Global Startup Blog : Startup Lawyer & Attorney : Reed Smith Law Firm : Corporate Law, Venture Capital

On Friday, the U.S. House of Representatives passed legislation that would tax the first 75% of carried interest as ordinary income starting January 1, 2011, with the remaining portion to be taxed at the current long-term capital gain rate of 15%.  The bill, which passed by a very thin margin (215 to 204), now moves to the Senate, where most anticipate some changes when session reconvenes on June 7.  Speculation is all over the board as to what the Senate might do with the bill, though many seem to think that some form of gradual implementation over the course of at least a few years is likely, as well as possibly reducing the percentage of carried interest that is taxed at ordinary income.  It will be very interesting to see how all of this plays out in the coming weeks, and, more importantly, how it impacts the venture capital industry as a whole as the economics of managing a fund dramatically changes.

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There are several signs that point to continued health in Silicon Valley's emerging growth, venture capital market.  Most significantly, in my opinion, is the fact that exits remain strong.  111 venture-backed M&A deals in the first quarter of this year, according to the MoneyTree Report, which was the largest number of exits in a single quarter since MoneyTree began tracking deals more than 35 years ago.  The MoneyTree also reported that there were 43 venture-backed companies currently in registration with the SEC for an initial public offering.  43 companies in registration is a healthy pipeline by anyone's standards, particularly since nine companies actually made it out in the first quarter, raising an average of approximately $104 million.  The renewed exit activity has to give everyone a sense of optimism.

On the venture capital side, funds are definitely either having difficulty raising money or aren't in the market for new capital raises these days (something that I seriously doubt).  According to the MoneyTree, the $3.6 billion raised in the first quarter represented the lowest aggregate raise by VCs in 17 years.  This statistic doesn't bother me that much because trouble raising money from limited partners coming out the nuclear winter of 2009 is to be expected.  There is little doubt, though, that the increase in venture-backed company exits will loosen the purse strings of at least a few LPs in the second quarter and beyond.

As with any statistical survey, one must read the above with a grain of salt or two.  VentureSource has slightly different numbers, citing 77 venture-backed M&A deals, eight initial public offerings and a full billion more in raise by venture capital funds.   I'm not sure which set of numbers is actually correct.  One could certainly surf Edgar and figure out the IPO statistic easily enough, but that isn't the point.  The point is that the activity is much more robust than the previous quarter, and that is noteworthy in and of itself.

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A few quick headlines on a Thursday afternoon:

• Just a few days after VMWare completed its acquisition of Zimbra, the Silicon Valley technology darling announced its intention to acquire certain assets from EMC.  The deal focuses on software products and expertise from EMC's Ionix IT management business in an all-cash transaction valued at up to $200 million.   Ben Verghese, Chief Management Architect, Virtualization and Cloud Platforms Business Unit, gave a bit of insight into the transaction on his executive blog.  VMWare is certainly keeping my former colleague and current Sr. VP and General Counsel Dawn Smith busy these days.

• Deutsche Telekom didn't rule out spinning out T-Mobile USA and taking it public later this year, though the global telecom giant did rule out trying to gain market share buy acquiring one of its competitors in a "multi-billion-euro" deal anytime in the next two years, according to a BusinessWeek article today.  An IPO of that magnitude could certainly serve as a nice shot of adrenaline for the still-stalled US IPO market.

• SecondMarket closed another round of funding.  Li Ka Shing Foundation and Hutchison Wampoa Ltd. each invested $7.5 million, joining an investor base that includes FirstMark Capital, New Enterprise Associates and Silicon Valley Bank.  The raise was for expansion into the Asian markets.  SecondMarket certainly seems focused on scaling its operations and really making the secondary trading market for traditionally illiquid securities part of everyday life in Silicon Valley and beyond.

