StartupSD

I’m a VC/startup lawyer with a budding interest in blogging, so naturally I was attracted to startupSD. Before I go on I have to give the legal disclaimer: nothing I say should be held against me (or my firm), and this blog isn’t legal advice. If you need legal advice, call a lawyer (I know a few)!

With that out of the way, I figured a good way for me to add value on the site was to post a few blogs to help de-mystify some of the terms in VC term sheets. You’re probably dying to get a term sheet from a VC, but this is a case where you should be careful for what you wish for. As soon as you get one, the question is what the heck do the terms mean and what’s important and what’s not? If this post gets some positive feedback and is considered useful, I’ll de-mystify other terms with future posts. So feel free to comment below.

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One dirty little secret among VC lawyers is that there’s a relatively standardized set of terms and forms for VC deals. Not all VCs or their lawyers rely on them, but the forms on the website of the National Venture Capital Association, including their term sheet, are very helpful in getting yourself an education as to what terms mean, what the choices are between VC friendly and entrepreneur friendly, and some middle-ground solutions. You should be aware that the forms, not surprisingly, are VC friendly out of the box, but they’re useful for entrepreneurs to begin to educate themselves nonetheless.

VC Term Sheet Term of the Day: “Participating Preferred”

What is “Participating Preferred”: the Short Answer

What does “participating preferred” mean? The short answer is that it’s the VC-friendly version of a liquidation preference in a VC financing, compared to the company-friendly version, a 1X non-participating preferred. If that sounds like jargon to you, check out the longer answer below.

The More Detailed Answer

To back up, VC investments, at least ones for equity (instead of convertible debt, a subject for another day), are usually made through investing in convertible preferred stock. “Convertible” means it’s convertible into common stock, usually on a one share of preferred to one share of common basis. “Preferred” means is that this stock has special rights compared to the common stock it can convert into. Those preferences could conceivably be anything, but in the VC world there’s a fairly standard set. And the main right is a liquidation preference. Because these rights are specific to the preferred, they’re lost if the holder decides to convert into common stock.

Liquidation Preferences

A liquidation preference is what it sounds like: if the company has to liquidate, the “preferred” get a “preferential” payment before the common stock does. You may think that’s not likely to be relevant to you, because if the company liquidates, the game’s over anyway. And in many cases that will be true. But consider this: VC term sheets define liquidations to include a sale of the company. So we’re not only talking about payment on the “downside” of a liquidation, but the “upside” when that big multi-national notices your technology and is willing to pay big dollars to snap you up. Perhaps it’s not a surprise, but in that instance, the VCs will get paid before the founders due to the preferred’s liquidation preference.

A liquidation preference can be any amount. Traditionally (and currently) that preference is usually set at what the investors originally paid. Back in the tech meltdown, venture investments were seen as riskier than they’d been during “the bubble,” so in that dark and uncertain period, not only did VCs ask for their money back, they asked for multiples of three to five times their money back before any money went to the common. If the economy continues to slow, we may see VCs start asking for these multiples again, but for now I’m still seeing 1X liquidation preferences, or in other words, VCs being entitled to their money back first, but not more.

Participating Preferred

Here’s the deal. Imagine again you’re selling your company in a deal that’s a big winner. A really big winner, where the common stock is going to get many times more than the preferred is with their 1X liquidation preference. For illustration’s sake, let’s say the company sold 1 million shares of Series A at $5 each, and there were another 4 million shares of common outstanding. If the preferred don’t convert into common, all they’ll get is their 1X payment (or $5 per share), while if they do convert, they’ll get twice that ($50 million divided by 5 million shares = $10 per share). So in this scenario they’ll obviously convert to common, in the process losing that initial liquidation preference. Why not, the enterprising VC and their lawyer wondered to themselves, get our cake and eat it too? Why can’t we have both the liquidation preference and participate with the common? And the answer is, of course they can, if the VC asks for participating preferred and the founders agree.

