Business Law Society event explores lawyer’s role in industry
By Lori Craig
In the volatile world of venture capital, it isn’t just the financiers who take on risk. Lawyers also make a calculated gamble, given that about 75 percent of venture capital-backed companies fail.
“A lot of times [law firms] see startups before venture investors do, so we have to make the decision: Is this worth our time? Is it worth deploying resources, associate hours, and incurring costs?” said Nathaniel P. Gallon, a partner in Wilson Sonsini’s Palo Alto, Calif., office. “In some sense, we are making the same kinds of bets that venture capitalists are, but in smaller dollar amounts, namely legal fees.”
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| Bill Elkus and Chris Shoff |
Gallon was part of an expert panel, “California Venture Capital,” hosted Sept. 21 by the USC Business Law Society. He was joined by three other speakers representing different parties that might be involved in a venture capital deal: Bill Elkus, founder and managing director of Clearstone Venture Partners, with offices in Santa Monica and Palo Alto, Calif.; Chris Shoff, a founding partner of Cooley LLP’s Los Angeles office; and Andy Wilson, founder and CEO of Graphight and three other companies that have gone public. The event was moderated by USC Gould Prof. Donald Scotten.
Venture capital firms are financial intermediaries, gathering funds from one group of people, investing them in another group and trying to help grow the companies they invest in, said Elkus, who has a J.D. and an MBA.
“Typically, the investors in venture capital funds are institutional investors that can afford to take a great deal of risk,” he said, pointing to university endowments, state pension plans, sovereign wealth funds and some wealthy families. “They usually invest less than 5 percent of their total assets in venture as an asset class.”
Venture capital firms make their money by charging a management fee and securing a share of the profits, usually about 20 percent.
Companies pursuing venture capital generally do so after they’ve gotten “seed stage” funds from family, friends, and possibly angel investors.
“There are fairly well-known rules of thumb” for what Elkus’s firm looks for when deciding whether to invest in a company, he said. “We certainly look for a product or service that’s transformational, groundbreaking; you look for a market that’s growing; you look for entrepreneurs who have prior success, or at least prior experience; you do diligence on the individuals.”
This round of funding is known as “Series A,” when a professional investor gets behind the fledgling company — which typically has zero sales at this point. Series B and other rounds follow, in which the price increases, but risk and stake in the company decrease.
“The end of the game is that the company has an exit,” Elkus said. “Exit” can be an IPO (to monetize the value of the stock), purchase by another company, or a merger and acquisition.
Lawyers work with entrepreneurs from the very beginning of the process, Shoff said.
“We help get the company formed, working out the details of who’s going to own what percentage of the company, and get their IP protected,” Shoff said. “The goal is to make sure that the documents and the company [are] formed in a way that will make it easy to find investment, whether it’s angel investment or friends and family investment.”
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| Andy Wilson and Nathaniel Gallon |
When launching a business and securing financing, entrepreneurs must carefully discern who will provide their legal representation, Wilson said.
“There’s one thing that’s always true about entrepreneurs: You never have as many resources as you’d like; the last place you want to spend money is on lawyers,” Wilson said. Good lawyers will understand this and determine the “necessary amount of lawyering you want to do to make sure not that it’s perfect, but that it’s not wrong.”
A lawyer’s experience can also make a huge difference for an entrepreneur when it comes time to negotiate.
“If … you have someone who hasn’t done venture representing on the other side, the negotiation process can be very protracted, because not only [is the lawyer] educating the entrepreneur, but [the lawyer is] educating the other side,” Wilson said. “The effectiveness of lawyers, and part of the value … in having good counsel is them having experience and good relationships with other lawyers who can kind of work things quickly — because remember, as the entrepreneur, you’re paying for this stuff. So getting to the right answer quickly is usually valued.”
Wilson’s advice dovetailed with that from Dean Robert K. Rasmussen, who opened the event.
“The thing you have to learn first as a lawyer is, we work for other people,” Rasmussen said. “We have to provide value. We have to get in their heads; we have to know, first of all, the process they’re involved in, the structure of their industry, and what counts as success.”
“And you’re actually paying for both sides,” Shoff added, noting that the company will pay for its own lawyer and for the investors’ lawyers.
Wilson said working in a technology-focused law firm allows him to spend a lot of time on non-legal issues with startup clients, such as cleaning up their business plans, helping them with their pitches, and making introductions to potential investors.
One thing attorneys must keep in mind is the distinction between entrepreneur as client and company as client, Gallon said. They may mean the same thing at first, when there is little to the company aside from the founder’s sweat equity, funds and technology. When negotiating a term sheet on behalf of the company, a lawyer also is effectively advising the founder about protecting his or her employment, compensation, equity, and control rights.
“In the initial state, what you’re doing is in essence representing the founder as the company, as the single board member, versus the institutional investor who is putting in money to take a minority investment but is going to have veto rights over key decisions and fundamental changes in the company’s business,” he said. “What happens after the money comes in is the switch flips and all of a sudden you are counsel to the board, and you are not counsel to the founder.”
Watch the full video of this event at http://www.youtube.com/watch?v=4V1lG1qTSjg
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