Startup Toolbox

Jay Parkhill January 31st, 2008

Clients ask me all the time whether they should form their businesses as Delaware corporations, and what the benefits of Delaware are generally. My advice is that for early-stage businesses Delaware is an added, unnecessary expense, but as companies mature, spread out nation-wide and go public, Delaware has a volume of law and litigation history- and a degree of consistency in its decision-making- such that the outcome of a variety of disputes can be predicted with a decent amount of accuracy.

I don’t get to cite many great examples of this, though. Here is one where litigation in a Tennessee court seems likely to end badly. I can’t imagine a Delaware Chancery Court reaching a similar decision.

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Clothing retailer Finish Line, Inc., backed by UBS financing, made an offer to buy Genesco, Inc. in a deal valued at $1.5B. Finish Line and UBS then tried to back out of the deal, saying that Genesco had failed to disclose material information that would have made the deal less attractive had it been provided up front.

The Tennessee Chancery Court held that although the merger agreement allowed for termination based on “material adverse events”, the reasons for Genesco’s declining performance were general economic conditions that fell within an exception to the termination right.

The Chancellor went on to hold that the appropriate resolution of the case is to require Finish Line to complete the merger.

This can’t end well for Finish Line, whose market capitalization, at $110M, is about 10% of what it was when the deal was announced in June 2007. That means the purchase price is close to 15x Finish Line’s current value. Ouch.

I can’t say for sure that Delaware would have reached a different decision, but I would be amazed to see it force a merger to go through under circumstances like this.

The other point worth mentioning here is that choice of law provisions are hard to negotiate in contracts. Each party usually wants its home state law to govern, the business principals never want to get involved in that level of detail and the lawyers seldom have enough specific data to make a convincing argument that ___ state will work out badly. In probably 99% of cases *not* arguing the point is probably the right result as well, since so few disputes actually go to litigation.

Sometimes, though, it matters. When I negotiate deals there is a handful of states whose laws I am comfortable with and I try not to let choice of law slow done completion of a transaction. The Finish Line case is a good piece of ammunition for compromising on Delaware when asked to provide for choice of law of a state with which I am not familiar.

• M&A

Jay Parkhill January 15th, 2008

VentureBeat reported that Facebook is set to buy Plaxo and speculates that the latter company’s huge database of email addresses and its technology for syncing contacts across platforms could be driving factors. That sounds like a reasonable idea, and it might be just as likely that any acquisition is a preemptive one to keep Plaxo’s technology from being snapped up by another social network.

Whatever the reasons, and assuming there is any truth to the rumor it sounds like a great idea. I have accounts on Plaxo and Facebook and check them both almost daily. I’ve realized they are nearly complete opposites: Facebook has a wealth of “stuff” happening with all the various applications my friends use, but it’s a roach motel- data goes in but has a hard time getting out.

Plaxo, on the other hand, is a completely open list of many more of my contacts, but with nothing much happening. I get news feed updates showing my friends’ Twitter and blog posts, updated contact information and birthdays, but that’s about it. Nothing original.

A merger that combined Plaxo’s openness with Facebook’s usefulness could be interesting somewhere down the line. I (along with probably just about everyone else) would love to check out new social websites from time to time without having to re-invent my social graph on every one just to make it useful. If Facebook could Plaxo-sync-invite my friends into applications that live outside of Facebook (I gave up on Tumblr after about 15 minutes because I didn’t know anyone else on it)- now that would be neat.

P.S.   I’d be pleased if Plaxo’s current or future management made it a little more difficult to send “connect with me” invitations. I realized recently that I accidentally spammed every single person in my address book- including all the people I met once and don’t really know- with an invitation.  Sorry about that.

• M&A , social media

Jay Parkhill August 8th, 2007

Congratulations to the group at Kaboodle, who just announced their acquisition by Hearst Media. I was privileged to work with them at their inception- it’s a cliche, but you would be hard pressed to find a nicer group of people. They worked hard to build Kaboodle into a solid shopping bookmark destination, and I know Hearst has big plans for the future as well. I’m looking forward to seeing it.

• M&A , Startups , Web

Jay Parkhill January 5th, 2007

I recently found a couple of articles talking about the AIM and its place in the scheme of things for cash-hungry businesses. My earlier point about the AIM was that it is not a very good “out” for companies hoping to escape the US environment. Most companies merge eventually, and if a suitor is subject to Sarbanes-Oxley and the rest of the SEC’s requirements, the prospective selling company had better comply as well or risk a drop in its purchase valuation.

