Experience matters

In 1987, we were in a period when many of the younger investors had great educational credentials and could analyze how much to invest in a specific sector, but they lacked enough operational experience to understand what to do when the business was not succeeding. Many of the venture partnership funds were coming to the end of the lives of specific partnerships, and decisions on disposition needed to be made. If this sounds familiar, the same thing happened after the dot.com bubble broke, and again after 2008. Liquidity has become a big challenge even for successful companies, and thus many funds are again faced with critical decisions on how to gracefully exit companies that in good times could have had successful exits.

A memorable client

I remember one of our first clients, which was a little fair afield of technology businesses. We were called in to help a national RV dealership that had started the IPO process, only to find out they were almost out of business when the 1987 recession became a reality. They filed bankruptcy, and that is when we were called in by the debtor’s counsel. No one had been able to determine what the debtor’s financial status really was, as it appeared to be a moving target.

After analysis, we determined that the founder and his son had actually embezzled funds from the company. When I informed them they should not come back to the office, the son came back with an assault rifle to “take care of the guy who had fired him.” The federal Judge later said, “Mr. Brenner, I am not paying you enough for hazardous duty. Are you sure you can continue?” We did continue, and tried to find all of the money they had taken, which was in offshore bank accounts. This is clearly one of the most interesting memories over the past 25 years.

A difficult founder

Another interesting client was in the mid 1990′s, when we received a call on a Sunday from a large VC investor regarding a software company that the board thought was preparing for an IPO. The board had wanted to change CEO’s, but had to deal with a difficult founder. They had waited until the company needed a bridge loan to get to the IPO before telling the founder that the only way they would put more money in was for him to step aside as CEO, and serve as Chairman. We were asked to step in as interim CEO.

Once we got in, we found that the founder would try to undermine anything we tried to do, and that the company was far from any successful exit. The company had stuffed its customer pipeline full of product to the point that the distribution network had stopped paying for any inventory until it had sold through to their retail outlets. The average days sales outstanding in their accounts receivable was close to 200 days, and this was the reason they had run out of cash. When speaking with the customers in the channel, we found out the products just weren’t selling through to end customers. In the end, what was supposed to be an interim CEO position while the board looked for a CEO to take the company public, became an interim CEO position to salvage what we could, and sell the pieces of the business to interested buyers.

The last part of this story which is interesting is that the founder was needed when speaking with potential buyers of the software to explain the code, and the roadmap for the future. On the way to a major meeting with Microsoft, he informed the investment banker and me that no one would buy this piece of software because it was poorly written, and obsolete. But, he added, he could put a syndicate together to take it off our hands. At the end, one of the products was sold to a successful company for a reasonable amount, but the piece the founder wanted was sold to him for a very low sum, as he was never able to help us sell the technology.

A gratifying success story

I recall being called in to help a fabless semiconductor company. The company had been trying to develop too many different products, and had used about half of their available cash. The board decided that the company should focus on just one product, and one product only. We were asked to oversee the general operations and spending for the company. We immediately reduced their headcount by 80%, and brought their burn rate down from over $1 million per month to just over $150K per month. Then whenever someone wanted to spend money, we were the final say on whether it was necessary to complete the first product.

The first product was publically announced about 9 months after we started, and began shipping about 3 months later. Because of the low cash burn rate, the company was profitable within 4 months of shipping the first parts, and went public on NASDAQ 12 months later. When our assignment ended, the board passed a resolution stating The Brenner Group had single-handedly saved the company, and gave us a very nice bonus of shares in the public company. Clearly, this was a shining moment for our firm in our history.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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J. Weston (Wes) Rose is Senior Vice president of The Brenner Group, one of Silicon Valley’s premier professional services firms. Wes has enjoyed an extensive career as a C-level operating executive with multiple venture capital backed technology companies and now runs the firm’s interim management and restructuring practices.

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In this post, we will review what the definition of “zone of insolvency” is, and what Directors and Officers are supposed to do, and say, if they find themselves in or approaching this zone.

Two tests for insolvency

There are really two primary tests for determining insolvency

1. Balance sheet test: a company is insolvent if its liabilities exceed the fair value of its assets.

2. Cash flow test: a company is insolvent if it is unable to pay its debts as they become due in the ordinary course of business.