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I came across a very interesting blog post on Both Sides of the Table while browsing the blogosphere last night -- yes, Silicon Valley corporate lawyers have time to browse the web and read the occasional blog; don't listen to claims to the contrary.  The blog is written by a two-time entrepreneur who now sits on the other side of the funding table as a venture capitalist.  The post describes what the author believes are the 12 attributes that makes an entrepreneur, and each enumerated attribute leads to a separate post on that focuses on that individual attribute.  It is a well-written, interesting blog post with great information for entrepreneurs.

The one thing that I think the author should add to the list is the ability to do the most with the least.  From my perspective dealing with entrepreneurs on a daily basis and spending more than two years as the founder and CEO of an Internet startup, that is a crucial attribute for just about any entrepreneur.

Raising money is tough in any environment.  In the current economic climate, it is next to impossible for first-time entrepreneurs with little more than a business plan.  That means entrepreneurs are forced to actually develop the some part of the technology and often have some sort of customer validation before they will get funded.  That is a far cry from the golden days of the late 90s when entrepreneurs had to do little other than add DOT.COM to their corporate name and start a website to have the funding spigot busted wide open.  We can sit around and sulk about the good old days all we want, but the reality is that the game has changed, whether permanently or temporarily.  Today's entrepreneurs really need to know how to stretch the dollar.  They need to know how to build a company on less than a shoestring budget.  In other words, they need to find a way to take modest sums of friends and family money and accomplish more than entrepreneurs of the previous two decades did with their first round of outside investment.

Entrepreneurs who can do the most with the least stand a far better chance of succeeding, in my opinion, than those who require large initial cash infusions--unless, of course, the entrepreneur is either flush with cash or has close friends who are flush with cash.

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Green Plug, the first developer of digital technology enabling collaboration between electronic devices and their power sources, recently announced that it has closed its Series B financing.  The investor syndicate included Herald Investments UK, Killik & Co. and Peninsula Venture Partners. Reed Smith advised Green Plug in the round of financing.

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According to a recent survey of PE Hub's VentureXpert Database, Intel Capital invested in more U.S.-based companies than any other venture capital fund.  That may come as a surprise to many, particularly since Intel Capital the corporate investment of the technology giant, Intel, not a traditional venture capital firm.  Interestingly, number two on the list, JP Morgan, isn't a venture capital firm, either.  The traditional venture firms begin to appear at number three with NEA.  DFJ, Sequoia, KPCB, Bessemer, USVP, Goldman Sachs (the second investment bank on the list) and Venrock round out the list. 

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Reed Smith's Corporate Media and Technology group held an interactive breakfast panel discussion regarding the valuation of media and technology companies in today's challenging business environment. Attendees included executives from a range of high profile companies in the media, technology and investment industries. The panel featured leading individuals from the media, investment banking and financial services sectors who shared their insights into various aspects of factors affecting the valuation of media and tech companies in the current environment, while also discussing current trends and future outlooks for what looks set to be an uncertain marketplace going into 2010.

Key features of the discussion included:

• Positive signs - increased activity in many sectors in Q3 2009 regarding potential transactions
• Difficulty in accurately valuing companies in the current conditions
• Managing the contrasting opinions of owners and potential buyers regarding valuations
• The sectors most likely to see an upturn first in 2010

The panel members were:

Chris Whiteley - Ingenious Media, Robert Lees - Strata Partners, Chris West - Deloitte. The discussion was chaired by David Boutcher - Reed Smith.

The attached slides provide an outline of the key discussion topics.

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In a continued run of positive news for the emerging company, venture capital industry over the last few weeks, Norwest Venture Partners just announced that it closed a $1.2 billion fund  to invest globally in private companies across a number of industry sectors.  Norwest's new fund is particularly impressive considering that the entire venture capital community only raised $1.7 billion in new or follow-on funds in the third quarter of 2009, according to the National Venture Capital Association and Thomson Reuters.  The Q3 results marked the second consecutive quarterly decline in terms of the total number of venture funds raising capital and aggregate dollars raised by those funds.

