VentureBlog

Fun With SEC Filings

It is hardly a revelation to state that the Internet is an astonishing resource. Perhaps the most amazing thing about the Internet is the incredible amount of information it makes available at the click of a mouse. Blogging has undoubtedly escalated the amount of information being shared but, far more so, the dissemination of government mandated information via the web has created huge pockets of searchable information that otherwise required pretty significant resources to unearth. And for individuals focused on business, there is an unending amount of interesting information available in filings with the SEC.

One such snippet of information about the Venture Capital industry was recently published in a registration statement for Tumbleweed Communications. Tumbleweed purchased a Sequoia Capital backed company called Corvigo. In connection with that acquisition, Tumbleweed registered about five million shares of stock in the name of Sequoia's various limited partners (known as "LPs") -- specifically, the investors in Sequoia Capital's tenth fund (Sequoia Capital X). While the names of the investors in a venture capital firms are generally not public information, in this instance they are a matter of public record (a complete list of Sequoia's LPs -- give or take a few really small cats and dogs -- can be found on page 14 of the Tumbleweed registration statement). Sequoia has a fairly typical mix of investors: Universities (e.g., Columbia, Dartmouth, Duke, Harvard, MIT, Stanford, etc.), Foundations (e.g., Carnegie Foundation, Rockefeller Foundation, etc.), Fund-of-Funds (e.g., HarbourVest, Knightsbridge, etc.), and high profile individuals (e.g., Andy Bechtolsheim, Wu-Fu Chen, Ed Kozel, Ram Shriram, Jerry Yang, etc.).

Noticeably absent from Sequoia's LPs are public pension funds like CalPERS. Much has been written about the impact of recent lawsuits requiring public pension funds to disclose venture capital firm results under the Freedom of Information Act. We've pointed to Tim Oren's excellent discussion of the topic in the past. As Tim rightfully points out, the result of requiring public pension funds to reveal venture returns is that the best funds will simply not accept public pension funds as investors. The proof would appear to be in Sequoia's LP list -- just one of the many interesting facts to be discovered by scouring the SEC filings.

NB: As PE Week Wire rightly points out, while there are no public pension funds, there is still one public university (University of California). Mea culpa. Nonetheless, I still strongly believe that forced disclosure will result in funds like August and Sequoia avoiding investment from public institutions like calPERS and the University of California. I guess we'll have to wait a few years before we get a registration statement that will answer that question with respect to Sequoia's latest fund.

What's Left To Say About Participating Preferred Stock?

Man has Venture Blogging come a long way since we started VentureBlog a year and a half ago. At that time, the only way that there would be robust discussion and debate about venture capital related topics in the blogsphere would be if Andrew and I took different sides of an issue and duked it out on VentureBlog. Now folks like Brad Feld from Mobius Venture Capital and Fred Wilson from Flatiron Partners are discussing and debating VC issues of real interest and import. While Venture Capital still remains quite individualistic and, at times, enigmatic, VC bloggers have gone a long way to help demystify what has for years been a bit of a black art.

It struck me just how much information was being shared these days as I read a set of posts about Participating Preferred Stock by Brad and Fred. While there are real world implications to decisions made by VC's and entrepreneurs about Participating Preferred Stock, this is still a pretty esoteric topic. As recently as a year ago, the posts about venture financings were pretty rudimentary (here's what Joi was talking about, and here was my effort to just put the terms in context). Brad and Kevin Laws (at VentureBlog) upped the anti with deeper analysis of Preferred Stock. And now there is a debate raging online about the use and appropriateness of Participation in Preferred Stock. The real debate, mind you, is in the comments of Brad's and Kevin's pieces (we VC's are far too gentle on one another but entrepreneurs are more than willing to call BS when they see it).

Quantitative Evidence Of An Upswing

I am often asked if things are feeling better in Silicon Valley. Are things looking up? My answer is essentially "yes." Things do feel better. Serial entrepreneurs who sat out the early 2000's are getting back into the game. Deal flow has picked up across the board. The public market for technology stocks is opening up . . . a bit. Later stage venture investors are more enthusiastically looking for opportunities to put money to work. The environment really is feeling better. But as much as it's feeling better, it has just been that, a feeling. Until now.