So what “participating preferred” means is that the preferred gets its initial liquidation preference back first, then it participates with the common as-if it had converted. In our $50 million sale of the company, rather than the $10 per share the preferred would get under non-participating preferred, the first $5 million would instead all go to the Series A, then the Series A and the common would be treated as equals for distribution of the remaining $45 ($45 million divided by 5 million shares yields an additional $9 per share). That sums to a total of $14 per share to the preferred and $9 per share to the common.

As a result of this math, VCs will most often want to get participating preferred. It’s always better for them. Entrepreneurs and their lawyers have learned to push back, but success in this negotiation depends on negotiating leverage, and the one with the upper hand usually wins. Doing a deal requires two interested parties, but someone is often more interested than the other, and they’ll probably be the one that gives up on this point.

Somewhat of a Middle Ground

Since non-participating is “company-friendly,” and participating is “VC-friendly,” the obvious question is whether there’s a middle ground. And the answer is a qualified “yes.” Sometimes investors and companies will settle on a “capped” participating preferred, where the participation is capped at 3X to 5X the original investment. This will only come into play where the deal is rich enough to get above these levels. For example, using our stock numbers above, imagine that the deal is for $100 million instead of $50 million. With participating preferred, the preferred gets the initial $5 million then gets another $19 per share ($95 million divided by 5 million shares), for a total of $24 per share for the preferred, and $19 per share for the common. If the participation were capped at 3X, the preferred would get a maximum of $15 per share back and the common would get $21.25 ($85 million divided by 4 million shares) each. But again the holders of the preferred would want to convert into common at that point since it yields a cool $20 per share ($100 million divided by 5 million). If there were no cap, there would never be a reason to convert. The preferred would always take the first $5 million and then share the entire upside. But with a cap, once the return hits the cap it can become more lucrative to convert into common, which effectively re-distributes that initial $5 million among all stockholders. In our example, because $20 per share for the common is better than $19, if the company can get capped participating preferred rather than pure participating preferred, the common holders will be better off.

Conclusion and Disclaimer, Again

There are a number of assumptions built into the general statements I make above, so your mileage may vary. And again, you’ll need a good lawyer to walk through your particular situation, on this issue as well as the many others in the Series A term sheet you and your co-founders and employees worked hard to get. But if you get that term sheet, and your lawyer says “they want participating preferred,” now you’ll know that you’re being asked to give up more of the “upside” than you would if you got the VCs to accept non-participating preferred. And if you can’t move the VC back to non-participating, you may be able to at least cap the participation and re-capture some of that upside should your company be a huge winner. So best of luck, and be safe out there!

Popularity: 19% [?]

Mahalo, the Los Angeles based human powered search engine startup who’s CEO is the infamous internet personality, Jason Calacanis, is searching for the next host of their popular vlog, Mahalo Daily. The contest, which was announced about a month ago, is now a tight race between 12 different female contestants, all with varying levels of geekiness and experience in front of the camera.

Here’s the contest teaser video…

San Diego’s very own Lisa Brewster is one of the 12 finalists currently on pins and needles awaiting the next, but already delayed, announcement about the contest finalists. Check out Lisa’s initial audition or her most recent appearance in the second round of auditions below.

Contestants were initially informed that another round of cuts would take place on the day of the second audition, but that didn’t happen and now everyone, Lisa included, is in a holding pattern awaiting the next decision.

About Lisa Brewster

Lisa’s diverse background includes everything from system engineering experience, modeling for Zivity, to a minor in Theatre from the University of Texas at Arlington. On her blog, Sophistechate, Lisa describes herself as…

…an engineer, photographer, and web 2.0 entrepreneur starting trends in technology, culture, and geek sexuality. Broadcasting live from San Diego, California.

It’s a pretty incredible feat that Lisa has managed to beat out the majority of the competition, and become a top 12 finalist, all the while never having vlogged before. In her own words, Lisa states:

I have no vlogging experience whatsoever, so it’s been extremely stressful to throw myself into this kind of “sink or swim” environment. There’s no way I’d have the confidence to keep going if it wasn’t for all the people who believe in me. I highly advise taking these kinds of risks, though…it’s a sweet reward when you suddenly realize that you haven’t drowned yet. This experience has changed how I approach my life, and for that reason alone this contest is a personal success for me.