But in reality, smaller companies may see themselves within these definitions a number of times in their early lives, particularly companies seeking institutional funding. Logically, if you find yourself meeting these tests, but are in the process of closing a new round of financing, you can look past these tests to the reality that you will be out of this Zone of Insolvency soon enough to make taking actions a moot point. That doesn’t mean you have discharged your obligations as a Director or an Officer that will be discussed below, but simply says that you are in this Zone of Insolvency only on a temporary or short term basis.

However, each company and its board must take a long look at the facts surrounding their ability to raise additional capital to get them out of this zone. Merely “hoping” that you will raise more money in the short term does not take you out of the Zone of Insolvency. You may be trying to raise money, but you must be honest with yourself and your stakeholders regarding your chances of success.

What’s expected, once you are in the “zone”?

If you find yourself in this Zone of Insolvency, there are certain legal actions which are reasonably expected of the company and its Directors and Officers.

For Delaware Corporations

• The directors of an insolvent corporation have the traditional fiduciary duties of care and loyalty to both the creditors and the stockholders;

• Creditors may bring derivative claims against to board for a breach of these duties, but may not directly due the directors; and

• Business Judgment rule will apply

For California Corporations:

• In these cases, the board does not owe any broad based fiduciary duties to its creditors simply because it is insolvent.

• The scope of a director’s duty to creditors is limited to the “trust fund doctrine”: avoiding actions that divert, dissipate or unduly risk cooperate assets that might otherwise be used to pay creditor’s claims.

The differences between these two are not major, but your legal advisor should give you advice about what your specific duties are to avoid exposing the Directors and/or Officers to personal liability from the creditors. Basically, there is a theory that if the company knowingly incurs debts after it has recognized that it is in the Zone of Insolvency, the Directors and Officer have allowed a fraud to be committed, and as such, they become personally liable for these debts. This is difficult to prove, but it has been done. In these cases, D&O insurance will not protect the D’s and O’s because “fraud” is not a covered liability in these policies.

Navigating the turbulent waters of the “zone”

So, what are we supposed to do to avoid liability and abide by the legal requirements of your State of incorporation? The short answer is that the D’s & O’s are supposed to stop incurring ANY liability after knowingly having entered this Zone of Insolvency. This means, no further payroll, contract or vendor costs are to be incurred. This could mean furloughing employees, or simply laying them off. It could mean notifying creditors that you are in this zone, and you agree to not incur further liability without having a solid plan to leave this zone.

Below are some important things for executive management and Boards to remember as they navigate the Zone of Insolvency:

• Prepare and regularly update an honest appraisal of company status and prospects:

o Fund-raising assessment – why have you so far been unable to raise funds?

o Where are you in the fund raising process and do you have any investors lined up or in discussion?

o What timeline are you setting for the fund raising, before Plan B actions will be taken?

o Are you really in the Zone of Insolvency?

o Enumerate and understand all creditor obligations by type: secured, unsecured, statutory, etc.

o What is the potential enterprise value, or separate value of your IP?

o Identify potential buyers. Having this list done early helps the process.

• Focus internally

o Conserve cash—scrub balance sheet to convert whatever assets are available into liquid resources, like CASH

o Reserve cash for statutory obligations and liquidation costs. Statutory obligations include payroll and payroll taxes.

o Do not disseminate any information behind required “circle of people” until decisions are clear about what you will do.

• Understand, prepare for, and pursue multiple liquidation options in the event fund raising is ultimately unsuccessful

o It is very important that the Directors are on the same page

o Having the Board in agreement goes a long way to a smooth set of actions.

Legal and financial advisors are available to help companies that find themselves in, or approaching the Zone of Insolvency. It is not an enjoyable place to be, but to avoid liability it is essential that D’s and O’s understand their responsibilities and consider the interests of all stakeholders as they decide whether to continue the business, suspend the business, or simply close the doors.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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As the name implies, inside rounds are rounds of investment by existing investors, versus outside rounds that are led by new investors.

