Jay Parkhill Bio

April 25th, 2013

What I Do

I am an attorney to early stage and growing businesses. I help brand new startups form companies, allocate equity among founders, raise money and create starter templates for customer agreements, user Terms of Service and proof-of-concept transactions.

I also work with later-stage companies that have products, customers and revenue transactions. I work with executive, sales and engineering teams on enterprise sales deals, channel distribution arrangements, web & mobile user issues, commercial and open source questions and other aspects of the development, acquisition, commercialization, protection, licensing and disposition of intellectual property assets.

I love helping clients to develop contract playlists of the key issues for their businesses. This lets clients know where to agree and where to push back in negotiations, helps clients negotiate consistently from deal to deal, and allows me to work with clients efficiently.

Where and How I Do It

I am the principal of Parkhill Venture Counsel. I am a licensed attorney in California and have been practicing law in San Francisco since 1998. I cut my teeth at two startup-focused boutique law firms, Niesar & Diamond LLP and Montgomery Law Group LLP. From August 2008 through March 2013 I was a partner at VLP Law Group LLP, an officeless, nationwide firm.

Where to Find Me

My LinkedIn bio at http://www.linkedin.com/in/jayparkhill has a good summary of what I do.  I have been active on Twitter @park3 since sometime in 2007. You can check out my postings there on IP issues, privacy, corporate governance and other legal topics along with a smattering of bicycle racing and outdoor adventures.

Contact Me

You can reach me at:

T: 415 963-4114
E: jp at jparkhill dot com

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Dodd Banking Bill Aims Shotgun at Investor Fraud, Hits Early Stage Companies

March 30th, 2010

There has been a lot of news recently about Senator Christopher Dodd’s banking reform bill, which was introduced in the Senate a couple of weeks ago.  I dug into the details relevant to startup and private company financing transactions (with help from the comments on avc.com and an insightful piece on TechFlash), and thought a bit about how it would likely affect my client base.

Principal Terms
The entire bill runs 1036 pages, of which about 6 are relevant to angel and VC financings.

First, the proposal requires that the accredited investor dollar threshold be increased regularly to adjust for inflation.  The current requirement (which dates from 1996) is that an investor earn at least $200,000 per year or have a net worth of at least $1,000,000.  The Dodd bill requires that a retroactive inflation adjustment be applied to those figures and that they continue to be adjusted at least every 5 year going forward.  I haven’t tried to do the math, but pundits say this would increase the threshold to $450,000/$2,300,000.

Second, the bill kicks oversight of Regulation D transactions (the principal exemption from public offering registration requirements used by private companies) largely to state authorities.  The bill would (i) set a dollar threshold below which the SEC would not even try to regulate, saying that small transactions are exclusively overseen by state agencies, and (ii) for larger transactions provide a 120 day SEC review period, following which state authorities could also choose to review if the SEC did not.

Where This Comes From
The president of NASAA is also a Texas state securities regulator and in testimony to Congress explained NASAA’s belief that (i) fraud is most effectively prevented when SEC and state authorities can review/investigate problem cases, (ii) NSMIA prevents state authorities from preemptively investigating cases and only allows them to investigate after fraud has occurred, and (iii) lack of Reg D oversight contributed to the financial meltdown.

It looks to me as though NASAA is concerned about the Bernie Madoffs of the world and sees increased regulation over private securities transactions as the best way to reign in this type of fraud.  Clearly NASAA also does not believe the SEC is up to the job of policing this environment.

Things I Don’t Understand
I don’t understand how the 120 day rule would work and I would love to ask Sen. Dodd the following questions:

-Will private companies be required to wait 120 days before closing financing transactions?
-If not formally required to wait, will investors have a rescission right if the SEC or state authorities find noncompliance with procedural or substantive requirements?
-How would this rescission right be enforced?  Brokers are subject to bonding requirements so there is the possibility of recovery in a fraudulent sale by a stock broker, but seemingly none with early stage companies in particular.  Six months after closing an angel financing a company may have already spent a decent chunk of the financing proceeds.
-Will state pre-closing notice requirements apply even prior to the SEC’s review period, so that e.g. a company would need to file a notice (and forms!) in NY, file an SEC notice 2 weeks later and then wait 6 months to see if NY would be able to pick up again?

