Venture Capital: California dreaming or wake up screaming?
You think you’ve found a place in the sun for your business venture. But into each life, a little rain must fall, says Paul Corren
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I suppose I am not the only corporate lawyer to reach a point where my clients' faces are becoming younger and younger. I keep reminding myself that, from a business perspective, that's a good thing. The younger faces are, one hopes, the future clients of the firm, relate well to our younger lawyers and bring fresh drive and impetus to our practice. All of that is true, but of course I am covering up the fact that I am feeling older...
So why am I telling you this? Well, the other day I had a visit from a 20-something entrepreneurial client, looking very pleased with himself. He had been looking to find £3 million to develop his growing e-retailing business and was delighted to have been courted and offered the money from a very well-known and respected venture capital outfit in California.
You could see his delight at being presented with the key to his future plans and how the deal could liberate his business. With some pride, he recited the terms that he had struck and of course gave me the "well thought-out timetable", which meant that the deal had to be "legalised" yesterday, but preferably earlier.
And then, he looked up and saw my face. I tried to smile and show my enthusiasm, but - rather like a child looking for the blessing of a father but realising that it would never quite come - he could see through me.
Don't get me wrong. I was genuinely pleased for him, but at the same time a tad protective. I always encourage young owner/managers (particularly successful ones) to think really carefully about the level of equity - and rights - they give away. There is always a price for money, even if this does not translate into hard cash. We have seen a significant increase in funds made available from the private equity and venture capital communities, particularly those in California. These deals often appeal to our younger clients. They are very aware of the importance of the right management team and industry expertise and certainly these outfits can often provide the business with access to industry leaders, some of whom join the board and all of whom have a genuine interest in the business. The energy and drive of the Californian spirit resonates with the hungry entrepreneur.
However, when you read the small print, many of these deals are more "engulfment" than "liberating". In fact, liberty is a good place to start. You see, in addition to the 30 per cent of hard equity that you may have to give up, you are likely to see a change in class rights - the actual rights that attach to your shares. Suddenly the shares that go across to your funder may well become "preferred stock", paying a coupon to the funder and having preferential treatment compared to the ordinary shareholders. And there's more. Mr California may well want some really complicated anti-dilution rights to ensure that his shareholding will never dilute below a percentage in addition to having a long string of veto rights - oh, and did I mention the exit fees?
There is nothing wrong with wanting to grow your business - and quickly. It is just worth remembering that there are a number of ways to do it. We always start with the existing shareholder base, because often there is a real appetite for further investment. This can have the advantage of keeping the company private and investor relations have a track record and history which, if positive, can be extremely helpful. In addition to certain mezzanine and structure debt products, we have had some success recently with the PLUS market.
A smaller secondary market that enables companies to obtain a listing with considerably less regulatory red-tape than with larger markets of AIM and others. There is a good deal of flexibility built into the rules concerning PLUS and you do not need to have a full-blown admission document which significantly reduces the legal fees on listing.
Like all these decisions, the route to capital and ultimately exit is reflective of a number of factors - but the key point here is make sure that you take the time to explore your options - even if the trip to California looks the most appealing at first sight.
Paul Corren is managing partner at Corren Troen, where he heads the firm's corporate department and advises young and dynamic entrepreneurs with their capital-raising plans. www.correntroen.com