In our valuation practice, we are often confronted with clients having gone through inside rounds, and we need to make a determination if the pricing of those investments provides an indication of value of the equity of a company (regardless of which class of shares; but usually invested as preferred equity). Each case is different, but often such an investment is not a good indicator of value as it lacks arm’s length characteristics.

Although Broughman and Fried only cover a very limited geography (Silicon Valley), a very limited time frame (companies that were sold in 2003 and 2004), and had very specific exit circumstances (M&A), it provides a welcome quantitative analysis of such inside rounds.

The study tries to answer two questions:

1. Are inside rounds (ab-)used by venture investors in order to dilute founders?

Broughman and Fried’s analysis suggests otherwise: inside rounds were mostly used when outside financing was not available. Inside rounds were often flat or down rounds, outside rounds were often up-rounds. Companies using inside financing were less likely to return a profit to their investors. In those cases, the valuation would really not have mattered to the founders, given that any proceeds were first and foremost used to satisfy the liquidation preferences embedded in venture investor’s preferred stock. This analysis seems to be confirmed by the founders’ assessment: in all cases, the inside round was used as a backstop when outside financing was not available.

2. Are inside rounds overpriced or underpriced?

The authors analyze the valuations used in the inside as well as outside financings in their sample and compare those with the ultimate sales price of the target company. Not a perfect measure by any means, but the results are striking: the last inside round valuation was up to six times higher than the ultimate sales price for companies receiving inside rounds, with a median of about two times. Companies with the last round being an outside round had pre-exit financing round valuations of up to two times higher than the ultimate sales price, with a median closer to one times. We’ve summarized this in the following table:

And why would inside rounds be overvalued?

The authors propose several reasons why inside rounds may be overvalued:

1. Litigation risk: VCs can avoid litigation from disgruntled and diluted founders by overvaluing their follow-on round

2. Signaling: An inside flat round looks much better to the limited partners of a VC than an outside cram-down round. And after additional development milestones are met, it is much easier for the company to fundraise, even if the last was from existing investors.

3. Reduce down-round cost: Staying with a flat inside round avoids triggering anti-dilution provisions, and may eliminate the need for topping off the management option pool, which would lead to additional dilution.

4. Over-optimism: VCs need to be optimists by nature in order to invest in fledgling start-ups. They might as well be optimistic when it comes to pricing their current investments and dismiss an outside investment that comes in “too low”, i.e., carries too much dilution for them.

The study has a number of limitations, foremost its small sample size. Yet it provides some genuine evidence that not all investment rounds are created equal, and that inside rounds may indeed come with a valuation bias of being overpriced.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Master’s Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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• Zillow, Inc. provides online real estate information. Its IPO occurred on July 20, 2011 at a price of $20.00 per share. The price about one week later was $32.37. Holders of stock options granted in the 18 month period preceding the IPO received positive bumps relative to its issue price. Stock options granted March through May 2010 had exercise prices of $3.25 per share (16% of the issue price). Options granted in March 2011 had exercise prices of $3.89 per share (less than 20% of the issue price). Options granted in May 2011 (two months prior to the IPO) had exercise prices of $6.33 per share (32% of the issue price).

• SkullCandy, Inc. manufactures and distributes headphones. Its IPO occurred on 7/20/2011at a price of $20.00. The price about one week later was $19.70. Holders of stock options granted in May 2010 had an exercise price of $10.32 per share (52% of the issue price). Holders of stock options granted in November 2010 had an exercise price of $12.00 per share (60% of the issue price). Holders of stock options granted in the first quarter of 2011 had an exercise price of $16.42 per share (82% of the issue price).

• Pandora Media, Inc. is a personalized radio service on the Internet. Its IPO occurred on 6/15/2011at a price of $20.00. The price about five weeks later was $15.02. Holders of stock options granted in the fiscal year ending January 2011 had an average exercise price of $2.16 per share (11% of the issue price). Holders of stock options granted in the quarter ending April 30, 2011 had an exercise price of $5.67 per share (28% of the issue price).

• Solazyme, Inc. provides plant based petroleum products. Its IPO occurred on 5/27/2011at a price of $18.00. The price about eight weeks later was $22.07. Holders of stock options granted in the calendar year 2010 had an average exercise price of $4.09 per share (23% of the issue price). Holders of stock options granted in the quarter ending April 30, 2011 had an exercise price of $8.62 per share (48% of the issue price).

