Reports on Venture Capital Investments for 2011 Show Mixed Results

While there has been a lot of concern recently about the level of investment (and expected investment) in early-stage companies, some recent data suggest that the climate isn’t as bad as we thought, although there continues to be a lot of room for improvement.

According to a MoneyTree Report (which is prepared by PricewaterhouseCoopers and the National Venture Capital Association, based on data from Thomson Reuters), approximately $28.4 billion of venture capital investments were made nationally in 3,673 deals last year. This represented a 22% increase in terms of dollars, and a 4% increase in the number of deals, compared with 2010. Investments were up in all stages of company development, except for seed stage investments, which were down 48% compared with 2010. Locally, venture capital investments in Minnesota-based companies were up to almost $265 million in 2011, which is about a 78% increase over the nearly $149 million invested in 2010.

I won’t bore you with all the details in the report, which you can read for yourself. But I did find a couple of things especially interesting.

First, investments were up in almost all industry categories, particularly for software, Internet-based, biotechnology, medical device, and clean technology companies. I was not surprised by the software and Internet-based company results, as—at least locally (see more below)—this area seems very active. I suspect it has something to do with the lower capital needs of those companies, and the quicker path to exit based on fewer regulatory hurdles. I was surprised, however, to see that investments were also up in several other industries, especially the medical device and biotechnology industries. Personally, I’m aware of several companies in those areas that have had difficulty raising capital. Apparently, while raising capital remains a challenge for those companies, well-valued deals are still getting done.

Second, I wasn’t surprised that investments in seed stage deals were down, although the 48% decrease seemed high. Based on my own experience, seed stage companies are still finding it difficult to attract investment right now, although the right types of deals (with the right valuations) seem to be getting done. I think the difficulty is in part based on the fact that venture capital investors don’t seem to invest in seed stage deals anymore, so there are fewer investors (angels) willing to look at these companies. Instead, venture capital investors tend to invest almost exclusively in more experienced companies, those whose path to exit is shorter. Indeed, the MoneyTree Report shows that later stage investments were up 37% last year. One thing that is helping this trend locally, at least, is the Minnesota Angel Tax Credit. For 2011, all $15.9 million of tax credits available for allocation was subscribed. For 2012, Minnesota will have $12 million of credits available. I wouldn’t be surprised if that too was fully subscribed well before the end of this year.

While local deals were up in 2011, one real bright spot was investments in tech deals. According to this TECHdotMN article, more than twice as much money was invested in Minnesota tech deals in 2011 as was the case for 2010. The report defines tech to include IT, web, mobile, SaaS, and hardware companies. 2012 is also off to a good start for local tech deals, based on the recent announcement of a $52.5 million investment in Code 42 Software, Inc. 

We hope the economy will continue its recovery from the meltdown in 2008/2009, and more early-stage companies will get funded in 2012.

The 2012 Election: The Soundtrack

With Minnesota caucuses only a couple of weeks away (February 7), it’s time to prepare (brace yourself) for the onslaught of political campaign commercials. Although I admit to being a bit of a political junkie, I really hate the commercials. The unabashed laudatory sound bites and unchallenged claims add nothing to the political discussion, and this year the added vitriol of the super PAC ads make my stomach churn. But I have found one thing of interest:  The music choices. Not just for the video material, but also for the personal appearances of candidates. 

In prior years, poor John McCain was challenged by John Mellencamp for using his songs “Our Country” and “Pink Houses” and by The Foo Fighters for using “My Hero.” Heart protested the use of its song “Barracuda” after speeches by McCain’s running mate Sarah Palin.

Mellencamp openly objected for political reasons (both songs were intended to convey a strong pro-labor message), and informally requested that McCain refrain from the use of these songs. McCain agreed, thereby avoiding an ugly public battle. Heart and The Foo Fighters also objected for political reasons, and the matters were resolved without conflict.