We obviously don't want to get ahead of ourselves with optimism.  A few lucrative exits and a massive raise by a Silicon Valley stalwart doesn't necessarily mean that the industry is poised for a turnaround.  It is certainly the case that the two are not related, as Norwest has likely been working on this raise for months.  Yet, the timing couldn't be better, in my opinion, because it feels like momentum is beginning to swell.  The emerging company, venture capital industry is very circular in nature. Increased exit opportunities enable funds to raise additional capital from existing and new limited partners.  As those cash coffers grow, more and more private companies receive funding, which will help the newly funded companies grow into attractive exit candidates.  Wash, rinse, repeat.

Are we in the midst of a turnaround?  We'll all know soon enough.

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For the first time in nearly a year, the venture capital industry showed a positive return, according to Cambridge Associates, LLC.  The Cambridge US Venture Capital Index returned 0.2% for the three-month period ended June 30, 2009, ending three consecutive quarters of negative returns.  Of course, in an economy still clouded in doubt and pessimism, the positive news was paired with a cautionary outlook.  Managing Director Peter Mooradian raised questions about whether the asset class can generate sufficient exits to provide healthy long-term returns. 

It will be interesting to see the figures for the current quarter after Google's recent acquisition of AdMob for $750 million and EA's recent acquisition of PlayFish for $300 million (with an additional $100 million in earnouts).   

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We are adding a new feature to the blog.  Each Friday, we will link to the top five headlines for global entrepreneurs.  Of course, the bulk of those will often involve Silicon Valley, since that tech-concentrated center remains the global front line of technology and venture capital.  Enough intro banter.  Let's jump right into it.

• Talk about a long time in the making.  On Wednesday, Ancestry.com, a website that allows people to trace their roots by searching online documents, priced its IPO of 7.4 million shares at $13.50.  By my math, that will bring in approximately $100 million in aggregate gross proceeds, assuming that the round is fully subscribed.  It took Ancestry.com a scant 26 years from the time it was founded until it priced its IPO, making it the oldest venture-backed IPO of 2009.  Talk about patience and perseverance!  Read more.

• Who said that it was next to impossible for venture capitalists to raise additional funds in this economy?  Greylock Partners obviously missed that memo, as the Silicon Valley stalwart recently announced the closing of Greylock XIII, a $575 million fund.  They also announced the addition of Reid Hoffman, co-founder and current Executive Chairman of LinkedIn, as a new investing partner.  Read more.

• I wonder what ridiculously expensive champagne former British investment bankers Eldar and Roy Tuvey will be drinking in celebration this weekend after selling their company, ScanSafe, to Cisco for up to $183 million earlier this week?  The founders are set to spit up to a cool $60 million between them.  With an exit like that, they can afford to take a bath--literally--in 1990 Louis Roederer Cristal Brut, which is priced around $2,500 per bottle.  The exit was also a good win for London-based venture capital fund Balderton Capital.  Yahoo Finance estimates that Balderton enjoyed a four times return on its four rounds of investment in ScanSafe.  Not bad, indeed.  Read more.

• The government of the People's Republic of China doesn't seem squeamish about the future of its venture capital market.  China's key economic planning body recently launched 20 venture capital funds to develop China's growing technology sector.  Read more.  That news certainly seems to support estimates that China's private equity industry will grow by ten-fold over the next five years.  Read more.  Yes, I know that is two headlines combined into one, but who is truly counting anyway?

• When Google head honcho Eric Schmidt talks, people tend to listen.  When he talks about his view of the employment trends in Silicon Valley's technology sector, even more people turn an inquisitive ear or two.  Read more.

Enjoy your weekend!

