had engaged in tortious conduct harmful to [the former corporation]. In a nutshell, there was evidence from which a trier of fact could reasonably infer defendants, in anticipation of enormous corporate and personal profit, knowingly invested at a bargain price in a corporation whose sole business assets consisted of stolen confidential information and processes, and subsequently controlled the entity which was engaging in unlawful conduct.

(emphasis added). In reaching this conclusion, the Court relied upon evidence that the defendant corporation was an "exact replica" of the plaintiff corporation and was founded in order to capitalize on the plaintiffs' manufacturing processes and contracts.

In addition, there may be a further limitation available to a passive director. Kadisha was unclear regarding whether the fact of the investors' resulting positions at the corporation (as various officers and directors) is sufficient to impose liability on its own, or whether liability was based on actual exercise of control over management of the business. Courts interpreting Kadisha, however, have required that plaintiffs demonstrate the investors have actual resulting control over the management of the business. See, e.g., Verigy US, Inc. v. Mayder, No. C-07-04330, 2008 U.S. Dist. LEXIS 89271 (N.D. Cal. Nov. 4, 2008); M-Cam Inc. v. D'Agostino, No. 3:05-CV-00006, 2005 U.S. Dist. LEXIS 45288 (W.D. Va. Aug. 22, 2005); but see Moser v. Triarc Co., No. 05-cv-1742, 2007 U.S. Dist. LEXIS 22983 (S.D. Cal. Mar. 29, 2007) (that the defendant was only a shareholder in the corporation was insufficient to support dismissal of claim; plaintiff could still show direct participation in the alleged tort). --For example, in Verigy US, Inc. v. Mayder, Plaintiff contended that defendant W. Mayder, as a director of defendant STS, Inc. and member of defendant STS LLC, was liable based on his investment in and control of the companies and his knowledge or constructive knowledge of the misappropriation of plaintiff's trade secrets. Plaintiff argued that W. Mayder had control over the companies based on: (1) his investments of $250,000 in each corporation; (2) the referral of a new investor to STS, Inc.; (3) the use of his driver's license to obtain a seller's permit for the company; (4) the operation of a website for STS, Inc.; (5) the recommendation of someone to help date R. Mayder's (W. Mayder's brother) lab notebook. Plaintiff argued W. Mayder knew or had reason to know of his brother's misappropriation of trade secrets prior to the lawsuit based on a pair of letters sent by plaintiff to R. Mayder raising the same allegations made in the lawsuit, which were forwarded to W. Mayder, who allegedly failed to perform any investigation other than asking his brother's opinion of the letters. The court rejected plaintiff's argument for liability under Kadisha, finding that there was insufficient evidence to show an active role in either the misappropriation itself, or control of the corporation.

Similarly, in M-Cam Inc. v. D'Agostino, the court addressed the control point in the context of analyzing entity liability based on investor/director status. Defendant Principal Financial Group (Principal) was an investor in Defendant IPI. Plaintiff alleged that Principal continued to invest in IPI even after plaintiff informed the company of IPI's illegal behavior, including misappropriation of its trade secrets. The district court distinguished Kadisha on the basis that Principal did not gain substantial control over the company through its investments:

[I]n that case [Kadisha], the defendants "became majority shareholders, officers, and directors[,] effectively took control of the corporation, hired personnel to run it, and continued its operations." The California court based its holding both on the defendant company's investment in and substantial control over the offending corporation. M-CAM has not alleged that Principal had any control whatsoever over IPI's activities, aside from providing funding. Nor can the court infer from the Complaint that Defendant had sufficient control over IPI to be held vicariously liable for IPI's misappropriation of trade secrets.

(internal citations omitted).

In Kadisha, the directors sought protection under the BJR, but the rule did not provide protection from the claims because, given the nature of the misappropriation allegations, an adequate investigation was required to invoke the rule. Under established law, an investigation prior to officer/director action is necessary to invoke the BJR where there are: "(1) allegations of facts which would reasonably call for such an investigation, or (2) allegations of facts which would have been discovered by a reasonable investigation and would have been material to the questioned exercise of business judgment." Lee v. Interinsurance Exchange, 50 Cal. App. 4th 694 (1996). Kadisha shed more light on the nature of an adequate investigation, counseling that:

(1) The person responsible for the investigation should be given direction regarding its scope;

(2) The investigation should cover any alleged past acts of misappropriation;

(3) The investigation should include interviews of the person(s) alleged to have actually conducted the misappropriation, and examination of relevant evidence to determine how the corporation had produced its products; and

(4) The expert hired to opine on the investigation should express an opinion regarding whether the company's products were produced using plaintiffs' trade secrets.

However, Kadisha and subsequent cases provide little guidance as to precisely what parameters an investigation must have to support summary judgment of no liability for trade secret misappropriation or other torts. One potential analogy comes from cases analyzing the adequacy of an investigation in the context of assertions of a special litigation committee defense to a derivative action, since that defense is essentially an application of the BJR. See, e.g., Desaigoudar v. Meyercord, 108 Cal. App. 4th 173 (2003); Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. Super. Ct. 1981); Auerbach v. Bennett, 393 N.E.2d 994 (N.Y. 1979).