Others—such as the rock band Rush, which objected to Rand Paul’s use of some of their songs in his senate race in Kentucky—objected on the basis that the use of their songs was a violation of  their intellectual property rights.

Copyright law gives the author the exclusive right, among other things, to reproduce the musical composition and to publicly perform the work. But music is complicated. While individual artists may own copyrights in the music and lyrics, record companies generally own the copyright in the recordings. Such recordings are typically licensed through performance rights organizations such as ASCAP, BMI, and SESAC.

My guess is that most of the campaigns (including the McCain and Rand Paul organizations) had the appropriate licenses, and the musicians had no legal basis to object to the use of their music at public events and rallies. Use in an advertisement may be different, however, as that may require a synchronization license that can require a license from the song writer or possibly a music publishing company. 

So what do I take away from the choice of music in political ads and at political events? It’s this: Music used in ads and at personal appearances is probably with the consent of the musician (or at least without the musician’s objection), for both legal reasons (in connection with the commercials) and political reasons (in connection with political events). But given the complexity of music licensing, I wouldn’t bet that I’m right in any given case.

Timely Tip for Investor Communication

I sat down at my computer late last week to begin work on my latest blog post. Since I am easily distracted, I was quick to open the incoming e-mail from a client (I’ll admit that I do leave my notify box on in Outlook, notwithstanding the sage advice of experts in time management). The e-mail contained a Q4 update on progress at his start-up venture. It was being sent out to angel investors in his seed capital financing (which includes me). What struck me about this communication—at least enough to change the topic of my post—is that this particular client does such an outstanding job of regularly communicating with his investors. This is something so few early stage entrepreneurs realize is as important as it is.

It seems like a simple concept. These people have invested their hard-earned money in your enterprise; the least you can do is keep them updated on progress, right? Incredibly, many entrepreneurs (even those with dozens of investors) fail to communicate with any regularity. Regular communication helps to ensure that nobody is surprised and that investors are ready to help out when needed (even when it means re-opening their checkbooks).

Here are my quick tips on investor relations for entrepreneurial ventures:

·       Communicate with the right level of frequency, probably at least quarterly but even more frequently when things are moving fast

·       Keep it short and hit the key points (no need to analyze the financials in MD&A fashion)

·       Don’t sugarcoat the news (although it might be good to have identified a proposed solution or plan to address any hiccups you are describing)

·       Remind investors you value more than just their money—contacts and even questions are welcome

As usual, the particular update I received last week tracked well with these tips. I really shouldn’t seem so surprised. This client has been consistent in his communication. Heck, he’s even taken the trouble to remind his first-round investors twice that the annual filing they are required to make for Minnesota Angel Tax Credit purposes must be made by February 1. His reminders even included links to the relevant forms and information.

In case you weren’t as fortunate to get a reminder, you’ve still got about a week to get your form filed (or to remind your investors to get theirs filed) without having to pay a filing fee five times greater… I guess you can thank my client (or me) for this helpful reminder.

Thinking About Selling in 2012? Be Prepared to Show Buyer Why your Business is Worth What You’re Asking

For many of our entrepreneurial clients, the sale of the business he or she founded is the most obvious exit strategy when the entrepreneur no longer wants or is able to continue actively running the business and the entrepreneur’s children have not inherited his or her “entrepreneurial spirit.”

While a few of those entrepreneurs have been through a sale transaction before with other businesses they owned or when employed in other capacities before becoming an entrepreneur, for most of them a sale of the business he or she founded is a once-in-a-lifetime event. Having never participated in an M&A transaction before, it is hard to know what to expect or what is “normal.” 

One way we help entrepreneurs evaluate what is “normal” in their negotiations is by reviewing the results of various published studies, including the Mergers & Acquisitions Committee of the American Bar Association Business Law Section’s Private Target Mergers & Acquisitions Deal Points Study. The most recent iteration of this study was released in December 2011 and analyzes the frequency of certain material legal terms in 100 acquisitions of private companies completed in 2010. Of the transactions reviewed by this committee in 2011, almost half involved entrepreneurial sellers, so we know these results are relevant to what our entrepreneurial clients can expect in sales of their businesses.