IPO Bumps are not necessarily a guarantee of instantaneous riches. Most stock options are subject to vesting limitations over several years (usually four years), so any grants in the period preceding an IPO do not lead to an immediate windfall for the option holder at IPO. The employee will only receive the incremental value if the company itself is able to grow in value in the years after the IPO. Yet the evidence suggests that stock options continue to be an important element of compensation, providing the potential for strong ultimate payouts to the lucky (or hardworking) few who successfully steer their companies towards an IPO exit.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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IRC 409A requires the company to estimate the fair market value of its stock at the time of an option grant. As a venture capital backed company grows successfully and starts aiming for an IPO exit, the fair market value of the stock should grow as well, in theory. If the company had perfect foresight, the discount relative to the IPO price should decrease the closer the company gets to an IPO.

One comment first: most stock options are subject to vesting limitations over several years (usually four years), so any grants in the period preceding an IPO do not lead necessarily to an immediate windfall at IPO. The employee will only receive the incremental value if the company itself is able to grow in value in the years after the IPO.

Based on several recent IPOs, experience indicates the IPO Bump appears to be alive and well. I looked at SEC filings by LinkedIn, ZipCar, Boingo Wireless, and Freescale Semiconductor, as well as their traded prices as of June 7th:

• LinkedIn Corporation operates an online professional network designed to help members find jobs, connect with other professionals, and locate business opportunities. This company’s IPO occurred on May 24, 2011 at a price of $45.00 per share. The price two weeks after the IPO was $77.82. In addition to the increase in value since its debut, holders of stock options granted in the two years preceding the IPO received impressive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $2.32 per share (5% of the issue price). Options granted one year before the IPO had exercise prices of $6.20 per share (14% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $9.63 per share (44% of the issue price). [The Brenner Group has provided valuation services for LinkedIn.]

• Zipcar, Inc. operates a car sharing network that provides self-service vehicles that are located in reserved parking spaces throughout the neighborhoods where its customers live and work. This company’s IPO occurred on April 19, 2011 at a price of $18.00 per share. The price seven weeks later was $21.54. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $5.10 per share (28% of the issue price). Options granted one year before the IPO had exercise prices of $8.74 per share (49% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $11.90 per share (66% of the issue price).

• Boingo Wireless, Inc. provides mobile Internet access service through wireless fidelity (Wi-Fi) networks. This company’s IPO occurred on May 9, 2011 at a price of $13.50 per share. The price five weeks later had declined to $8.87. Holders of stock options granted in the two years preceding the IPO received positive bumps relative to its issue price: stock options granted two years before the IPO had exercise prices of $1.40 per share (10% of the issue price). Options granted one year before the IPO had exercise prices of $2.85 per share (21% of the issue price). Options granted about 3 to 4 months before the IPO had exercise prices of $8.50 per share (63% of the issue price).

• Freescale Semiconductor Inc. provides semiconductors, microprocessors, and similar electronic devices for automotive and telecommunications products. This company’s IPO occurred on June 1 2011 at a price of $18.00 per share. The price one week later was $18.12. Holders of stock options granted in the first quarter of 2011 received a positive bump relative to its issue price: stock options granted three to five months before the IPO had an average exercise prices of $12.69 per share (71% of the issue price).

Stock options continue to be an important element of compensation. However, as demonstrated in the discussion above, not all IPOs result in an IPO bump for all option grants. It should not be assumed that every IPO provides a guaranteed bump in value to the employees that receive options in the period before the IPO. The recent IPOs discussed in this blog would suggest the IPO Bump is still with us, although the magnitude of the benefit can vary significantly from IPO to IPO.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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Several positive indicators underscored that sentiment: rebounding stock market, low interest rates and a poor real estate market suggesting that growth stocks could be attractive investments, several big name private companies were raising institutional funds at billion dollar valuations, and anecdotally the local law firms all spoke to the resurgence in their S-1 filing activity and often referred to a healthy “IPO pipeline”. So confidence in a tech IPO resurgence was high. But with a third of the year gone, there have been few notable IPOs and while activity is up over 2010, we’ re not seeing the kind of breakthrough IPO activity including the big name consumer internet players that most had expected. What happened?