What I Will Probably End Up Telling My Clients
In the most practical terms as a California lawyer, if this bill passes I will probably tell my clients that there is a sliding scale for transaction costs and timing that depends on where investors reside.  My gut tells me neither the SEC nor the CA Department of Corporations wants to begin scrutinizing early stage investments, so my advice to clients will be to keep all their investors in CA, and if they have investors in XYZ other states then the cost of completing the transaction will be dramatically higher and riskier.  This will be unfortunate.

What I Plan to Do
I am going to write a letter to both of my senators raising the questions above and asking them to look carefully at how this language will affect companies in California, and also how the concepts might be revised to avoid penalizing startup companies for the sins of hedge fund managers and unscrupulous securities brokers.  I have also added my name to the online petition here: http://gopetition.com/online/32354.html Apart from that, I plan to watch this closely to see how it plays out.

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LLCs and Corporations in New Entity Formation

March 20th, 2010

Limited liability companies (LLCs) have been around for 20 years now.  Until somewhat recently the conventional wisdom was that LLCs are useful for businesses whose ownership won’t change frequently (a huge range that covers retail businesses, service companies and investment funds) while corporations are better for businesses that plan to raise money from angel or VC investors.  That is changing fairly quickly and it is becoming more common to see LLCs set up in a way that looks a lot like an investment-driven corporation.

There are still big differences in the way ownership is divided among owners of LLCs and corporations.  This post will offer a quick example of how these differences can manifest themselves.  I need to emphasize that LLC structures are heavily tax-driven, I am not a tax lawyer and I am going to steer clear of tax discussion here as much as possible.  Tax experts reading this are encouraged to set me straight if I oversimplify or inadvertently mis-state tax concepts.

The example is from a situation that a client brought to me somewhat recently.  The client was a new company to be owned by two people.  One was the passive investor who put in $100,000 in seed capital and got 40% of the company.  The other owner was the day-to-day manager who invested nominal cash whose principal contribution was sweat equity and who was to own 60%. The question was whether to form a corporation or an LLC to do this.

As I have described in a couple of prior posts, the core principle behind stock in a corporation is that two people buying the same type of stock at the same time need to pay the same price per share.  If the client formed a corporation, Owner A’s $100,000 might buy her 1,000,000 shares at $0.10 per share.  To get 60% of the company using a single class of stock, Owner B would need to invest $150,000 and receive 1,500,000 shares.  We already know that Owner B is not going to do that, so if we use a corporation the only way to get the percentages to sync up with the amounts invested is to use preferred stock.  Owner B could invest $15,000 at $0.10 to get 150,000 shares while Owner A invests her $100,000 at $1.00 share to get 100,000 shares.  The table below is a simpler way to show how this works.

This gets the desired result but requires a lot of steps, two classes of stock, Owner B still needs to put in $15,000 and there is a 10x difference between the common and preferred stock prices that may or may not work well for accounting, 409A and general capitalization planning purposes.

LLCs are not restricted by this equal-price-per-share requirement.  Instead, one of the structural principles behind LLCs the the concept of a capital account- essentially a ledger of cash (or other assets) invested in the business, profit allocated back to the investor and cash (or other assets) paid out.  This accounting is also separate from voting, so we can easily set up an LLC that gives Owner A a 40% voting interest and a $100,000 capital account, while Owner B has a 60% voting interest with a $15,000 (or $1,500) capital account.  The voting interests and the capital accounts do not need to follow the same ratio.

The part that becomes non-intuitive is that we might want to make our company look like a corporation so that the owners have Units rather than just percentages.  Again, in a corporation we would need two classes of stock to get the desired result, but in an LLC we can provide that Owner A has 100,00 Units and Owner B as 150,000, meeting our desired a 60/40 ratio.  Voting is linked to the Units, while accounting and economic outcomes follow capital accounts.  We end up with a Units structure that looks similar to a corporation, but simpler because we only need one class of Units instead of the common/preferred shares described above.