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The U.S. Department of Energy recently announced two new solicitations for loan guarantees pursuant to its loan guarantee program under the Energy Policy Act of 2005.  Here are some quick facts:

• The solicitations relate to projects that either (i) employ "New or Significantly Improved Technology" related to a renewable energy system or a leading edge biofuels project or (ii) improve transmission infrastructure using commercial technology.
• Combined, the solicitations make available more than $12 billion in federally funded guarantees.
• Applications are accepted on a rolling basis, with those applicants who participate in earlier rounds receiving a "first mover's advantage." Two applications are required to be submitted, with a specific due date for the second application based on when the first application is submitted.
• Preliminary applications under the transmission infrastructure solicitation are due by Sept. 16, 2009.
• Eligible projects are required to commence construction no later than Sept. 30, 2011.

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Legislation is currently pending before the House Ways and Means Committee that would provide a partial fix to a technical tax flaw that is limiting investment in the renewable energy sector, notwithstanding provisions enacted as part of the American Recovery and Reinvestment Act of 2009 to encourage such investment.  Our Public Policy, Renweable Energy and Tax Groups issued a joint client alert discussing the proposed legislation, which should be of great interest to qualified wind facilities.

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I'm the first to admit that market prognostication is not my cup of tea.  Nor is that the purpose of this blog.  Nevertheless, it is undeniable that general economic conditions greatly impact business in Silicon Valley.  From venture capitalists seeking to raise new or follow-on funds to startups looking to get tap the Sand Hill Road coffers, 2009 has hardly been "business as usual," unless one benchmarks against the days of the dot.com crash.  Sure, great startups continue to get funded at a decent clip--probably more so in the last few months than in the first quarter of the year--but the next tier of emerging companies are finding it exceedingly difficult to raise capital.   That isn't surprising considering the lack of money pouring into new and/or follow-on funds from limited partners in the first half of 2009.

The National Venture Capital Association, in connection with Thomson Reuters, recently released its Q2 2009 venture capital fund raising report.  One had to expect that the numbers would be modest.  Nevertheless, the actual numbers were shocking -- to me at least.

In the second quarter 2009, a total of 21 funds raised capital.  That is the lowest amount since 1996.  The total raise was just over $1.7 billion, which is more than a 60% decrease from the first quarter and the lowest total dollar raise since the first quarter 2003.  Those are staggering numbers.

Taking a look at the health of the current economy, our friends at Tatum released their monthly market assessment, with the focus on predicting market conditions over the next 30-60 days. While previous Tatum reports brimmed with cautious optimism, the July installment of its market survey is much more cautious, with a declining outlook over the next 60 days. 

Again, I'm not a market analyst, Nostradamus, or even Jimmy the Greek.  I have no idea what the market has in store for us.  Is the venture capital market poised for a major slow down in activity?  Will investment appetite increase as the year comes to a close with VCs still sitting on piles of money?  Will next month's short-term Tatum outlook be more positive?  I wish I knew.

For those looking for positive outlooks, Michael Hartnett, the CEO and Chariman of Bank of America Securities-Merrill Lynch Research Investment Committee went wild with his long-term prediction.  With many of the pundits singing doom and gloom, Hartnett boldly predicted an end to the global recession. 

I certainly hope he is correct.

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I know.  This blog is rapidly becoming the home for all things Stimulus-related.  Hey, when it rains, it pours, and the current topic of interest for most emerging companies is how to obtain funding -- by any means necessary -- which should absolutely include a review of non-dilutive options such as Stimulus Package funds, other grants and/or tax/production credits (the latter is only realistic if you are an alternative energy company).  For those looking for more traditional emerging company topics, we've got one for you coming down the pipeline shortly.

In the meantime,let's jump into our fourth consecutive ARRA blog entry.  This one should be of particular interest to any company considering going down the government funding path because all such funding comes "with strings attached."

Those "strings" are the obligations to comply with a host of laws and regulations. Broadly, any recipient of stimulus monies, whether as a grant recipient, contractor, or sub-recipient or subcontractor, must be prepared to shoulder the burdens of tracking the use of such funds, ensuring that the funds are used only for proper purposes, and following the ancillary rules, such as environmental laws or equal employment opportunity requirements, that do not necessarily arise in the commercial transactions to which contractors and grant recipients may be accustomed.

