The Micro-MBA for Attorneys Strategy, Startups and Virtual Corporations Course #BU Instructor Hugh Taylor

Transcription

1 The Micro-MBA for Attorneys Strategy, Startups and Virtual Corporations Course #BU Instructor Hugh Taylor

2 Course Series Overview The Micro-MBA for Attorneys Based on the course I co-each with Barry Kaye, Esq. at Berkeley Law: Interactions of Legal and Business Imperatives. Provides an overview of key business management concepts for attorneys, with the goal of helping them understand their corporate clients needs better and have greater insight into the business issues that drive their clients decision making process: Accounting and Finance Strategy, Startups, and Virtual Corporations Communications and Marketing for Attorneys Information Technology, Compliance, and Security Throughout: Issues of economics, leadership, organizational behavior and human resources management 2

3 A Little About Me Technology marketing and PR executive Faculty Member, Berkeley Law and School of Information Industries worked in: High tech Entertainment Printing and graphics BA, MBA from Harvard 3

4 Course Outline Introduction Section 1 Startups Section 2 Term Sheets Section 3 Virtual Corporations Section 4 Competitive Strategy

5 Course Learning Objectives Understanding the financial, interpersonal, and operational issues facing startups, and their legal implications Basic familiarity with term sheets Gaining a basic understanding of corporate strategy The Five Forces model of strategy and valuation Connections between strategy, valuation, and operational tactics The role of the corporate counsel in strategy decisions Analyzing the virtual corporation, a new popular form of corporate structure Strategic implications Value-chain implications Legal implications Limits of legal solutions in solving virtual corporation challenges Interweaving the topic of human resource management and organizational behavior into the discussion. 5

6 Section 1 STARTUPS

7 The WebSaver Case Summary New dot.com company, ca 1997 Successful, but no profits, going public Figuring out issues related to cheap stock, hidden founders, non-solicitation, and intellectual property 7

8 People in WebSaver Samantha Fine, Founder and CEO of WebSaver Ann Chen, MBA classmate of Fine and co-founder of WebSaver N gai Aw - MBA classmate of Fine and co-founder of WebSaver Salinas former co-worker of Fine s from Diamondware Dennedy Fine s family attorney Guy Wilson Securities attorney

9 Legal Issues, facing: Next Step, Inc.? Samantha Fine, as an individual? Chen, Aw, Salinas? James Dennedy, Esq? Any other entities, or people?

10 Why this case is interesting Set aside the dot.com mania all startups are in the same boat: Rush to create a high valuation Then, exit! A million things can go wrong: The product has to nail a big problem at a unique moment in time It has to go to market in a way that attracts the right kind of interest An organization that ever existed before has to perform as well as any business ever has

11 Let s say that you are Guy Wilson What is his job? If you were him, what would you say is wrong with this picture? What would you do? What s a high priority? A low priority? Why? Who is your client? 11

12 If you were counsel to Diamondware Do you have a cause of action against Samantha Fine, Next Step, or both? Do you have a cause of action against Mr. Salinas? What would you do about it? 12

13 If you were counsel to Ann Chen Is she entitled to 10% of the pre-ipo stock in Next Step? How would you give her the best chance to get that share? How would you react to the 5% offer? Is there anything you can do about it? 13

14 What is 5% Worth? Capitalization Table Shareholder Shares Percent of ownership Value of equity stake Value of equity stake (Model A) (Model B) Value of equity stake (Model C) Fine 50 34% $ 68,965,517 $ 344,827,586 $ 689,655,172 Chen 10 7% $ 13,793,103 $ 68,965,517 $ 137,931,034 Aw 10 7% $ 13,793,103 $ 68,965,517 $ 137,931,034 Salinas 10 7% $ 13,793,103 $ 68,965,517 $ 137,931,034 Option Pool 20 14% $ 27,586,207 $ 137,931,034 $ 275,862,069 Investor A 45 31% $ 62,068,966 $ 310,344,828 $ 620,689,655 Investor B 0% $ - $ - $ - Invest C 0% $ - $ - $ % $ 200,000,000 $ 1,000,000,000 $ 2,000,000,000

15 If you were James Dennedy, Esq. Who is your client? What would you do if Samantha Fine came into your office with her idea? 15

16 The verbal agreement What was the verbal agreement about ownership? Will this hold up? Can it cause a problem? If you were Guy Wilson, Securities counsel, what would do about this situation? Management issue: What kind of company culture do you want to create? 16

17 Cheap Stock Problem What is the problem? What can be done about it? Will the solution have an impact on resolving the other issues with Next Step, or complicate them? 17

18 Protecting IP Has Next Step done anything to protect its IP? What can it do? What will work? What is cost-justified? What is not? 18

19 Takeaways This kind of messy situation is very common, and lawyers get pulled into them all the time it s critical to know who your client is (and isn t) Getting organized about ownership, roles, and investment are critical to assuring smooth growth of a business and avoiding legal risk. Reality often trumps legal agreements and precedents. 19

20 Section 2 TERM SHEETS

21 Term Sheets What is the purpose of a term sheet? Is it a contract? Who are the players in this situation? What are their respective agendas? Why does the investor want convertible preferred stock?