How can you help Lisa Brewster be the next host of Mahalo Daily?

Show her some love! The only way to keep her in the contest is to prove to Jason Calacanis and crew that Lisa Brewster is capable of inspiring and motivating people to spread the word about Mahalo Daily. Help Lisa get exposure by using Twitter to proclaim your love for her (@adora) and/or Mahalo (if @jasoncalacanis follows you, why not send him a DM), comment on her videos or photos, and tag all related content with “mahalo” or “mahalo vlogidol.”

If all goes well, Lisa will be selected as a top 5 finalist and we’ll all have the opportunity to vote for her — American Idol style. Of course StartupSD will keep you posted as soon as we know more.

Quoting Lisa - Some Thoughts on Mahalo Daily and the VLOGIdol Contest

• She found out about the contest through this tweet by Sean Percival.
• Her toughest competition is probably Sara Atwood, who has “her own weekly show called Nerdtainment and is one of the few contestants with the coveted geek cred.”
• The Mahalo Daily vlog was initially started as “a way to generate buzz about result pages that they’ve recently added to the search engine.”
• Mahalo has “an irc bot in their main chatroom that tells them every time anyone mentions mahalo on twitter.”
• She thinks Jason Calacanis is a visionary, although she says, “I still don’t have a good read on what he thinks about me. In spite of all the recent controversy regarding his work ethic for employees, I think he’s a smart guy who isn’t afraid to go up against public opinion for something he believes in.”

Popularity: 27% [?]

Tech Coast Angels is hosting their 8th annual Fast Pitch Competition on May 19 in Anaheim. The Fast Pitch Competition will consist of 14 entrepreneurs who will give 60-second pitches to a panel of investors. Each pitch is judged for the quality of the presentation and its investment potential, and three winners will be selected.

The three winners — for Best of Best, Best Presentation, and Best Investment Opportunity — will be automatically invited to make presentations at Tech Coast Angels deal-review screening sessions.

Unfortunately, the pool of entrepreneurs has already been selected for this particular competition, but the event should prove to be an excellent exploration of the best startup ideas in Southern California, and a great opportunity to network with the actual angels. I’ll be there covering the event for StartupSD, and I’ll make sure to keep an eye out for any San Diego based presenters.

Event Details

• What: 8th annual Fast Pitch Competition, sponsored by Tech Coast Angels
• When: 6-9 p.m., May 19
• Where: Anaheim Marriott, 70 West Convention Way, Anaheim
• Price: Early-bird pricing of $85 ends Monday, May 12, and goes up to $115.
• Registration: www.pitchtheangels.com.

About Tech Coast Angels

According to their site, Tech Coast Angels is the largest angel network in the U.S., with nearly $100 million invested in more than 140 companies. TCA operates five networks in Los Angeles, Orange County, San Diego, Westlake/Santa Barbara and the Inland Empire. Last April, the San Diego TCA led the funding process for Dayak.com generating a total of $1.15 million and provided ongoing counsel to help Dayak define the company’s strategy.

Popularity: 17% [?]

The most recent Web Design Meetup discussed the topic of Content Management Systems. Anita Cohen-Williams of MySearchGuru, a San Diego SEO, social media, and blogging fixture, as well as the group’s organizer, conceded leadership to Larry Truett of FluffyCat.com, for the evening.

The main Content Management Systems discussed were Drupal, Joomla!, and WordPress. All are relatively easy to install, especially if your hosting service uses cPanel and Fantastico, which automates installation. Each CMS has templates or themes to alter the look of sites, plug-ins to expand site functionality, content syndication (RSS), and extensive developer communities. Drupal and Joomla! are more robust and may require a learning curve for newbies. WordPress most notably lacks commerce tools, however it is the easiest to use of the three, especially for blogging or creating informational websites. There are many other open source options that can be explored at CMS Matrix, where you can compare up to 10 CMS’s at once.