Which is Better?
We can reach the desired outcome with either a corporation or an LLC.  In this case, the LLC provides a somewhat simpler way to get there and I have seen a number of situations recently where an LLC made more sense for clients with issues like this.  There are a half-dozen or so other factors to consider before deciding for sure which way to go (esp. ability to take tax losses for investment in the LLC and the likelihood that outside investors will be sought and that they will be comfortable with LLCs) so this is definitely not the beginning and end of the analysis.

This was a lot to pack into one post.  Feel free to post any questions or comments in the comment section or contact me directly.

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Key Considerations in Negotiating Earnouts when Selling a Company

March 6th, 2010

Last week the WSJ ran an article saying that Google is moving away from earnouts when it acquires companies.  Earnouts are a tricky thing whether you are a buyer or seller in an M&A deal.  The article gives a glimpse into some of the issues.  Here is a rundown on some of the background considerations.

Definition of an Earnout
An earnout means that if you are a key employee in a company being acquired, some of the total purchase price in the deal gets paid to you over time based on your continued work on the product post-acquisition.  The premise is that some people are passive shareholders who put in cash and don’t have a key role going forward, so they just get paid out at closing.  On the other hand, some team members may be necessary after closing to keep development moving on the product, so their compensation in the deal is linked to continued success of the selling company’s product post-closing.

Keeping the Product Going
Implicit in this formula is the idea that the buyer will keep the seller’s product alive post-closing so that both sides can measure success and the sellers have confidence in their ability to achieve the earnout.  The WSJ gives Disney’s purchase of Club Penguin as an example of this- Disney bought Club Penguin and has kept it as an independent product.  This makes it easy(ier) to measure Club Penguin’s future results and calculate whether earnout metrics have been met.

Compare this with Google’s acquisition of Grand Central.  The product essentially went dark for about two years and then re-emerged as the largely free Google Voice.  I don’t know if the Grand Central acquisition involved an earnout.  If it did, it would certainly be much more difficult to work out success metrics than in the Club Penguin situation.  Google buys a lot of companies for the teams or for product sets that can be worked into larger Google suites, so I can see why they would have trouble measuring earnouts.

Key Considerations
When an earnout is involved in a deal there are several important factors that buyers and sellers need to consider.

-The first is the most objective metrics the deal will permit.  Product revenue is ideal.  It is a pretty easy number to track and works well if the product will be independent post-closing.  If the product will be rolled into a suite of buyer’s products post-closing, or if the seller’s product is free then this metric doesn’t work as well.  On top of that, even if revenue is the main goal we need to think about what would happen if the buyer decides to close down the product line.  Would the earnout accelerate in that situation? Partially accelerate?

-Second is freedom to manage the business.  This usually comes down to “best efforts” language so that the seller has something in writing to say the buyer will put enough resources behind the product to allow the earnout to be met.  It is very hard to make an ironclad promise out of this, since the buyer usually wants freedom to change its business plans and goals as the market requires.

-The third factor is flexibility.  It is impossible to predict what will happen to a product or business, so an ideal earnout will provide enough wiggle room so that if the buyer’s business plans change, the seller can still claim right to payment of some or all of the earnout.

-The last factor is trust.  When a big part of the deal hinges on future performance, buyer and seller both need to have faith that everyone will behave going forward.  The buyer wants to know that the seller personnel won’t make decisions that guarantee their earnout at the expense of the larger business, and the seller needs to believe that the buyer will keep the product alive and manage it in a way that lets the seller achieve the earnout.

Earnouts are usually the most contentious part of M&A deals.  We always do our best to understand the other side’s needs and objectives in the deal, but there is inevitably a leap of faith on both sides that the deal will work out to everyone’s benefit.


Reading Agreements Critically with a Contract Playbook

March 1st, 2010

Followers of this blog may be aware that I avoid reading contracts front-to-back as much as possible.  I find that breaking a contract into chunks lets me read more quickly, more effectively and more critically.

To do that, a client and I recently adopted a strategy that I have used informally for a long time, which is to develop a playbook of preferred terms that we incorporate in our form documents so that when I sit down to read a contract I know exactly what I am looking for.

I start my review by comparing the contract against my playbook and making notes on any differences.  After I finish that I usually have a good sense of how the contract is structured, and I can then read through to put the sections together.