I've written about Fenwick and West's survey of venture financings before. Fenwick has been tracking venture financing terms since the second quarter of 2002. In this quarter's survey (First Quarter 2004) Fenwick is reporting a noticeable and uniform upturn in venture financings. For the first time since 2002, the number of up rounds (51%) exceeded flat (19%) and down rounds (30%) combined. In fact, the percentage of down rounds decreased in every series, most notably in Series E and higher. Terms generally followed price as well, with less punitive liquidation preference and anti-dilution being the norm. Given all that, I would say that we have our first quantitative piece of evidence that the venture financing environment is on the upswing. That's good news. I hope that the trend continues.

Ok, that said, despite the apparent evidence of an upswing, lawyers can never leave well enough alone, can they. The Fenwick survey points out, "it is important to bear in mind that most of the companies that raised funding this past quarter last raised funds 12-24 months ago, when valuations were depressed." Sure, that's true, but the environment still feels better to me. So we'll have to wait and see if the trend continues.

Legally Gray (Observations From My Law School Reunion)

I spent last weekend at my 10th law school reunion. About 125 of my 500 or so classmates came back to Cambridge to reconnect with others who had suffered together through torts and civil procedure, through law firm interviews and the law review competition, through moot court and ultimately the bar. It was easy to pick out my classmates from the crowd -- we were the young ones (relatively speaking). The other reunion classes were the 25th, 30th, 40th and 50th. While I'm impressed that so many folks came back for their 50th reunion, they did tend to blend together -- the men all looked an awful lot like the portrait of the grey and distinguished Archibald Cox that hung in the law school halls and the women pretty much looked like Sandra Day O'Connor.

Do It Yourself Corporate Law

I joined Venture Law Group in the 90's when the Internet Bubble was rapidly inflating. Prior to joining VLG I was a litigator in New York, so I arrived in California knowing nothing about startups or venture financings or corporate law for that matter. But venture capital was flowing like water at the time and there were more financings than the experienced lawyers could handle, so I was thrown in head first. And the only thing that kept me afloat in those first handful of financings was VLG's set of proprietary form financing documents. I was able to go on VLG's system and pull up documents that looked the way VLG thought the financing documents should look. The trick to being a corporate lawyer was to then conform the documents you were working on to the model docs in VLG's system.

The VLG forms were a hugely valuable resource for me when I was trying to get my arms around the world of venture financing. They made it possible for me to get up to speed surprisingly quickly. And now there are just such a set of form documents available online for everyone, not just the folks working in corporate law. Over a year ago a group of lawyers from throughout the venture community got together to create what they collectively believed were the model financing documents. After innumerable hours of drafting and arguing, they came to agreement on the documents and have now made them available to the public. Rather than creating a single set of documents for all financings, the model documents read a bit like a Mad Lib. In virtually every instance, the drafter is given choices among typical financing clauses. As a result, the model documents encompass virtually any reasonable financing term a VC or entrepreneur might encounter.

I am grateful that these financing documents are no longer a part of my daily routine. But I'm equally grateful that I had to opportunity to learn the ins and outs of venture financings before becoming a VC. It has given me the ability to appreciate the true nature of the tradeoffs reflected in the financing terms themselves. For those VCs and entrepreneurs who have not had that luxury, I would urge you to read through the model documents. While they will likely produce as many questions as they do answers, they will give you a good sense of the issues at stake and a pretty comprehensive lay of the land.

High Tech Energy Crisis

According to the San Jose Mercury News, a recent survey by Deloitte & Touche demonstrates that increased scrutiny of option issuance has resulted in a notable decrease in option use by tech companies. 73% of the public companies surveyed said that they have reduced or will reduce the number of options they issue in the coming 12 months. And two thirds anticipate overhauling their compensation plans if the accounting rules require the expensing of options. To my mind, those are devastating numbers. Stock options are the fuel upon which tech companies are propelled. They give everyone in a company the incentive to strive to make the most of that company. If those incentives are dismantled, I fear that startups will no longer achieve the same velocity that has historically been the case in the United States. And that is not an economic advantage this country can afford to lose.

