My partner and co-conspirator at AsktheVC (Jason Mendelson) guest blogs tonight.
Unfortunately, I (Jason) get stuck being the shareholder representative in our merger deals where we can’t find someone else to do the job. (Someone should start a company – hmmm.) We had a deal that over a year ago distributed the escrow, but the escrow agent wasn’t able to find a dozen or so shareholders and today, we still have $500,000 or so in the account.
Every month, I get a statement from U.S. Bank saying “Hi, you have $500,000 in your account.” And every month, I ask myself “what can I do to bring this to a close?” I’ve done the obvious. I’ve gotten the shareholder list, tried some Internet searching, asked former company executives if they know any contact information, etc. Nothing. (As an aside, I don’t really have a duty to do this, but I figured it’s all good karma to try.)
So today, I ask our friends at U.S. Bank “what happens” if these folks are never located. Simple, she says: the state gets the money. (In this case, the state being California.)
Huh?
It seems that money left in escrows defaults to the state after some period of time. Here is a little source of revenue for the state that I was previously unaware of. I began to ask myself is there a way that lawyers can better draft a merger agreement; i.e. all money left over in the account is distributed pro-ratably to shareholders who are locatable. Answer: no.
CA state law says that you must treat all shareholders equally. If you give one set of shareholders the consideration earmarked for other shareholders, you breach this covenant. Even is Delaware if the choice of law, or the companies involved are located outside of CA, it still may be possible for CA to go after you if the shareholder who doesn’t get paid is a resident of CA. You can, however remit the cash or stock back to the acquiring company if you so choose to do so. Um, yeah, thanks.
So, the bottom line is that the state has found a hidden revenue source and is using corporate law as a shield to support its position. I love it.
This example is relevant for California. We haven’t done an exhaustive analysis of other states, but we will just for our perverse curiosity.
The MIT Enterprise Forum has an annual program called Venture Capital Outlook. If you are in Colorado, you can see a 40 minute digital presentation of this from MIT/Cambridge and a panel of Boston-area VC’s followed by a live panel of Colorado VCs discussing the same questions, namely the trends from 2006 and what they see happening in 2007.
The Colorado–based VCs (in the flesh rather than digitally rendered) are:
If you are interested, you can register online. The coordinates for the event follow.
Date: Wednesday February 28
Time: 5:30-7:30pm (doors open at 5pm for networking)
Location
The Main Auditorium, ATLAS Building
CU Boulder Campus
18th Street and Euclid
Boulder, CO 80302
Cost
$25 General Admission
$15 MIT Alumni Club & Ivy League Club Members (and their guests)
$20 MIT Graduates & CTEK, CIK, CSIA, DTP, TiE, YEO (and their guests)
$10 (cheap) for CU/DU/CSU MBA or Law students
Following is an exchange I had with a friend and someone I like to co-invest with.
Me: You’ve been awfully quiet lately. Is everything ok? Just checking in and saying hi.
Friend: Thanks for checking in. Yes, all is well. Just busy with an office move, some projects at home and work with my companies. I am expanding beyond web 2.0 as an investment strategy so spending time with peeps outside of our traditional network. Will tell all about it during our next dinner.
Me: Sounds cool. Glad you are starting to fish in a new pond now that this one is starting to feel like a river at peak salmon season with everyone wall to wall doing some combat fishing,
Friend: I have been up river for almost 3 months, fishing with a shell launcher shotgun and an ice barbed spear.
When the river that you have been fishing in for a while becomes the popular place for everyone to hang out and fish, it’s often time to go find a new river (or at least a new spot on the river) that doesn’t have anyone around.
Earlier this week eBay announced it was buying StubHub for $310 million. My partner Ryan McIntyre – who was an early angel investor in StubHub (congrats Ryan – dinner next time is on you) has an excellent post titled StubHub: the value of vertical specialization.
While building a horizontal technology is often the starting point for many entrepreneurs and VCs, we continue to experience the incredible power of vertical specialization. This is distinct from “going after a vertical market” (say selling products to law firms, or manufacturing firms, or financial services firms) which is another classic approach of entrepreneurs and VCs (I can’t tell you the number of times in the past 10 years I’ve heard “we are doing X and are going to dominate vertical market Y and, after that, dominate vertical market Z.” Much of this emerged from the Geoffrey Moore bowling alley thesis from Inside the Tornado but was also a standard strategy of many of the successful software companies in the 1980s and 1990s.
Vertical specialization is different. Service Magic took the notion of a generic buyer / seller marketplace and applied it to an ecosystem around home ownership (contractors first, then home buyers / real estate agents, and finally mortgage financing.) Stratify took a horizontal enterprise search technology that was awesome but difficult to sell (“hey Mr. CIO – do you want to buy some horizontal enterprise search?”) and applied it to the business of electronic discovery, building in awesome company in the process. Granted – you could say that each company went after vertical markets (which is an element of vertical specialization), but the key is that they took a horizontal technology and applied it very clearly to a vertical market and then built out a robust business around that, rather than customizing a generic application for a vertical market and then expanding into the next vertical market after they had some success.