A little VC history – the 80’s and 90’s

In the glory years of venture capital which led up to the dot bomb bubble, typical VC backed tech companies were able to reach successful liquidity events in 4 – 6 years. Today, that number is much higher, if it ever comes at all.

As part of this change, the definition of a successful liquidity event shifted from IPOs to M&A because there has been no significant public appetite for new tech company offerings for over a decade. What caused this, and will it improve?

In the early 1980’s, there was a rash of VC backed IPO’s, and most VC’s felt it was a natural occurrence to have one of their companies achieve an initial public offering, providing liquidity and large returns to the investors in the companies. By the mid to late 1980’s the IPO market had gotten a little cold, and there were significantly fewer IPO’s in the second half of the decade compared to the first half.

By the early 1990’s VC’s became more stringent about their investment opportunities, and focused on fewer companies with larger amounts of venture capital required. VCs looked at their portfolio and targeted a successful IPO with about 1 out of 5 portfolio investments. That one would be enough to more than outweigh the other 4 unsuccessful ventures, and still provide significant returns.

As the decade of the 1990’s progressed, many technology models (e.g. fabless semiconductors) had matured to the point where capital efficiency was lost. Without capital efficiency, VC’s could not rely on the returns they had become accustomed to, and began to look for other, more capital efficient investments. Enter the dot.com bubble.

The dot com phenomenon

By the late 90’s VC’s began to see very capital efficient businesses that appeared to grow out of nothing into companies, where success was measured in large part on “eyeballs” and not actual revenue and profitability. They believed that revenue and ultimately, profit, should follow the growth in “eyeballs”. We all know how this story ended in 2001. But in the intervening years, there were hundreds of companies which went through an IPO process, only to go out of business a year or two later.

Exacerbating the huge number of failed dot.com companies were companies like ENRON, who bilked their shareholders out of fortunes. So, on top of the public being worried about large scale fraud such as ENRON, the public had to deal with all the speculative investments that were now going out of business. So, enter the governmental regulations from Congress and the Securities and Exchange Commission. The Sarbanes Oxley legislation in 2001 was to overhaul what public companies had to do to earn the trust of the investors again. And the price tag to earn this trust was very high.

Cost of being public exploded

The costs of being a public company, complying with all of the regulations and reporting requirements, rose to several million dollars per year! How many early stage tech companies can afford that much cost coming right out of earnings in their formative years? So, by 2009, there were fewer than a dozen VC backed tech IPO’s in the entire year. And 2010 wasn’t much better. The prediction for 2011 is still better than 2010, but nothing like the glory years leading up to the dot.com bubble.

So, the issue of the cost of being a public company together with the lingering doubts in the mind of individual and institutional buyers has continued to depress the market for public offerings. Yet it is generally accepted wisdom that there are a several well known companies rumored to be teed up for an IPO and, if successful, might well reignite the IPO fever which we saw in the 80’s and 90’s. Web 2.0+ companies like LinkedIn, Facebook, Zynga, and Groupon all have proven profitable business models which can sustain a public company. Moreover their valuations are reportedly all in the billions. Only LinkedIn seems poised and ready to go public. The other big names, and many others, have not gone out and may not in 2011—how come? What’s the hold-up? My next post will examine the reasons these big names have not taken the big leap.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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A search for “cloud computing bubble” on Google returns an amazing 1,350,000 results, leaving our other contenders in the dust. The Google News search returns an increase to 83 results in 2010 from 31 in 2009. Cloud computing now may be more of a pervasive paradigm shift in IT infrastructure than a subsector like social gaming, and a multitude of companies are involved, or like to be thought of as being involved, in delivering a cloud computing solution. In that respect, cloud computing may be more about bubbly IT marketers rallying behind a common term to increase sales than a genuine business sector bubble.

In Gartner’s hype cycle of August 2010, Cloud Computing and Cloud/Web Platforms just surpassed the “peak of inflated expectations” and are slated for the deep dive into the “trough of disillusionment”. With an expected time to mainstream adoption of 2 to 5 years, such trough could of course be crossed relatively quickly.

