Emerging Enterprise Center Blog : Boston Startup Lawyer & Attorney : Foley Hoag Law Firm : Startup Financing, Venture Capital

Recently I ran into this little conundrum: an investor client agreed in a term sheet that he would get (in a liquidation event) the greater of a 4x capped participation or what he would get upon conversion into common stock. Well, we served up a draft with the NVCA standard term that embeds in the certificate of incorporation a provision that says in a liquidation event, the company will make distributions to give effect to this arrangement without the bother of having to convert.

Counsel for the issuer objects along the following lines "am inclined to remove it as it's not a standard provision that I have seen in certificates. I think it also tends to unduly burden the holders of common in an acquisition scenario." This works its way up to me as a "deal point." So my question to opposing counsel was something along the following lines, "Do you really think that the business people think that the investor has signed on to buy the right to guess whether conversion or non-conversion will provide the greater return or to actually be assured of getting the greater return?"

That issue went away. All hail Morty.

We look at the gross number of deals that were done in New England by category in the period. So we look at Series A deals and then later stage deals. One thing to think about is the simple number of deals done in the period compared to the prior year period and the preceding period. One measure of robustness would be whether or not the number of deals is increasing.

But, simple numbers are not enough. For example, what if there are a lot of deals, but they are all down rounds. It turns out that we can determine this. If I am not mistaken, we are the only source that researches this fact and publishes objective data on it. What if there are a lot of Series B and later stage deals but relatively few Series A deals. At the risk of stating the obvious, increasing numbers of deals and rising valuations for later stage deals indicate strength in the market.

By the way, we also look at it by industry sector and by size of investment.

Some of these larger trends suggest what other data might be. By way of example, in a robust market (increasing numbers of deals and increasing valuations) you would expect certain terms, such as the number of deals with participating preferred stock, would decline. (A robust market, I think, implies greater bargaining power for entrepreneurs, hence more favorable deal terms.) For this reason, we also track and report on deal terms, such as how many deals have participation, how many have dividends etc.

One thing is that you need a very broad sample to be comfortable that you understand the market. We don’t look at every deal, or perhaps I should say we don’t report on every deal we look at. However, we have been doing this for 18 months and are now starting to feel that we have enough data and historical information to come to meaningful conclusions about where we are at the end of any given quarter.

Another thing is gut instinct and anecdotal evidence. To feel comfortable that you have your finger on the pulse, all these inputs should be pointing in the same direction. Right now, my sense is that the market is confused. Anecdotal evidence suggests that there are still a lot of down rounds and low valuations but the same instinct says that there are a lot of new Series A deals – which suggests increased activity. I am looking forward to the end of June to take a good look at the numbers. Separately, if you want to be on the email list for EEC Perspectives, send me an email and we will add you to our distribution.

Back to forms for a moment: Provisions in forms, especially widely used and accepted forms are often there because they address in an appropriate way some basic commercial issue. In effect, there is usually a good reason that can be articulated for a particular provision in a form. If you want to deviate from the well worn path, do so, but know why you are doing it, understand the underlying commercial issue and be able to articulate your concern in a way that the other side will find compelling. Blind adherence to forms is not generally a good idea, but neither is wanton disregard for accepted norms.

So what do you do when someone (the other side’s attorney or your attorney for that matter) asserts that some provision is not "normal"? This is truly a sticky wicket. You probably don’t know what normal is and now you have to supposed experts (each with an opposing agenda) making contrary assertions. This situation arises with some degree of frequency. One way to consider the problem is to try to understand the underlying commercial issue. Often merely articulating the reason for the particular provision in layman’s language will make the relative merits of the positions clear to you (and to the business person with whom you are negotiating).

By the way, you sometimes you will have to suck it up and give on something you have a good reason for just to get the deal done. If that happens, well so be it. I am back to where I began, negotiation can be about a lot of things – living to fight again another day is often one of them.