The following summary discusses the steps that government agencies are taking to prevent fraud, abuse, and regulatory noncompliance with respect to stimulus monies; it sets forth the repercussions of failure to maintain compliance, and provides an overview of the steps companies can take to protect the value of their investments in competing for and obtaining stimulus monies.

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The American Recovery and Reinvestment Act of 2009 included a number of significant changes affecting businesses engaged in the renewable energy market. One of those changes allows a taxpayer to elect to receive a cash grant in lieu of the investment tax credit under Section 48 of the Internal Revenue Code, or the production tax credit under Section 45 of the Code on specified renewable energy property placed in service during 2009 or 2010, or by a later credit termination date if the property is not placed in service during 2009 or 2010 but construction has begun during 2009 or 2010.

Our Renewable Energy Group summarized the cash grants in lieu of investment or production tax credits in a recent Reed Smith client alert. 

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With the recent data on the economy showing little improvement since the enactment of the $787 billion American Recovery and Reinvestment Act of 2009, there has been talk in the Obama administration and in Congress about whether another stimulus program is needed. Our Policy & Infrastructure Practice has been monitoring these discussions and the key questions that would need to be addressed before any new stimulus-based legislation is introduced--or, more appropriately, enacted into law.  Chris Rissetto, who is a partner in our Washington DC office, offered some interesting insights into the matter.

Why am I blogging on this matter?  Simply put, I have multiple clients who are closely following these developments, since the increased odds for non-dilutive financing can have a major impact on the development of their respective technologies and corporate growth.  So, this is a topic that should be somewhere on the radar screen, at the very minimum, of companies of all sizes and across all industry verticals. 

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Many technology companies incorrectly believe that the American Recovery and Reinvestment Act of 2009 is focused on the commercialization of clean technology at the exclusion of all other industry verticals.  Nothing could be further from the truth.  To date, there have been multiple Funding Opportunity Announcements that have applied to technology companies at various stages of their corporate lifecycle across a wide range of industry verticals.  And I guarantee that when the 2010 Appropriations Bill becomes final, there will be more than a few earmarks for companies who fall outside that category.

One such example of a non-clean tech vertical eligible for stimulus money is broadband. 

Last week, the Commerce and Agriculture Departments released a joint Notice of Funding Availability (NOFA) announcing the application criteria and general policies that will apply to awarding the first $4 billion of the total $7.2 billion in federal broadband stimulus funds.  Rolling applications to access that $4 billion slug of stimulus money begin today!

The remaining funds, not dedicated to this award cycle or program administrative matters, will be made available under subsequent NOFAs. As both agencies learn from the application process, the terms of subsequent NOFAs are subject to change.

Read more about this excellent broadband funding opportunity in our Reed Smith client alert.  Our Advertising Technology & Media practice also blogged on this topic.  Anyone interested in reading about issues intersecting digital advertising, new media, ecommerce and the law should check out their blog.

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Clean technology continues to be the darling of the investment world, at least in terms of publicity and proclaimed investment focus. The CleanTech Group, along with Deloitte & Touche, recently released a survey of clean technology investments by venture capitalists in North America, Europe, China and India for the first quarter of 2009, and the results may surprise many. According to the survey, first quarter investment in clean technology companies by venture capitalists declined in back-to-back quarters following the third quarter of 2008, to $1 billion--the lowest level of investment in this sector in two years. That isn't surprising based on the status of the U.S. economy during that period. It's also no surprise that investments in solar companies once again led the way. The gap between solar and biofuels, the sector attracting the second highest investment dollars, remains huge, with the former attracting nearly 400 percent more investment dollars than the latter. It will be interesting to see how the American Recovery and Reinvestment Act, and other economic stimulus allocations from the G20 nations, will affect the overall dollar amounts flowing from venture capitalists into clean technology companies over the next four quarters, as well as the breakdown of dollars across the various sectors.

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