AIM as a Step on the Road to Liquidity
Cleantech Investing summarizes the benefits and pitfalls of the AIM pretty well. It is easier and cheaper to go public, but harder for big shareholders to get liquidity given the thin trading in most stocks on the market. The AIM therefore serves more as an alternative to mezzanine financing for certain kinds of companies- it is not a good source of liquidity and at present doesn’t appear to be a great place to remain long term.

This may all change over time, of course. The number of US-based companies on the AIM (36 by my count) is very small. Still, the data definitely supports my thinking that companies need to maintain a plan for Sarbanes compliance.

AIM as Market of Choice for Clean Energy Companies
The other interesting point Cleantech notes is that a survey lists the AIM as the go-to market of choice for clean energy companies, and predicts it will remain that way for the next three years. The survey summary is frustratingly short on detail as to why this should be so. It cites the “arduous US regulatory environment” as the principal driver behind the trend, but doesn’t explain why this makes the AIM more compelling for clean energy businesses than for those in any other sector.

The danger I see in this thinking is companies financing themselves into a corner by going public too quickly with too little planning for how to keep M&A valuations high in the long term.

• Cleantech , M&A , Markets , Sarbanes-Oxley , Securities

Jay Parkhill January 1st, 2007

The AIM, formerly known as the Alternative Investment Market of the London Stock Exchange, has gotten attention recently in the US due to increasingly complex and burdensome reporting requirements for companies listed on US-based stock exchanges, most notably the Sarbanes-Oxley Act of 2002.  In particular, Sarbanes-Oxley’s Section 404 requires companies to certify that their internal controls and procedures are sufficient to provide complete and adequate disclosure of material issues to investors.

Sarbanes only applies (formally at least- more on that point below) to public companies listed on US exchanges, esp NASDAQ and the NYSE. A trend has thus arisen in the last couple of years where companies seeking to raise capital from public markets do so on exchanges outside the US. A few companies have listed on the Toronto Stock Exchange, but the exchange receiving the most attention is the London Stock Exchange’s AIM.

In some respects, this is a natural fit. The AIM was created in 1995 as a “lighter-touch” alternative to the main London Stock Exchange. Costs of an initial listing are much lower than the LSE, NASDAQ or NYSE and ongoing regulatory requirements are much less stringent as well.

There are currently about 1,600 companies listed on the AIM, of which 36 described themselves as US-based as of this writing. The regulatory requirements consist principally of the oversight of a “nomad“, a nominated advisor hired by the company both to vet the company’s filings and to advise the company on investor-relations issues. The Wall Street Journal (subscription required) has a good article on pros and cons of the nomad system. Since January 2005, the number of US companies listed on the AIM has tripled from 12 to 36, indicating a possible trend in the making (though the numbers do not exactly indicate a mass exodus from US exchanges).

However, companies hoping that the AIM will let them avoid the US regulatory framework are misguided (Sarbanes-Oxley imposes the most stringent set of requirements in the US currently, so this post focuses on compliance with it).  It is the rare company, public or private, that continues in business indefinitely without being acquired.  Any company that lists on the AIM thinking it will be able to forever avoid Sarbanes issues succeeds only in (a) limiting its pool of prospective acquirors to other business not subject to US securities laws, (b) reducing its sale price by the amount required to bring the company into compliance, or some combination of the two.
Thus, companies listing on the AIM still need to comply with Sarbanes-Oxley. AIM provides a way for companies to go public at significantly lower cost than in US markets, but as the title of this post suggests, the AIM is not a way out of Sarbanes-Oxley compliance.

However, this is not to say that AIM has no value.  There may well be companies capable of going public and supporting a reasonable valuation on a small-cap exchange, but for whom compliance with Sarbanes-Oxley and other US regulations would be excessively burdensome.  This seems like a pretty big gamble, but it is possible that such companies could go public on AIM, get enough cash to kick the business into high gear, then bring in US compliance at a later date.

Given that the AIM has underperformed major US indices recently (see chart), it seems as though the risk here is extremely high. As this chart shows, the S&P 500 during 2006 outperformed the AIM as a whole by close to 15% (note: I have not tried to separately measure performance of US-based AIM companies).
On balance, then, the AIM sounds like a great opportunity, but it entails significant tradeoffs as well.  Companies listing on AIM need to be aware that long-term planning will probably require them to deal with Sarbanes-Oxley and other US securities laws at some point, and choosing not to comply in the short term may foreclose- or alter the economics of- merger opportunities in the future.