I thought it would be interesting to compare the results of the 2011 study with those of the 2007 study, which analyzed acquisitions of private companies completed in 2006, well before most of us knew that we would soon be facing an economic crisis. 

When comparing the results, I expected that certain deal terms reflecting heightened buyer apprehension would be more common in the 2011 study than the 2007 study. Specifically, I expected that buyers would be demanding more post-closing remedies against sellers in the event of breaches of purchase agreements by the sellers. Certainly, it has felt to me that buyers have been more conservative than they used to be and less willing to take the risks that are inherent in any acquisition. What I found was that some of the most highly-negotiated indemnification provisions were almost the same in the two studies, but that there was a substantial increase in the use of certain provisions that arguably bear a more direct relationship to the bottom line.

Buyers in the 2011 study certainly seemed to be more concerned about overpaying for the target company than they were in the 2007 study. Post-closing working capital adjustments (usually requiring a target company to have some minimum amount of working capital delivered to the buyer at closing) were included in 68% of the transactions in the 2007 study and 82% of the transactions in the 2011 study. Additionally, the use of earnouts (additional purchase price to be paid to the seller upon the business achieving certain performance goals after the closing) to bridge a valuation gap between what buyers were willing to pay and sellers were willing to accept for their businesses increased from 19% of transactions in the 2007 study to 38% of transactions in the 2011 study.

By contrast, the primary contractual provisions that provide remedies to the buyer after closing were almost unchanged between the 2007 study and the 2011 study. There was no significant change in the period of time after closing during which a buyer was entitled to assert indemnification claims against the seller for breaches of the seller’s representations and warranties. In both the 2007 and 2011 studies, the most common survival period was 18 months, followed by 12 months and then 24 months (each appearing with similar frequency in both studies).   

Similarly, there was no significant change in (a) the amount of the purchase price held in escrow or held back by the buyer for some period after closing, (b) the percentage of transactions for which the escrow or holdback was the buyer’s exclusive remedy after closing, or (c) the cap amount for the seller’s general indemnification obligations as a percentage of transaction value. In both studies, more than half of the transactions had an escrow or holdback amount in the range of 7-15% of the transaction value and just over half of the transactions had the escrow or holdback as the buyer’s exclusive remedy. In the 2011 study there were actually a higher percentage of transactions in the lowest category of cap amounts, but overall the cap values were similarly distributed in both studies.

These few data points are, of course, just a small sample of the results of these studies, but they serve as a good reminder of something attorneys are prone to forget: the dollars and cents of a transaction matter most. Legal points and risk management are important, certainly, but favorable indemnification terms alone don’t make a financially unsound transaction suddenly attractive. My advice to entrepreneurs looking to sell their businesses is this: be prepared to show your buyer why your business is worth the price you are asking—whether it’s based on current financials or future potential. If you’ve done that, negotiating the legal and risk allocation points is likely to lead to similar results in any economic environment.

A Post by Alyssa Hirschfeld, Guest Blogger

The Order of Things

What: Malcolm Gladwell, “The Order of Things: What College Rankings Really Tell Us,” The New Yorker (February 14, 2011).

Why You Should Care: Ratings impress all of us, but sometimes it makes sense to ask whether they actually measure, in any meaningful way, what’s important.

The news came our way last week that entreVIEW—this blog, at which my intermittent scribblings appear—has been named to the 2011 “Top 25 Minnesota Blawgs” list by the Minnesota State Bar Association. While doubtful as to my own contribution to this achievement, I was, of course, among the first to applaud the wisdom of the anonymous list-maker who recognized the talent of my colleagues and their far-flung, arcane, and—yes—eclectic interests, not to mention their downright likeability.

I’m a big believer in synchronicity, so it didn’t surprise me that this pronouncement was made the very day I read Malcolm Gladwell's essay regarding the business of compiling rankings, in particular as it applies to educational institutions.