Valuations for companies with some ties to anything cloud are still (or again) very substantial. VMWare is trading at a healthy 14 times revenue, Citrix is at 7 times revenue.

This leaves social gaming company valuations looking rather tame.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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A search for “social gaming bubble” on Google returns a whopping 266,000 results. Move over, cleantech! The search in the news section shows an increase from 22 hits in 2009 to 87 in 2010. Getting closer.

The social gaming industry has seen some inspiring transactions: Disney bought Playdom for more than $750 million, Electronic Arts bought Playfish for $400 million, and Google bought Slide for $182 million. Zynga gobbles up one game company after the other, making use of its war chest of more than half a billion dollars that it raised from online media stalwarts like Google, Softbank, and Digital Sky Technology.

Usage numbers are certainly impressive. According to market research company The NPD Group, 20 percent of the US population ages 6 and older reports having played a game on a social network in the past three months. That equates to 56.8 million US consumers. And anything that 20 percent of the US population does, must have some value. About 35% of social network gamers are new to gaming, and at last the interactive entertainment industry seems to have reached the elusive female audience: the majority of social gamers are indeed female.

Is Zynga, at an estimated market value of over $5 billion, a tad frothy? Maybe; but for a three year old company with 320 million registered users and estimated revenues above $500 million, such a growth rate has to account for something.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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So here goes our list of contenders for 2011 bubbles:

Cleantech

A search for “cleantech bubble” on Google returns 87,300 results. Not bad for an aspiring bubble. A search in Google News returns 74 results, up from 26 results for 2009. A Google search may not be scientific evidence of a bubble, but it can serve as a helpful proxy in our hunt for bubbles. The Cleantech Group researched that Q3 2010 venture investment in cleantech was down to $1.53 billion; 30 percent less than the previous quarter, and 11 percent less than the same period a year ago. Investments for the first three quarters in 2010 were still slightly ahead of the same period in 2009, thanks to a strong first half of 2010. Public markets are still somewhat supportive of anything green; Li-Ion Battery maker A123 systems, which went public in 2009 may be down from its high of $25.77, but even around $9.50 it is trading at about 10 times trailing revenue. Electric car maker Tesla trades at over 25 times trailing revenue, which leaves ample room for future revenues to catch up with the current valuation.

In general, it seems that the public market has not yet caught up to the more modest outlook of venture investors.

For a more bullish view on cleantech, Claremont Creek’s Nat Goldhaber looks at a rebounding IPO market to stoke the public interest in all things green in 2011.

Of course timing is everything in bubble land: one man’s short term investment gain is another’s man’s loss when the bubble pops: And, as the example of the Li-Ion battery market shows, those bubbles may take a while to pop: strategy consulting firm Roland Berger expects the shakeout in the Li-Ion battery market to decimate the number of companies from around 60 to 6. But consolidation is not expected to start until 2014. That leaves plenty of time for bets before the bubble pops!

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

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See http://www.pwc.com/us/ipo for PwC’s IPO resources page. Here is the link for their press release.

How does this compare with what the VC industry is reporting? We do not have Q4 2010 results yet, but for the first nine months of 2010, the National Venture Capital Association (NVCA) together with Thomson Reuters reported that 40 of the IPOs were by venture capital (VC) backed companies. Of these companies, 21 were in computer hardware or software, semiconductors, communications, or Internet services, 11 were in biotech, medical technology, or health services, and 8 were in other categories. Overall, it appears as if VC backed companies represent about 25% of the number of IPOs.

This level of IPO activity is an improvement compared to the previous seven quarters (from April 2008 through December 2009) when there were just 13 IPOs by VC backed companies. However, it is still only half the number of IPOs by VC backed companies in 2007.

So clearly, VC backed companies are playing an important – but not dominant role is the US equity markets.

Source: News Release series by National Venture Capital Association (NVCA) and Thomson Reuters dated April 1, 2010, July 1, 2010, and October 1, 2010. NACVA’s study results may be found at http://www.nvca.org/index.php?option=com_content&view=article&id=79&Itemid=103.