On top of the contract-review benefits, having a formal playbook makes it easier to coordinate contract strategy with clients, and also to maintain consistency over time.  When we have a clear sense of what “normal” is, we can develop a set of arguments to support our preferred terms, and also keep track of which deals required us to deviate from our standards.

A contract playbook is a great tool to read difficult contracts quickly, carefully and comprehensively.  I recommend it to anyone who needs to review a lot of documents.

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Making SaaS out of a Services Agreement

February 20th, 2010

Many software companies build products that live on the web and don’t install on local computers at all.  Enterprise-focused companies call this SaaS; everyone else just calls them web-based or hosted services.

Either way, developers of these products sometimes look for customers among big companies.  It is really common then that the customer’s contracts manager doesn’t quite get the nuances and sends over some kind of Master Services Agreement to document the deal.  Those agreements are generally based on the idea that the vendor is providing a specific, custom deliverable and don’t fit the situation very well.  I have been through this drill a lot and have a few observations about some of the important differences between a custom services and a SaaS deal.

1)  Work for hire language.  A Master Services Agreement will almost always say that the customer owns all technology and works created by the SaaS vendor during the course of performance.  This would be true if the vendor was writing custom software, but is the opposite of what the vendor wants in a SaaS situation.  This should be replaced with something that says the vendor owns all the software and anything developed during the term of the contract, and that the customer has a license to use all of it (subject to payment of all fees).

2)  Service levels.  The Master Services Agreement may not have any service level terms, such as an uptime guarantee or detailed procedures for responding to service errors.  This can work out well for the vendor since it allows more flexibility and avoids difficult conversations about discounts if the service goes down.

3)  Source code escrow.  Some companies feel strongly that if an important vendor goes out of business they should be able to take over the source code to preserve continuity.  With SaaS products these terms are especially inappropriate because the service is hosted- a customer would have to take over the entire service rather than just getting the source code to maintain an installation at its own facility.

4) On-site services.  Master Services Agreements can use a lot of ink on issues like vendor behavior on the customer’s premises and the customer’s ability to replace vendor personnel.  This comes out of the idea that vendor personnel will be in the customer’s data center regularly, which is not correct in a SaaS relationship.  I watch out for language that is really egregious here, but mostly try to leave this stuff alone since it just doesn’t apply very often.

The point of this post is that a Master Services Agreement is the wrong tool for the job in a SaaS deal.  From the vendor’s side, some terms definitely need to be changed, while others are not applicable but can be left mostly alone.  I always try to make the minimum set of changes that will let everyone sign the deal and get the relationship underway, while making sure there is nothing in the agreement that can come back to bite my clients later.

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IP Law for Startups Blog on Bratz vs. Barbie IP Dispute

February 15th, 2010

I recently started reading Jill Hubbard Bowman’s excellent IP Law for Startups blog.  I don’t practice IP law, but a lot of the work I do touches on intellectual property issues so I find her posts helpful and illuminating.

The “moonlighting” problem is pernicious for startup entrepreneurs.  It can take months or years to nurture an idea to the point where it can pay a salary, so it is natural for many people to chip away at their plans while earning a paycheck somewhere else.  The problem is that if their idea is closely related to their day job activities, and if they are not extraordinarily careful to avoid using work resources for the side project, then their employer can claim ownership of the new business ideas.

Jill has a great example up on her blog based on the Bratz dolls.  You should click through to read the whole thing (and subscribe to the blog), but some key facts include:

* $1 billion in claimed damages

* $100 million in legal fees for defendants MGA Entertainment, Inc. and Carter Bryant.


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6 Important Terms in Your Website Terms of Use

February 10th, 2010

Website Terms of Use are challenging for many entrepreneurs.  Many new companies have limited cash resources so deciding to pay a lawyer for a set of TOU can be a hard decision, especially with so many free examplars out on the web.  You should definitely review existing TOU prepared by other companies in your space.  At the same time, details matter a lot.  A company in your sector may have a different set of features that makes its TOU mostly, but not quite applicable to your exact circumstances.  I can’t tell you exactly what should go in your terms or whether you always need to pay a lawyer to prepare them, but here are some key terms to think about when you review the TOU landscape in your field.