22 Sample Term Sheet FOR SERIES A ROUND OF FINANCING OF XCORP Amount of Investment: $3,000,000 Investors: ABC Ventures, XYZ Capital Type of Security: Series A Convertible Preferred Stock Premoney Valuation: $7,000,000 Capital Structure Following Series A Round: Existing holders of Common Stock 55% Option Pool 15% Holders of Series A Preferred Stock 30% Total 100% Use of Proceeds: The Company shall use the proceeds from this financing for working capital purposes Morse, Barnes-Brown & Pendleton, P.C. and Jeffrey P. Steele, Esq. Certain of the annotations and some of the language in this model term sheet (including the veto rights) are borrowed from National Venture Capital Association (the NVCA) model documents. 22

23 The Terms Valuation How to calculate? How to defend? Percentage ownership How much to give up What are their options? Conversion Dilution Control

24 Valuation Valuation Worksheet Equity Stake Value of stake Founder shares % $ 16,666,667 Investor Shares added 30 23% $ 5,000,000 Total shares % Amount of investment $ 5,000,000 Post Money Valuation $ 21,666,667 Pre-Money Valuation $ 16,666,667 Pre-Money Valuation = Post Money Valuation - New Investment Post Money Valuation = New Investment * (Total Post Investment Shares Outstanding/Shares Issued for New Investment)

25 Conversion Conversion: Each share of Series A Preferred Stock shall be convertible, at any time, at the option of the holder, into shares of Common Stock, at an initial conversion ratio of one share of Common Stock for each share of Series A Preferred Stock. Mandatory conversion of the Series A Preferred Stock upon the effectiveness of a registration statement covering a firmly and fully underwritten public offering of Common Stock of the Company by a reputable underwriter acceptable to the Investors at a price which equals or exceeds five times the purchase price per share of the Series A Preferred Stock and where the aggregate gross proceeds received by the Company exceeds $25 million (a Qualified Public Offering ). Preferred stock should convert into common stock automatically at the company s IPO. The special rights generally accorded to preferred stock sold to early-stage investors could create problems for a public company Morse, Barnes-Brown & Pendleton, P.C. and Jeffrey P. Steele 25

26 Antidilution Antidilution: The terms of the Series A Preferred Stock will contain standard weighted average antidilution protection with respect to the issuance by the Company of equity securities at a price per share less than the applicable conversion price then in effect, subject to standard and customary exceptions. The conversion rate of the Series A Preferred Stock into common stock will be adjusted appropriately to account for any stock splits, recapitalizations, mergers, combinations and asset sales, stock dividends, and similar events. Antidilution protection shall not be triggered by the issuance of up to 1,000,000 shares of Common Stock (or options therefor) issued in accordance with the Company s Stock Option Plan Morse, Barnes-Brown & Pendleton, P.C. and Jeffrey P. Steele 26

27 Liquidation Preference The holders of Series A Preferred Stock shall have preference upon liquidation over all holders of Common Stock and over the holders of any other class or series of stock that is junior to the Series A Preferred Stock for an amount equal to the greater of (i) amount paid for such Series A Preferred Stock plus any declared or accrued but unpaid dividends, and (ii) the amount which such holder would have received if such holder s shares of Series A Preferred Stock were converted to Common Stock immediately prior to such liquidation. Thereafter, the holders of Common Stock will be entitled to receive the remaining assets. For purposes of this section, a merger, consolidation, sale of all or substantially all of the Company's assets, or other corporate reorganization shall constitute a liquidation, unless the holders of at least a majority of the Series A Preferred Stock vote otherwise Morse, Barnes-Brown & Pendleton, P.C. and Jeffrey P. Steele 27

28 The Terms Liquidation Preferences What are liquidation preferences? What does the term sheet mean by Liquidation What are the effects of liquidation preferences on: The entrepreneur Key executive talent Later investors How do these effects change with the size of the liquidity event (eg a $1 billion IPO vs. a $5 million M&A exit)

29 Voting Rights On all matters submitted for stockholder approval, each share of Series A Preferred Stock shall be entitled to such number of votes as is equal to the number of shares of Common Stock into which such shares are convertible. In addition, the Company shall not, either directly or indirectly by amendment, merger, consolidation or otherwise, without the prior consent of the holders of at least a majority of the then issued and outstanding Series A Preferred Stock, voting as a separate class: Liquidate, dissolve or wind-up the business and affairs Amend, alter or repeal any provision of the Certificate of Incorporation Create, or authorize the creation of, or issue or obligate itself to issue shares of, Reclassify, alter or amend any existing security of the Corporation Purchase or redeem (or permit any subsidiary to purchase or redeem) or pay or declare any dividend Create, or authorize the creation of, or issue, or authorize the issuance of any debt security

30 The Terms Voting Rights Why do these holders of preferred stock want voting rights? Board of Directors How is this business governed? What rights do the investors have as a minority? Who is really running this business?