Several people in the group have created their own CMS’s from scratch, which allowed them to develop a customized product. Dana Nevins, founder and chief software architect for Web Design Solutions, created an intricate CMS based around a shopping cart called Web Shop Manager. In addition, he provides hosting to clients, making it easier to push out CMS updates to all servers simultaneously.

It would be interesting to see if anyone has had any experience with TYPOlight or Plone, both of which seem to get high ratings among users. Are there any other kick-ass CMS’s out there that folks are using and having great success with?

The San Diego Web Meetup convenes on the third Monday of every month. The next meeting is on May 19th at 7 p.m at Wahoo’s Fish Tacos in Mission Valley. For more information, you can visit the group’s Meetup profile.

Popularity: 64% [?]

Gary Vaynerchuck is interested in extending his book tour to San Diego and he needs our help! Gary (@GaryVee) is the host of Wine Library TV, and a pinnacle member of the social media community.

First and foremost, we are looking for San Diego bookstores or wine retailers (e.g., The Wine Bank or BevMo) that are interested in hosting a book signing for Gary Vaynerchuk’s 101 Wines Guaranteed to Inspire, Delight, and Bring Thunder to Your World.

The online exposure the for this bookstore and event would be very influential. Most of Gary’s fans blog, Twitter, Flickr, YouTube and Qik before, during and after the event. All of these references are good for your store’s website and search engine exposure, among other things.

How to Help:
* Comments: Please let us know you’d support this tour by commenting below.
* Host Location: If you know of any bookstores or wine retailers or can talk to managers for us, please help get the word out.
* Volunteers / Sponsors? If you’d like to consider sponsoring this event and you are not a bookstore or wine retailer, please let us know.
* Pre-order the book
* Blog and Tweet about the book tour

Popularity: 76% [?]

Got plans this weekend? Reschedule! BarCamp San Diego 3 is this weekend and it promises to be absolutely groundbreaking.

The venue is twice as big, the contests are twice as big and people from the BarCampLA scene are arranging train-rides and carpooling to come to this event.

We’re planning on having a healthier selection of snacks and food and we’re going to be vegetarian friendly!

Here is some quick information about the event:

• May 3rd and 4th
• At the Microsoft offices in San Diego: 9255 Towne Centre Dr
• Breakfast is served at 10am!

For further information, please check out the Blog or Our Wiki!

Popularity: 34% [?]

Big Keynote News

I recently spoke with Rick Calvert, Founder of Blog World and New Media Expo, who shared with me that they have selected Gary Vaynerchuck of Wine Library TV to keynote this year’s expo. Vaynerchuck’s keynote will consist of a standard talk followed by a live taping of an episode for Wine Library TV.

Calvert is still looking for additional keynote speakers on the same level as last year’s headliner, Mark Cuban. He’s also focused on finding a big name female blogger or new media expert. If you’ve got any suggestions or ideas, you can find him on Twitter or send an email to Rick [at] blogworldexpo [dot] com.

Blog World Background and Basics

Blog World is based out of San Diego (the event takes place in Las Vegas), and has been in existence since 2006. According to Calvert, a tradeshow coordinator for 30k - 100k people events by day, he was actively blogging and curious of finding a tradeshow to learn about ways to monetize his blog and become a better blogger. When he couldn’t find an event that met his needs, he decided to create his own.

Last year’s Blog World, the first of many to come, hosted over 100 speakers, 1,300 attendees, and 90 exhibitors. There was even a small controversy over Michael Arrington’s reported snub, which, according to Calvert, was actually taken way out of context and completely blown out of proportion. Such is the nature of the blogosphere, I suppose.

This year Calvert hopes to court more than 3,000 attendees and score some really interesting panels, speakers, and keynotes. His goal is to improve upon last year’s event and bring together blogger communities for learning, networking, and of course one big party on Saturday night.