This is a fairly obvious one, but will your site’s model be free, freemium or full-fare to users?  Will there be a trial period?  You would get extremely different pictures of what is standard for a news website depending on whether you used WSJ.com or NYTimes.com as a model.

Use and Content Licensing
This point is critical.  Will your users principally browse content on your site?  Will they use it to filter content from other sites?  Will they post a lot of original content? Reblogged content?  Will their information all be publicly available or will users maintain private information?  There are a lot of variables here and good terms of use will tailor themselves to your site’s particular needs.

For example, if your site is social like Flickr, your terms will reflect a higher degree of concern for ownership rights and you will want your users to affirm that they own or have rights to the content they post in very clear terms.  You also want unequivocal rights to display posted content publicly.

At the other end of the spectrum is a site like Mint, where users import private information on their banking and financial records.  You would want your users to grant you a license to incorporate their financial information within their accounts, but you would probably not want a lot of language about public display lest you cause confusion about what information you can/will make public.

Social Networking
Will your users interact on the site?  If so terms regarding a code of conduct are warranted.  Nearly all new web businesses I talk to these days envision some kinds of user interaction, so this is pretty close to “boilerplate” but I beef it up or trim it down depending on the site’s exact model.

Third Parties
If your site relies on advertising, sponsorship or other types of promotional content from third parties you need to explain to users what types of interaction to expect, what types of user information you can give to third parties and when you can/will give it.  This is a touchy area since sites need to develop partnerships and mine value from their user bases, but users are very wary of being spammed.  There is a delicate balance to be found depending on a site’s model.

Governing Law/Disputes
This one varies a bit less from site to site.  The important thing to know is that website TOU are enforceable in court, but fairness is a strong consideration.  If your TOU require users to come to a specific location to bring action against you, be aware that a court may well decide to throw out the term if the value users get is low.  Having a bunch of onerous provisions in your TOU may well lead a judge to look unfavorably on the whole thing as well.  There hasn’t been that much litigation over TOU in the last 15 years so it is hard to draw strict rules here, but the rule of thumb is to be reasonable.

Notice of Changes
The last important point is- what happens when you need to change your terms?  Most TOU say that changes are effective when posted to the site, and there is also case law saying that it is not reasonable to require users to check up on the current TOU continually.  Opinions vary widely on how to manage this, but my own view is that (i) non-material changes are ok to simply post, but (ii) if you need to add significant provisions or change material terms, you should let your users know by email as well.  That is why my practice with TOU is to tailor terms as carefully as possible to a client’s needs, and also leave room for the model to evolve so that we don’t need to revisit the TOU frequently and/or send out notices to users except in rare situations.

This is a complex topic and I have certainly not tried to be comprehensive.  Proper treatment of this subject would also include key terms in a Privacy Policy, since privacy policies and TOU go hand in hand.  This post is long enough already, though.  I will come back to privacy another day.




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How to Allocate Shares in a Startup When One Founder is Also an Investor

February 5th, 2010

I frequently talk to entrepreneurs starting a company where one founder is putting up seed capital while the others are putting in sweat equity alone.  The founders want to divide the company ownership according to some formula they have figured out, and then ask me how to document it properly.  This are several variables required to do this correctly.  Here is how I think about it:

Percentage Ownership
The founders have figured out an ownership ratio that makes sense to them.  Let’s say there are 3 co-founders, all of whom will be active day-to-day.  One founder will invest $100,000 in seed capital and the others will invest only nominal cash.  The founders have agreed that each of them should get 33.33% of the initial shares.  For simplicity let’s say that each founder gets 1,000,000 shares.

Stock Price
We always want to keep the price of common stock low so that as new employees, co-founders or others come along they can buy stock (or get stock options) at a low price.  I usually like to start with a founder stock price of $0.001 per share.  Stock should always be bought for cash, so we immediately have a problem matching the 1/3-1/3-1/3 ownership ratio with the varying amounts of cash being invested.

Using our hypothetical numbers, Founders A and B are getting 1,000,000 shares at $0.001 per share, which means they need to put in $1,000 each.  If Founder C is buying the same type of stock, also at $0.001, his $100,000 will buy him 100,000,000 shares; he will own 99.99% of the company.