Conclusion

Despite the potential "control" limitation and the ability to insulate directors from liability with a more thorough investigation, Kadisha represents a rather aggressive departure from traditional applications of the BJR that investors should consider when facing facts indicating potential wrongdoing at the subject investment. As the issue of directors' personal liability gains headlines in other areas, it is likely that the Kadisha doctrine will receive renewed attention by potential plaintiffs as well.

---

Charlene M. Morrow, Partner, cmorrow at fenwick dot com

Ms. Morrow is Chair of the firm's Patent Litigation Group, which has over 35 litigation members and also leverages the expertise of the firm's over 35 member Patent Group.

She has an active nation-wide trial practice representing software, semiconductor and medical device companies in a range of disputes, both on the plaintiff and defense side.

Full Bio

Todd R. Gregorian, Associate, tgregorian at fenwick dot com

Mr. Gregorian's practice focuses on intellectual property litigation and antitrust matters.

Mr. Gregorian served as a law clerk to the Honorable W. James Ware of the Northern District of California.

Full Bio

Fenwick & West LLP

Fenwick & West is a national law firm that provides comprehensive legal services to technology and life sciences clients of national and international prominence. We have approximately 300 attorneys, with offices in Silicon Valley, San Francisco, Seattle and Boise.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional.

? 2010 Fenwick & West LLP. All Rights Reserved.

I got a note from Nivi, the creator of AngelList, over the weekend saying that he’d put up a special page for angel investors in Boulder.  He’s looking for the local Boulder angels to add their names to the list.  Gang – let’s get ‘em up – if you are an angel investor and based in the Boulder area, sign up!

There’s been an enormous about of blog and news chatter about angel investors, especially seed investors and the emergence of super angel / micro VCs, in the past few months.  I’m a huge fan and supporter of the super angel / micro VC phenomenon and have watched with delight as it has built momentum.

However, in the past few weeks I’ve started to see a rant start to emerge that I’ll simplify as “VCs suck as seed investors – the only path to happiness are angels or super angels or micro VCs.” This rant bugs me as I think it’s incorrect and isn’t very helpful to entrepreneurs. While I know many VCs that I would categorize as terrible seed investors, I know plenty that are excellent seed investors.  And while I know many angels who are terrific seed investors, I also know some who are abysmal.

The thing that started to bug me last week wasn’t the discussions about the characteristics of what makes a VC a bad seed investor, but that the comments, including some from super angels, were becoming generalizations that all VCs were bad seed investors.  As I read through them, they started feeling like statements of “hey entrepreneur, trust me, I’m just trying to save you from Mr. Evil VC and here’s the answer, the answer is me.”

As a VC who has been a very active angel investor (I’ve made over 75 angel investments), an active seed investor as a VC (I just counted and 7 of the 25 investments we’ve made out of Foundry Group since we started our fund in Q4 2007 are seed investments), a co-founder of a “mentorship-driven seed stage investment program” (TechStars), and an investor in several super angel / micro VC funds, I believe both angels and VCs can be excellent seed investors.

There is a lot more transparency than there ever has been, the structural dynamics of early stage investing are moving around a lot, and entrepreneurs have more clarity on their choices, ways to figure out who is good and who is bad, and ways to get access to great choices than ever before.  Fred Wilson wrote two excellent posts on this over the weekend titled Angel vs. VC and The AngelList as well as an earlier post titled Some Thoughts On The Seed Fund Phenomenon.  Until last week I didn’t feel like I had a ton to add to the discussion, but I felt like it was time to weigh in as I saw the tone shifting to “VCs are bad seed investors.”

While I completely agree with the phrase “many VCs are bad seed investors” especially around VCs simply trying to create option value for themselves or the issues around signaling risk, I felt like there wasn’t enough discussion about why and when VCs were effective seed investors.  So I thought I’d take some of this on over the next few weeks. Hopefully my perspective and examples will be additive to the conversation and helpful to early stage entrepreneurs, especially first time ones.

In the mean time, if you are a Boulder angel (or seed) investor and you are still reading, sign up on AngelList already!

While I still don’t have my jetpack, I do have my picturephone.

I was four when the AT&T PicturePhone appeared on the scene. This dude went through a lot of iterations over the year – my favorite is in this Western Digital ad.

This morning as I was drinking my coffee, waking up, and trying to get motivated to go running in the rain (I think I’ll go swim instead), my dad called on Skype.  I answered and we had a nice video chat.  I heard about my mom’s newly rediscovered Corvette lust (go mom!) and the hike they were going to do.  I saw the study in my Keystone house where they are staying which made me smile.  And then I said a quick hello to my mom.

I really hate the phone.  I always have – and spend much too much time on it.  But for some reason I like the videophone.  Maybe it’s the novelty of it, maybe it’s a different way it grabs my attention because I really engage fully with it.

Regardless, the future is catching up with my childhood in interesting ways.

Or thereabouts. For those of you who have been following this blog, you may wonder why I’ve gone quiet. Well, an interesting opportunity arose and my wife and I move to Europe for six months or so. Slovakia to be precise. While we’re abroad, I’m a bit removed from the startup game, though I’ve got a few things cooking in the background. If you’d like a taste of the other side of my life, feel free to visit my travel-blog: “Lost in Transylvania“.