Bill Denebeim is a Vice President of The Brenner Group and has more than twenty years experience providing financial, regulatory and operational consulting services to executive management and investors of technology companies. Bill received his M.S. in Operations Research from Stanford University and his B.A. degree in Economics and English from the University of California at Berkeley. Bill is a holder of the Chartered Financial Analyst® designation and is a member of the CFA Institute and the CFA Society of San Francisco.

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner.

Original post permalink: http://banner.thebrennergroup.com/2011/2/18/is-ipo-market-momentum-benefiting-vc-backed-companies/



A recent survey of the professional services landscape in Silicon Valley yielded some unique insights into the top names in professional services among VCs and CEOs of VC backed companies. The survey, completed and published by the Silicon Valley Research Group in San Jose and Seattle, was designed to identify trends and the leading brands across six professional services categories in Silicon Valley.

1. Accounting Firms

2. Law Firms

3. Interim CFO & Controller Firms

4. Valuation Firms

5. Banks

6. Venture Lending Firms

The top two most mentioned names in each category are listed below.

Accounting Firms  →           Deloitte Touche and PricewaterhouseCoopers

Law Firms   →            Cooley and Fenwick & West

Interim CFO & Controller Firms   →           The Brenner Group and Ravix

Valuation Firms   →           The Brenner Group and SVB Analytics

Banks   →           SVB and Comerica

Venture Lending Firms   →           Western Technology Investments and TriplePoint Capital

For more information or for the full report, contact Shawn Fisher (shawnf@siliconvalleyrg.com ) for details.

J. Weston (Wes) Rose is Senior Vice president of The Brenner Group, one of Silicon Valley’s premier professional services firms. Wes has enjoyed an extensive career as a C-level operating executive with multiple venture capital backed technology companies and now runs the firm’s interim management and restructuring practices.

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

Original post permalink:  http://banner.thebrennergroup.com/2011/02/14/2010-professional-services-survey/

If you are an entrepreneur or CEO of an early stage company, and you are considering additional financing from current or potential investors, then this session should help you stay on top of the finance issues that are most important to growing your business and attracting additional financing.  For more information on the event, go to http://www.focus.com/events/finance/focus-finance-roundtable-financial-planning-and-management-s/ and register.

The debate has been carried out rather openly, and the borders of straight-talk, self-promotion, and honest reflection have become somewhat blurred.

The basic question is whether it’s better to take a limited amount of money from Super Angels – say between $100 thousand and $1.0 million, or shoot for the moon and go to Sand Hill Road where a self-respecting Series A starts with $5.0 million. Super Angels are loosely defined as business angels with more money making a lot more investments.

I give Dave McClure credit for kicking off the fight in his signature R-rated rant (and coming-out piece as a Micro-VC) asking traditional VCs to HURRY UP & DIE ALREADY.

Representatives from both sides finally square off in the informative and entertaining ”Super Angel/VC Smackdown” on TechCrunch TV.

The arguments of the Super Angels boil down to the following:

- Start-ups need less capital, get to revenue faster, and get to an exit faster. No need for the big pockets of a VC. The discussion almost exclusively centers on consumer-focused internet and mobile startups. Life-science, clean tech, and semiconductor may very well be very different.

- Traditional VCs invest too late, once market traction is already established, and hence overpay. The right way of early-stage investing is to invest BEFORE market traction, and double down if the company takes off.

- Exits are smaller: there aren’t those billion dollar IPOs out there, anymore. For the return metrics to work, those smaller exits need smaller investments. (We talked about this in this past post.)

The VCs counter back:

- Super Angel thinking is small-scale thinking: entrepreneurs will be trained to think small, try to flip a company in a couple of years if not months for a couple of million dollars, and won’t be building the next Google or Facebook: big thinking needs big money.

- Super Angels are merely hedging their bets, investing in a LOT of start-ups, and there is no way they can add value to the hundreds of companies that they invest in. It is better to focus on a select few and make them successful.

But the dollars aren’t always greener on the other side, and it seems to me that the whole discussion is focused on the wrong premise.