31 The Terms Options and Vesting Why does this company want to grant options to employees? What circumstances could affect the value of the options? What impact would these circumstances have on key executive talent? Registration Rights Why are registration rights important?

32 Takeaways There are incentives for the investor, entrepreneur and executive team to cooperate to create value for mutual benefit But, in some situations, these agendas fall out of alignment. How effective are legal agreements in satisfying the agendas and needs of each participant in the venture funding process?

33 Section 3 VIRTUAL CORPORATIONS

34 Walden Paddlers - Virtual Organization Walden Paddlers, Inc. Paul Farrow CEO Dale Vetter Operations Allott (Design) Hardigg (manufact) ClearVue (Plastic) Strezegowkski, CEO

35 Walden Paddlers Walden Paddlers situation breakdown What is a virtual corporation? What s right about Walden Paddlers? What s wrong with it? Micro MBA strategy and valuation Micro MBA value chain analysis Bringing it together, how to fix what s potentially wrong with Walden Paddlers

36 What is a virtual corporation? Definition Scenarios Outsourcing Alliances Vendors/Partners Virtual work/teaming Extent Limited Pervasive Non-strategic Strategic

37 What s right with Walden Paddlers Business model Product concept Product design Marketing Profitability Company culture/values Personal gratification of management

38 What s wrong with Walden Paddlers Critical points of failure Value chain Who owns what? What is holding together the virtual links? What is the long-term value of this business? What s affecting the long-term value of the business? What could cause it to fail quickly?

39 Can Walden Work as an Organization? Let s digress into a few major MBA themes: Organizational Behavior Culture/feeling of belonging Cohesion and clarity Authority and control vs. innovation Human Resource Management Career tracks? Job definitions? Organizational scalability

40 Key Concept: The value chain Buy Recycled Plastic Apply Kayak Design Create Kayak in Mold Sell kayak To dealer Deliver to dealer How does Walden turn 35 cent per pound plastic powder into a kayak worth $11.50 per pound at retail? What pieces of the value chain does it own? What pieces does it control? How does it control the whole value chain? Are there any weak links?

41 Section 4 COMPETITIVE STRATEGY

42 Micro MBA Strategy and valuation Diagram of Porter's 5 Forces The five forces BARRIERS TO ENTRY Absolute cost advantages Proprietary learning curve Access to inputs Government policy Economies of scale Capital requirements Brand identity Switching costs Access to distribution Expected retaliation Proprietary products SUPPLIER POWER Supplier concentration Importance of volume to supplier Differentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industry Presence of substitute inputs Threat of forward integration Cost relative to total purchases in industry BUYER POWER Bargaining leverage Buyer volume Buyer information Brand identity Price sensitivity Threat of backward integration Product differentiation Buyer concentration vs. industry Substitutes available Buyers' incentives How does Walden stack up against these forces? Today vs. tomorrow? THREAT OF SUBSTITUTES -Switching costs -Buyer inclination to substitute -Price-performance trade-off of substitutes DEGREE OF RIVALRY -Exit barriers -Industry concentration -Fixed costs/value added -Industry growth -Intermittent overcapacity -Product differences -Switching costs -Brand identity -Diversity of rivals -Corporate stakes

43 BARRIERS TO ENTRY Absolute cost advantages Proprietary learning curve Access to inputs Government policy Economies of scale Capital requirements Brand identity Switching costs Access to distribution Expected retaliation Proprietary products

44 SUPPLIER POWER Supplier concentration Importance of volume to supplier Differentiation of inputs Impact of inputs on cost or differentiation Switching costs of firms in the industry Presence of substitute inputs Threat of forward integration Cost relative to total purchases in industry

45 THREAT OF SUBSTITUTES - Switching costs - Buyer inclination to substitute - Price-performance trade-off of substitutes

46 DEGREE OF RIVALRY -Exit barriers -Industry concentration -Fixed costs/value added -Industry growth -Intermittent overcapacity -Product differences -Switching costs -Brand identity -Diversity of rivals -Corporate stakes

47 BUYER POWER Bargaining leverage Buyer volume Buyer information Brand identity Price sensitivity Threat of backward integration Product differentiation Buyer concentration vs. industry Substitutes available Buyers' incentives

48 Startups and the 5 Forces Barriers to Entry Supplier Power Buyer Power New Venture Existing Players New Venture Threat of Substitutes

49 Walden and the 5 Forces Barriers to Entry Supplier Power Walden Competitors Buyer Power Threat of Substitutes

50 How to fix what s wrong with Walden Must mitigate single points of failure. Must migrate core processes to be wholly owned. Must mitigate unique relationship issue. IF he wants to be able to sell the company one day.

51 THANK YOU