Blog World and New Media Expo will take place on September 20 - 21, 2008 in Las Vegas, Nevada. Registration is now open, and is currently heavily discounted to attendees who register before June 20. Also of note is that speaker proposals are being accepted through May 14, 2008. Keep in mind that Calvert is very conscious of the conference circuit chatter about declining relevancy in session topics, so he’s looking for really enganging topics and excellent public speakers. He’s also working on getting streaming video coverage and chat rooms, think Meebo at SXSW, set up for each session.

Exhibitors

Below is just a small sampling of some of this year’s exhibitors:

• Sony
• BlogTalkRadio
• Lijit Networks
• PRWeb

Popularity: 46% [?]

Planning on attending Structure 08 - Put Cloud Computing to Work? The conference, which was developed by GigaOM and created to “inform businesses so they can plan their future computing infrastructure needs,” is being held June 25 at the Mission Bay Conference Center in San Francisco.

GigaOM confirmed Structure 08 will host the first workshop on Google’s App Engine, their cloud service. The Google team will lead attendees through the App Engine system with a focus on what opportunities it opens up for entrepreneurs and hackers. Microsoft, which hosted a Lunch 2.0 event here in San Diego last Friday (check out the photos in our Flickr stream), will also run a workshop, but details on that content are not yet available.

Topics the conference will cover include:

• Cloud and Grid Computing
• Next generation Content Delivery Networks
• Peer-to-peer
• Low cost supercomputing
• Virtualization
• Next Generation Databases
• Web Services
• Software as a Service
• High Bandwidth Services

If you register before April 30, take note of GigaOM’s 10% discount if you register using its Facebook group member code (FBSAVER).

Let us know if you’re planning to attend. Even better, let us know if you are interested in setting up a local San Diego meetup or seminar on Cloud Computing or the new Google App Engine. We would be happy to promote the event.

Popularity: 43% [?]

We got an interesting event submitted to us from local Technomad, Colin Leath. He is definitely up to something unique and I can only assume that he sent the email from his campsite in the woods based on the following description from this blog:

“I’m working on getting rid of possessions I cannot carry and heading out to the forest with a PDA for reading books, a solar charger, and a cell phone. My goals are to be able to blog about what I’m doing, to provide an example others can learn from, to stay in contact with urban dwellers so they can come out and visit, and to encourage and help them to be comfortable and to live simply in the outdoors.”

Colin is inviting locals to join him during the weekend of May 9th to learn more about survival in the outdoors and to mobile blog about your experiences. Check out his blog post for more info on the event.

Now, Colin seems like a nice enough guy, but we don’t know him or his background. So please do your own due diligence if you plan to participate.

Popularity: 50% [?]

Here are a few tidbits of local San Diego startup news.

Nouri.sh Ranks Among The Top 100 Rails Applications Of The Web.

The local web app, Nouri.sh was recently ranked in the top 100 Rails apps by Alexa. Nouri.sh is a very cool .RSS feed-to-email newsletter tool that was developed by Matt Browne and his team at Integral impressions. Matt is also a blogger with StartupSD. We use Nouri.sh as our automated .RSS-to-email delivery system.

digital-telepathy Launches Newly Redesigned Website

My company, dt, has gotten very active in the community in the last year by starting websites like StartupSD, organizing events and planning a conference. Our site did a poor job representing our personality so we recently revamped the site to better show our involvement in the San Diego web community as well as our plans for the future.

Check out the new design and let us know what you think.

Collar Free’s “Coming Out Party” - May 1st

The T-Shirt community startup, Collar Free, is having a “coming out” party to celebrate the fabulousness of their newly launched website. The event is an open invite to their “supporters, friends, graphic designers, boutique owners, bloggers, and in general the fun, great people of San Diego.” Head over to the Quint Gallery in La Jolla for free Lotus Vodka drinks, beer and wine. Check out their blog for more details.

We would love to hear your tidbits and news. Please contact us with the juicy details.

Popularity: 55% [?]