1. Investment adequacy

Some start-ups will need little money, other will need a lot. Some start-ups will drive towards a smaller exit, others won’t. There are plenty of start-ups that will do just fine by taking little money and having a fast, reasonable exit that makes all stakeholders happy. Matching the right start-up with the right financing strategy is difficult. Too much money will spoil a company’s strategy and an investor’s returns; too little money will constrain and jeopardize the business plan. But there should be ample room for plain old Business Angels, Super Angels, and VCs. A lot of these arguments resurface in the recent discussion about fat and slim start-ups.

2. Value added investing

Early-stage investing should always be about more than money: open doors, help find strategic partners, and find the next investors. VCs may have been complacent in this respect, but the danger of offering “just money” and waiting for the start-up to develop is especially present with Super Angels who stretch their investment dollars among too many companies to be effective mentors to each one of them. Super Angels right now ride the wave of “we understand consumer internet investing”. Early stage investing is a numbers game, and a lot of the early investments will blow up. That’s not good for the reputation, especially if the perception switches from SuperAngels being able to pick winners and make them successful to spreading money indiscriminately and waiting to see who survives.

Venture Capital investing has been around for a while. It has shown that it can be very successful. In the last ten years, it has also shown that it can be quite unsuccessful. Super Angel investing hasn’t been around that long. Given the time frame and ups and downs in this industry, it yet has to prove itself right (or wrong). But in the big picture, more investor competition is usually a good thing; giving entrepreneurs choice and requiring investors to focus and differentiate from each other.

Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

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How many times does an entrepreneur with a great idea believe they are the only one suited to run their new venture? Usually, they believe they need to be the CEO. However, even if they are the well suited to lead a venture in the beginning, they are not the one to drive to higher levels beyond development. When this expansion phase occurs, the board usually has the difficult task of letting the entrepreneur/CEO know that it is time for him to take a new role in the company.

Often this communication does not go well, and the end result is that the entrepreneur cannot understand the message and leaves the company.

Here are two case studies I’ve personally witnessed:

1. Typical CEO transition scenario

A three year old company is doing very well. Making lots of profits and growing. The CEO and the board hire a seasoned executive with more big company experience than the entrepreneur/CEO has to help the CEO. The CEO and the new executive bond well, and it looks as if this transition will go well. In fact, the entrepreneur/CEO tells the new executive that he is glad the new executive has come on board, and that he will know when it is time to turn the reins over and step aside. About a year later, the board wants this transition to take place, but instead of knowing that it is time for prudent change, the entrepreneur/CEO starts fighting his board and terminates those executives on staff who agree that it is time for the change. This plays out over several months and by the time the board realizes what has really occurred, the company has lost market share, revenue, profits and cash. The change finally occurs, but it is too late, and the company ends up going out of business, when this did not have to happen if the transition had occurred smoothly.

2. Ultimate irony scenario

Another example is even more interesting. It would be funny if it was not so sad. An experienced venture capitalist decides to change “sides of the table”. An entrepreneur comes to him with a great idea but understands that he does not have the skills or inclination to run a business, only be a developer. The VC decides to run the company for a while until it gets going, at which time he will hire a new CEO, and go back to being a VC. As the company progresses, the business is able to raise in excess of $100 million towards building the company. It becomes clear after the major institutional round, at least to some of the employees and board members, that it is time for an experienced CEO. The VC acting as CEO however now decides that he is the only one that should lead the company and refuses to listen to his fellow VC’s and board members. He fights the board for quite a while, and in the meantime, the company’s spending runs out of control. By the time the board finally removes him from his position, the company is nearly out of cash, and has not completed its milestones. The irony of this is that the VC/CEO had experience on the other side of the table many times and witnessed other entrepreneur/CEOs not wanting to be replaced and fighting with the board. But in this case, he got enamored with the idea of running the company, he took it personally and lost sight of his original mission.

So, we give advice to young entrepreneurs to remind them that having a successful business should be more important than stroking their egos by being the CEO. Most entrepreneurs are best at developing ideas not at managing businesses. We advise that they have to be ready and willing to step aside – many times early on or earlier than they might like – and appreciate that it is nothing personal. It’s just part of the process of building a successful company.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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