A New Newsletter From Lessig's Gang

I just received the first issue of Packets, a new bi-monthly newsletter put out by the folks at Stanford's Center for Internet and Society. The purpose of Packets is to:

provide the legal community with concise descriptions of recently decided cyberlaw- related cases, and to point to the original decisions. We will distribute short summaries of the cases in the electronic version and host longer, more detailed summaries, as well as a keyword searchable archive of past Packets on the CIS website.

For those of you who are interested in questions of intellectual property law and how the law is emerging, I highly recommend that you sign up for the newsletter. Mind you, it is very much geared towards lawyers, so for those of you who did not give up three years of your life to Professor Kingsfield, you may find it less informative or interesting.

Q2 Venture Economy Looking Up

Mike Patrick and Barry Kramer at the Bay Area law firm of Fenwick & West have been collecting venture finance data since the beginning of 2002. They report their detailed findings quarterly. Here's the link if you're interested in having their quarterly survey emailed to you directly. Based upon the 94 venture financings they tracked in the second quarter of 2003, Mike and Barry conclude:

The terms of venture financings improved somewhat in the second quarter of 2003.� The percentage of financings that were down rounds decreased (although we note that a majority of financings were still down), the percentage of Series A financings increased, and the other terms of financings were generally less tough than in Q1 '03.�

Consistent with this trend, we note that various industry publications have also reported an improvement in the venture financing environment, showing an average 7% increase in the number of financings from Q1 to Q2 '03 and an average 10% increase in the amounts invested over the same period.

There are a couple statistics that I find particularly encouraging as an early stage venture investor. First of all, a greater number of early stage companies are getting funded than in recent quarters. Last quarter a full fifth of the financings were Series A rounds and another 24% were Series B financings. That's the largest percentage of Series A deals in as long as Mike and Barry have been tracking the statistics. Equally encouraging for VCs and entrepreneurs alike is the fact that the number of up rounds (financings that got done at a higher price than the last round) increased dramatically from the previous three quarters. In Q2 2003, 40% of those rounds that got done were at an increased price (the percentage ranged from 20% to 26% for the previous three quarters). Moreover, only 26% of the Series B financings that got done last quarter were down rounds.

That's great news and a pretty solid indicator that the venture economy is on the mend. Let's hope for a continuation of those trends in the second half of 2003.

The Danger Of State Sponsored Monopolies

Professor Lessig led a discussion on one of his favorite themes -- "free culture" -- at iLaw yesterday. He described at length the evolution of the copyright system in the United States and its impact on our culture. As a basic underpinning of his argument is his philosophical belief that our culture can only flourish with the free exchange of thought -- because our culture is by its nature self-referential and evolutionary, culture can not be free and flourish if laws can be used to restrict the degree to which future media can refer to past media. (No doubt, at this point, I owe an apology to Professor Lessig and the other iLaw professors for my vast simplifications of their arguments -- in this forum I am trying to be as succinct as possible, which no doubt massively bulldozes the subtleties of their arguments.)

Given his strong belief that free culture needs the ability to be self-referential and adaptive, Professor Lessig views time limitation to be a key feature -- if not the key feature -- of the copyright clause of the Constitution ("To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries;"). While there is clear value in allowing copyright monopolies to promote the creation of media, the founding fathers understood the need for that monopoly to be limited in scope and time. Despite that understanding by the founding fathers, Professor Lessig points out that copyright protection has expanded vastly in recent years. Not only has the length of the copyright monopoly ballooned, copyright protection is now afforded to all copyrightable material regardless of registration. A copyright holder need do nothing to secure his rights. The result is that the amount of material that is subject to copyright protection has burgeoned.

Can The Internet Stay Neutral?

The conversation at iLaw yesterday repeatedly came back to the danger of choke points on the Internet. The morning discussion led by Professor Yochai Benkler focused upon the broadband last mile. As Professor Benkler pointed out, given the high infrastructure costs involved in hardwired delivery of broadband to the home/business, the most price efficient way to solve the last mile problem would be to create a "perfectly regulated" monopoly. But since our government has proven a relative failure at creating "perfectly regulated" monopolies, we are left with the alternative method -- price competition. The government has gone to great lengths to promote an alternative to the incumbent RBOC monopoly (with, of course, the RBOCs kick and screaming) and, as a result, we now have a duopoly. The last mile broadband problem is now solved by Cable and DSL, to which Professor Benkler asks "do two pipelines a competitive market make?" The question implies the answer -- no.