Preferred Stock to the Rescue
My recommendation here is to treat Founder C an investor as well as a sweat equity founder.  By this I mean that we can issue some of his shares as common stock like the other founders, and some of it as preferred stock, which lets us set a higher per share stock price.

Preferred stock is “worth” more because it has rights preferential to common stock.  The rights can vary a lot, and in this case I would provide only a nominal step-up in rights compared to the common stock, so that if our company gets sold Founder C would get his money back before any money is distributed among the common stock holders.  If the company is sold in an extreme fire sale, it is possible that Founder C would be the only one to get any money out, but with luck we will be able to sell this company for more than $100,000.

Stock Repurchase Right
The last important piece here is that all founders should have their sweat equity shares subject to a company repurchase right.  The stock “vests” so that if a founder leaves after a year or two, she only gets to keep the equity she has earned through service.  In my view, all of the common stock should be subject to the repurchase right, but since the preferred stock is purchased for a cash investment, it should not have a repurchase right attached.

In this example, 100% of Founder A and B’s shares are subject to repurchase, but 90% of Founder C’s are not.  This might be the right outcome- or we could adjust the Preferred Stock price and the relative amounts invested for common stock and preferred stock so that Founder C owns more common stock, and has more stock subject to repurchase.  There are a no “right” answers here and it is just a matter of finding the set of conditions that best represents the founders’ relationships.

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Promise and Pitfalls of Convertible Debt

December 21st, 2009

Attorney Scott Edward Walker has a post up today on VentureBeat about angel financings.  His tips on due diligence and personal liability are superb and well recommended.  He also advises entrepreneurs to push for convertible debt as a way to take on small investments in a simple way.  I left a comment on his post with a caveat about debt financings and this blog is an extension of that.

(Convertible debt means that instead of purchasing stock in the company at $0.xxx per share, an investor buys a promissory note with the intent that when a larger financing happens in the future, the promissory note and accrued interest will convert into the same kind of stock sold in the large financing).

I agree 100% with everything Scott says about convertible debt.  It is simpler to document and it avoids having to put a valuation on the company.   I also know a lot of angels who know how to evaluate great technology, but have no idea how to figure out how much it is worth.  Convertible debt helps get money to entrepreneurs more quickly and with a bit less discussion of valuation.

There are a few gotchas, though.  The biggest one is that if the later financing never happens, or doesn’t raise the minimum amount needed to convert the notes, the company is stuck with a bunch of debt it generally can’t repay.  This becomes awkward.  The investors came on board expecting to end up with equity and instead hold a bunch of near-worthless promissory notes.  The notes themselves come ahead of the founders’ stock in line for repayment, so until the company can find a new source of cash to pay them down, management’s stock is completely worthless and the founders are working 100% for the investors.

Investors would end up with $0 if they foreclosed on their notes in this situation so they tend to be very accommodating, but entrepreneurs still spend a lot of time managing the relationships.

I have seen convertible debt work best as a bridge, where everyone knows the large financing is coming and one of the investors in that deal puts up a little short-term cash to see a company through a tight spot.  In a pure startup situation, taking on convertible debt is a gamble that the big money will present itself.

I talk to clients about their early-stage financing options all the time.  Here’s how I break it down to them in a nutshell:

Pro: Convertible debt is useful to document small investments quickly and without having to place a valuation on the company in its earliest days. 
Con: If the later financing doesn’t come through, or if it takes longer than expected, entrepreneurs can spend a lot more time managing the company structure than if they had sold stock at the outset.  In the worst case, note holders could force a company to sell and shut down before the founders are ready.

Con:  Preferred stock requires more paperwork to document.  It also requires that the founders commit to sell __% of the company to the investors, and the valuation can cause trickle-down issues for stock options and other equity incentive compensation, including the dreaded 409A rules
Pro: Once done, it’s done.  If founders and investors can agree on the valuation (and the investors can agree to do a stripped-down set of financing terms), I generally recommend going the equity route since then the investors’ situation is locked down and less likely to require time spent managing the equity relationship.

Good post, Scott.

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