• M&A , Markets , Sarbanes-Oxley , Securities , Startups

Jay Parkhill December 4th, 2006

I have been thinking about where things are headed with Web 2.0 recently. There is plenty of talk about how so many Web 2.0 companies aren’t real businesses, but are really features designed to be integrated into Google, Yahoo or some other larger property. I am sure this is true. Bubbleshare’s traffic is perfectly decent and I really like the company’s simplicity and tools, but are they enough to distinguish it as a standalone in a crowded field? If the rumor mill is accurate about its sale, the answer seems to be, if not flat-out “no”, then at least “let’s take the cash over the risk”.

The really interesting point to me is that there has been a small group of really huge exits (YouTube, MySpace, Skype) and a lot of transactions for $30M or less (Flickr, del.icio.us, Jumpcut, etc.). Until this year, I am aware of very few exits in the $50M - $200M range. Startup Review (to I am a contributor) is one of the best resources for these mid-tier exits that I am aware of, though it is not comprehensive by any means.

What does this all mean? The major acquisitions say to me that the biggies felt like they had missed something important and couldn’t catch up without buying the brand that already had the traffic. The small exits tell me there are many companies that really are just featuresets. Especially given the short lifespan of many of these businesses, this is not a criticism: acquisition within a couple years for a few $MMs is a nice result and a great launch platform for the next business.
It is the middle group that is the most interesting. These companies are more than some bits of great code and less than a runaway consumer hit. What made Sony pay a solid chunk for Grouper, or Google do the same (reportedly) for Jotspot? Both of those companies happen to be second at-bats for founders with substantial Web 1.0 successes behind them (Spinner and Excite, respectively). It may be that the acquirors in those cases really wanted the expertise of the management teams. I am sure that is part of it. I also hope that transactions like these representing a maturation of Web 2.0 business models. Yes, AdSense revenue is still a viable and important component of online businesses, but the ones worth a significant price tag have more to offer than just that.

• M&A , Web

Jay Parkhill November 1st, 2006

Mark Cuban posts an interesting read on his blog about the multiparty negotiations required to pull off the merger. The full description is worth a read, but the essential points are here:

*Youtube had rapidly mounting copyright complaints from content owners large and small. Revenue-share offers to the major studios didn’t go far because Youtube can’t track revenue/clip very easily (to the extent it gets any).

*Once Google came on board the lanscape changed. The piece claims that Google set aside $500M of the purchase price as an escrow to deal with copyright infringement claims.

*Youtube/Google also negotiated agreements with the major studios, as has been previously described. From what I understand, the studios got shares of Google stock, so presumably the escrow funds are still intact.

*The piece also says that Youtube got a 6 month “standstill” on any claims- i.e. they have 6 months to put copyright-policing measures into place before the studios start complaining again.

*At the same time, with Youtube at least nominally “friendly” to the studios, attention turned to the other video sharing sites. Hence the actions filed shortly post-closing against Grouper and Bolt.

Cuban did a great job calling this strategy long before it emerged. He predicted the studios would target some “shallower pocket” sites in order to set precedent before going after Google/Youtube (ok, so Grouper is owned by Sony, a pretty deep pocket itself. IMO Cuban still gets full credit for calling the play, even if the details werent’ spot-on).

Given the relationship between Google and the studios now, it might not be necesary to go after them at all. The lawsuits could have the effect of putting competitive video sites out of business and cementing Youtube as the home for online video for some time to come- and the only major player the studios need to deal with.

Assuming this is all true, it is a masterful piece of work by the Google & Youtube teams. Getting the studios on board seems like the only way to justify the $1.65B price.

There is definitely a lot of risk still in the strategy, though. One reason Youtube got so big is the availability of copyrighted material. If the spigot is turned off, it seems to me that consumers will find another source. Studios could be stuck playing the same whack-a-mole game with video sites that they do with peer-to-peer music sites: as soon as one gets knoecked down another pops up.

• M&A

Jay Parkhill October 5th, 2006

The story of Mark Zuckerberg’s negotiations with Microsoft has made the rounds after being first reported in the WSJ, but is amusing nonetheless.

Zuckerberg declined to attend and 8AM meeting on the grounds that he wouldn’t be awake that early, and further passed on a weekend conference because his girlfriend would be in town.

The Microsoft team had to get a pretty bad feeling from this treatment. “He’s just not that into you” seems to sum up the tone pretty well.

• M&A