How I found my way to this essay was itself synchronistic. I’ve written before (approvingly) of the writings of New York Times columnist David Brooks. Brooks recently wrote about the winners of the Sidney Awards, which—named for philosopher Sidney Hook—honor the best magazine essays each year. Lo and behold, Gladwell’s essay was among this year’s winners. I find it hard to pass up anything Gladwell writes, and the thought of reading a highly ranked piece about the questionable validity of rankings was too good to resist.

Gladwell doesn’t bash all rankings—just those that try to be all things to all people. While I’m sure he would completely endorse the methodology and results of the Bar Association’s “Top 25 Blawgs” list (well, maybe), he sure does have problems with, for example, Car and Driver’s comparisons. His point? Judging a sports car by exactly the same criteria as a minivan does not result in helpful information. “A ranking can be heterogeneous, in other words, as long as it doesn’t try to be too comprehensive. And it can be comprehensive, as long as it doesn’t try to measure things that are heterogeneous.”

If this is true of motor vehicles, it’s especially true of institutions of higher learning. Gladwell shows how fiddling with the criteria can lead to very different rankings. (For example, emphasizing cost in law school rankings results in ranking the University of Alabama in the top 10, above the fancy schools the editors of this blog attended.) And the criteria themselves—the proxies for quality used in the rankings—in reality often have a tenuous relationship to educational quality. The resulting rankings have a power well beyond what might be expected. The illusion becomes reality: “The U. S. News ratings are a self-fulfilling prophesy.”

Entrepreneurs of all stripes learn the basic lesson early: in the marketplace, perception is reality. But, as it is with taking test drives, so should it be with relying on rankings. It’s a good idea from time to time to check under the hood.

Local Entrepreneurs Jump into Shark Tank!

Minneapolis entrepreneurs, Sue Kruskopf and Nancy Bush, co-founders of My Wonderful Life, LLC, have jumped into the Shark Tank! You can watch it on January 20 at 7:00PM Central Time on ABC. That’s the season premiere of Shark Tank, which some have referred to as “…clearly the best business show on television.” [Marv Domon, Business and Finance Examiner, April 8, 2011.] 

If you have ever wondered what it is like to ask a seasoned investor to put real money into your small business, you must tune in to this show. How does the investor make the decision? What questions are asked? What does it take to raise funds from independent, sophisticated investors? Then, how should you use the funds to grow your business? Check it out. 

After January 20, check back to this blog site to trade feedback on whether Sue and Nancy were successful. I spoke with Sue and all she would tell me is that the experience so far has been truly exciting and she recommends it to all entrepreneurs. One more thing…Sue, Nancy, and MyWonderfulLife.com are clients of Gray Plant Mooty and we will be rooting for them on January 20.

Fun is a “Must-Have” Too! Another Definitive List from Your EntreVIEW Team

Last week, my colleague Kermit Nash graced entreVIEW readers with his definitive list of the Top 10 iPad apps for entrepreneurs, with the conspicuous condition that non-productivity apps were NOT ALLOWED. While I’m sure most of our readers have begun the New Year with the resolve to continue working hard in 2012, I couldn’t help but be reminded of the old adage, “all work and no play makes Jack a dull boy.”  Since the antonyms to “dull” include “intelligent,” “sharp,” and “witty” (and who doesn’t want to be described as sharp and witty?!), I have decided to respond to Kermit’s blog post with my own list of the top 10 FUN iPad/iPhone apps for the new year. While these apps may not directly foster productivity (okay, they may not even indirectly foster productivity), sometimes playing a game on your phone or tablet is a perfect way to de-stress and recharge.

