L. A. SECTION ENTERPRISE CHAPTER

On July 22, 2008 a gathering of the AIAA L. A. Section Enterprise Chapter assembled to hear Bart Greenberg, a partner of an Orange County venture capital firm - Manatt, Phelps, and Phillips LLP - describe the conditions under which a technology company can attract venture capital. To do so, the aspiring enterprise must have its legal affairs in order and must present a winning business plan.

The key question in the legal sphere is "Who owns the intellectual property (IP)?" The IP includes patents, trademarks, and logos. If the business structure is not clear as to ownership of the IP, a de facto partnership may exist, and this scares off venture capitalists. It is important to protect the IP. In order to maintain clear title to the IP, a "moonlighting" founder must develop the enterprise entirely on his own time and avoid using employer resources or trade secrets. When hiring employees, protecting the IP means checking the obligations of each candidate to a former employer and negotiating an employee agreement delineating obligations and restrictions. In hiring consultants, it means arriving at an agreement defining ownership of the product produced by the consultant before the work starts.

The state in which the business is formed is of interest to venture capitalists. For example, incorporation in California is shareholder-friendly whereas incorporation in Delaware is management-friendly. Incorporation in Nevada has tax ramifications in California and the law is less definite. The entrepreneur needs to be aware of such legal differences when establishing the firm.

At start-up it is important to structure the enterprise so as to minimize any future restructuring, which can be quite expensive and entail unwanted tax burdens. In the start-up phase, it is usually prudent to minimize the number of operating units, subsidiaries, related R&D organizations, and service companies.

Choosing suitable and capable team members is crucial. Careful vetting of candidates requires due diligence and discipline. Company leaders must be aware of their own limitations and choose candidates whose skills complement one another. In choosing associates, it is important to select people who can take the company to the next level. In discharging people, it is essential to follow the letter of the law with respect to accrued payroll and fringe benefits. Before the venture capitalist invests, he wants to be sure that releases from liability have been obtained from each individual who has been separated.

Venture capitalists are sensitive to the way equity is used in the business. One pitfall to avoid is the use of oral promises of equity, because they are legally enforceable but usually ill-defined and prone to dispute when a party wants to leave. Don’t get too many people involved in equity ownership, look for alternative financing methods, and be sure to comply with security laws. Use stock carefully, with disciplined vesting rules, probationary periods, repurchasing rights, restrictions on transfer, rights of first refusal, proxies and voting, and repurchase rights on "triggering" events.

Corporate formalities need to be observed. Corporate meetings must be in accord with the by-laws and decisions must be properly documented. Accounting records, licenses, and contracts must be properly maintained and personal items must not be mingled with company accounts.

The introduction to the plan is the Executive Summary.

The first requirement of the business plan is to convince the venture capitalist that you understand the market. Does your product/service address a real need or alleviate a real pain in the market? Has your research been sufficient to present a credible estimate of market size and segmentation? Have you demonstrated knowledge of promotional media and distribution channels? Have you recognized external factors that could impact the business? Is your competitor analysis realistic or merely wishful thinking? Is your prediction of demand growth realistic and is your plan to meet that demand credible?

The venture capitalist wants to feel confident about the management team. Team members with experience in the industry, an active and knowledgeable Board of Advisors, and founders and senior management with financial commitments to the enterprise are viewed favorably.

The operational plan must show a good understanding of the manufacturing, distribution, and selling processes applicable to the product/service. The plan should foresee and provide for contingencies in these areas and in R&D, testing, and staffing.

The financial plan must be based on realistic and clearly stated assumptions. Venture capitalists see so many overly-optimistic sales and profit forecasts that realistic estimates are needed to avoid this pitfall. Also, expenses must not be underestimated, and sensitivity to risk must be demonstrated by budgeting for unexpected costs.

The investment portion of the plan must indicate how capital will be raised and must explain to investors how they will recoup their investment plus a sufficient rate of return.

To see the slides presented by Bart Greenberg, go to Archive of Speaker Presentations at Chapter Meetings, under the title "What It Means to be Fundable", and click on bgreenberg.pdf, or bgreenberg.ppt.

Guido Frassinelli 10/08/08