Vertical specialization doesn’t work if your underlying horizontal technology doesn’t work. So – when you hear someone talking about how they are doing “vertical search applied to market X” or a “vertical social network for category Y”, dig deeper and find out how they are actually doing it and whether the underlying technology will work at scale.
A friend of mine and active angel investor asked me the following question recently: “I thinking of getting involved in a ‘base hit’ type company, but one that feels like I could really help. It probably won’t be a huge win, but then again I feel confident it will at least work and be viable. I’m just struggling with committing my time, which is of course my most valuable asset. I guess I fear the opportunity cost of not being able to focus on things that could potentially be bigger. How do you reconcile this sort of stuff as an investor? I sent him a long answer which – after I sent it – realized it was a blog post. Following is what I wrote him.
It’s difficult. There’s a natural tendency to over commit and then have to back off. I’ve been through the cycle several times and have ultimately come up with a methodology that works for me. I break down my involvement into three categories: Lead, Active, and Passive.
– Lead: I’m the most engaged investor. I’m often chairman or one of the large shareholders. NewsGator would be an example of a venture deal in this category; Lijit and ClickCaster would be examples of angel deals in this category. It’s important to realize that Lead is not an absolute – a company can have more than one investor categorized as Lead. For example, I’m not the largest % shareholder in FeedBurner (I’m second), but I’d categorize my involvement there (at least in my own methodology) as Lead.
– Active: I’m on the board, but someone else is a more active investor. As mentioned above, in venture deals, the % ownership doesn’t always determine Lead vs. Active. As a VC, I’m rarely simply “Active” (I’m almost always Lead – I don’t do “Active” very well). As an angel, I’m often Active. Me.dium would be an example – Spark and Appian are Leads, but I’m on the board and consider myself in the Active category.
– Passive: These are situations where I have money in a deal and am following others. Thetus, Wild Divine, Dogster, and Loomia are examples of these. I never have a board seat in these situations.
My level of involvement is highest in Lead, still high (but not as high) in Active, and much lower in Passive. In Lead, I’m always proactive about my behavior. In Active, I’m proactive, but usually in the context of “the board” rather than an individual contributor (e.g. Chairman). In Passive, I’m reactive – I’ll help as much as I’m asked and I offer feedback, thoughts, and connections regularly, but I’m not looking for additional responsibility.
I’ve found that I can handle about 10 companies in the Lead / Active category at one time and an infinite number of Passive ones. It took me a long time figure out this split – at one point around 2000 I probably had 20+ Lead/Active companies (including being co-chairman of two public companies) before everything melted down. Everyone is different – I know some VCs that can’t handle more than 4 Lead / Active companies; I know others that much prefer to have ONLY Lead (or Lead / Active) companies (and no Passive ones.) And – I know plenty of VCs that think they are in the Lead/Active category, but really are only Passive + board meeting attendees.
You have to come up with your own approach. At the stage that you are at and given your temperament (at least what I know of it), I’d recommend you go through one over commit cycle. You should be comfortable stretching your boundaries to see what you can / are willing to handle knowing that you ultimately control your level of individual commitments and can back off as you see fit.
Mark Suster of Koral has a great story up on his corporate blog about his experience raising venture capital. I’m just glad I don’t appear to be one of the assholes he met with at the beginning of the process.
Fred Wilson has a great, descriptive post on how he thinks about deal size in the context of his fund (Union Square Ventures.) The “Brad” in the post is Fred’s partner Brad Burnham. Overnight I received a question from someone about “typical deal size” – I couldn’t have answered it better than Fred did – who clearly demonstrates in his post that it is firm specific. If you want to get inside the brain of an early stage VC (e.g. have your own Being John Malkovich moment), read Fred’s post.
Fred Wilson of Union Square Ventures has a great post up on why he prefers to be the lead investor in the companies he invests in.
On Wednesday, the IRS announced what it called “relief” extending the “transition period” of compliance with 409A through January 1, 2008 (unless you are a public company and you are involved in a back dating scandal, then you are still hosed.)
What the IRS really means (as translated by my trusty sidekick Jason) is “We still can’t figure out how to implement this puppy, so we are telling y’all to keep complying the best you can (in good faith) and we’ll get back with you fine folks once we figure out what we meant in the first place.”
Bottom Line: Act as if 409A is alive and well. Refer to our prior posts if you are curious about our take on it. We continue to hope that someone important in Washington DC will wake up one day and realize how completely absurd 409A and kill it. Oh well – it’s good to have fantasies.