First, though, one major caveat. I am by no means an expert in “gaming.” In fact, it seems to me that many of the games that men in particular find to be stress relievers involve some sort of semi-automatic weapon, which stresses me out more than I think any job could. Thus, in order to provide an intelligent list of games for both genders, I elicited the help of a friend who just so happens to be a mobile game producer. A huge thank you is in order to Jimi Van Guilder from Recharge Studios, who helped me sift through the junk to bring you this list (disclaimer: a couple of the apps listed were developed by his company). Second, in terms of any other criteria, I followed only these rules: 1) Angry Birds, or any other game app so widely known that an additional mention of it on our blog would be overkill, is not included; and 2) I tried to incorporate a variety in the type of games listed (you can only shoot so many things in one sitting…can’t you?). Without further ado, and in no particular order, here are the ten apps yours truly recommends in 2012, to bring you hours of enjoyment, if not productivity:

Tiny Tower: One user described downloading this app as “the best decision ever.” Highly addicting, Tiny Tower is arguably entrepreneur-related; the goal of the game is to manage the resources in your tower, add floors and businesses, and maximize efficiency by placing the tower’s residents in their dream jobs.  FREE.

Drop7: This “critically acclaimed” puzzle game is at once a tough mental exercise and a great time waster. It seems a bit like Tetris at first, but becomes more and more challenging. High score charts are great motivators to keep playing. FREE.

Battle Bears Royale: As alluded to above, and according to my friend Jimi, “sometimes you just need to shoot things.” Battle Bears Royale is the best available online multiplayer game, meaning you can drop into a game and play with up to 8 players around the world in this quirky take on a first person shooter. FREE.

Rolando: This award-winning puzzle game requires using all of your iPad or iPhone’s tilt, tap, and multi-touch controls to maneuver around “Rolandoland.” Its cute characters have been compared to other iconic game figures such as Mario and Luigi or Sonic the Hedgehog, and one critic called the app “the best game you can buy for the iPhone.” $0.99.

Brew Masters: This game gets extra points because it combines two fun things: beer and games. As far as I know your tablet or phone still can’t conjure up real beer (despite the Bud Light commercial), but this is probably the next best thing. Reminiscent of Farmville, players attempting to become “Brew Masters” grow flavors of barley to create special recipes through the beer brewing process. If your brand of beer sells, you can upgrade your units to create more unique flavors. Relax and drink up! FREE.

Plants vs. Zombies: A winner of more than 20 “Game of the Year” awards in its former PC title format, this game hit the iOS market big with its simple interface and great artwork. A cautionary piece of advice from my friend Jimi: “You will probably not put this game down until you beat it or until your significant other takes your iPhone away.” $2.99.

Words with Friends: For a more civilized break, connect this app with your Facebook account to take on your friends in a game of Scrabble-like competition. Words with Friends has been called “social gaming at its finest.” You can start as many games as you want, so you'll always have something to come back to when you need to be distracted. Just make sure you don't set your opponent up for an easy triple word score. FREE.

GL Golf: Let’s not kid ourselves—having a good golf game can sometimes help you land an important sale. Hence this golf app is arguably productive and fun at the same time. While there are many golf games out there, I’m deferring to my husband on this one (despite the fact that I am pretty sure his GL Golf game is better than his real-life, “I lost $20 this afternoon” golf game). If you need competitive motivation to keep playing, sync the app online to see the best scores across the country. $4.99.

Veggie Samurai: If cooking rather than golf is your hobby (and if you don’t enjoy killing things that could actually be alive in real life), you will thoroughly enjoy this game. Veggie Samurai is similar to another popular game, “Fruit Ninja,” in allowing you to use expert swordsman skills to slice and dice your favorite food pyramid friends. The dice feature will create a whole mess of veggie juice nicely contained inside your tablet or phone. $0.99.

Zen Bound: This game has received acclaim for its uniquely calm and relaxing qualities, as well as its beautiful presentation. Focus and problem-solving, rather than high scores, are the goal, and play has been described as “meditative” and “contemplative.” This is my kind of game! $0.99.

As with Kermit’s post, feel free to mention any great games I might have missed!

A Post by Karen Wenzel, Guest Blogger