I have posted on this topic before, but feel compelled to re-post it based on some recent experiences I’ve had.  For those of you new to OC VC, it will probably be refreshing.  For you “old timers”, this is worth a re-read…especially in these economically challenging times.  Hope you enjoy.

Hi, my name is Marc… and I’m a recovering attorney.  Well, maybe I should say “reformed” instead.  Actually, while I like to make jokes at my former profession’s expense, a good number of my friends are attorneys (or ex-attorneys) and I am privileged to work closely enough with some of them on a weekly basis so please don’t misconstrue any animosity here.  I thought I’d re-post a popular piece I wrote in early 2007 about choosing legal counsel after being inspired by a recent piece by Jason Mendelson titled: Quick Ways to Get Fired as a Lawyer.  I strongly encourage you to read Jason’s piece in addition to my spiel below.

I’ve had the good fortune to work with some really great attorneys over the past fifteen or so years and would like to spend a few minutes explaining just how important they are to the VC ecosystem and, in particular, to entrepreneurs given the number of questions I’ve fielded of late as to whom to go to for legal service in OC. Rather than try to address each situation that I was presented with here, I’ll answer generally like any good (reformed) attorney and simply say it depends…and then provide you some general considerations when choosing an attorney.

First, I strongly believe that having one or more good attorneys in your corner can really help you at the inception of your new business endeavor and you should get them involved early and often (once you’ve decided on who you want) as they can truly help you avoid the frequent initial mistakes at a minimum. Some will tell you that a good attorney can be worth his or her weight in gold, but I prefer to think in terms of diamonds; namely, the right one can shine as brightly under the right light and should also be chosen based on the “4 Cs”. So, what are they? Simply put, they’re Competence, Chemistry, Collaboration, and Cost and I’ll take each in order.

Competence: You should retain the right attorney for the job based on the job at hand and the attorney’s competence in performing such job. This may seem like common sense, but you’d be amazed at how many people simply use their friend, neighbor, [fill in the blank], regardless of his or her specialty, out of convenience rather hire a domain expert. Doing so can be extremely detrimental to an entrepreneur, especially one in a sector where intellectual property truly matters. For the record, I’m not suggesting you don’t confer with your friend, neighbor, etc that is a litigator or maritime lawyer, I’m simply pointing out that (in my humble opinion) you should consult an expert in the subject matter you need help in. For example, you should consult with a corporate finance attorney with experience in representing start-ups in company formation and financings rather than a general practice attorney who dabble in a number of areas of law. Most good attorneys will be more than willing to refer you to an expert in a particular field when the matter is one off their proverbial reservation. Fortunately, there is a number of competent attorneys right here in OC with a vast array of specialties and extensive experience.

Chemistry: Bottom-line, you need to be able to work with your attorney and to trust him or her implicitly given the nature of the business you will likely be conducting with him or her. If you’re constantly at odds with your attorney, it can hinder your progress as a start-up. Spend some time upfront getting to know each other to see if he or she is someone you can work with. A good attorney will be rowing the boat right along side you and become a true team member. Again, it may seem like common sense but I’ve seen the uglier side of this relationship and it’s a very big distraction at a minimum.

Collaboration: This is similar to chemistry. You need to retain an attorney that not only understands your issues, but can dynamically work well with you to resolve the issues and get the work done. It is also a good idea to choose a local attorney as working with someone from afar on the litany of start-up legal issues can be a challenge and, in my opinion, deprives you from getting the most bang for your buck. It’s much better to be able to pop into your attorney’s office and chat, review docs, etc. than to attempt to do so by electronic means. Choosing a local attorney may also come with the fringe benefit of utilizing his or her offices and conference rooms for meetings with your team, investors, and the like (you know, when you don’t have an office yet and/or are trying to keep your burn down like a good entrepreneur). The other thing to consider here is whether your attorney is part of a larger firm that has a diverse set of practices to grow with you as your company grows. Having said that, I’m reminded of a plaque my father (a career pilot) had on his desk that read something like: “It’s hard to soar with eagles when you’re surrounded by a bunch of turkeys...” so I feel compelled to point out that it’s not always a good idea to rely on a single firm for all your matters just because you like and work well with one particular attorney. Make sure you’re getting the expert advice you need and will be presumably paying for rather than deal with a bunch of turkeys just because they share a nest with your legal eagle.

Cost: Before all you big-firm attorneys panic and think that I’m going to suggest that entrepreneurs simply get the cheapest attorney they can to preserve their much needed cash, relax…that isn’t even remotely close to what I have to say here. I use the term “cost” here but I just as easily could have used the phrase “value exchange”…but it wouldn’t have started with a “C” and would have therefore thrown off my analogy. The value exchange I’m talking about here is simply making sure you receive appropriate value for the money you spend on your attorney (which goes to the other 3 Cs). It can actually be, and often is, more expensive to go with a particular attorney just because he or she is cheaper. How?   Simple.   A good attorney brings more to the table than just basic legal service. He or she has presumably worked with a number of companies you might want to work with but are unaware of, know a variety of capital sources, know a number of potential employees that you’d be interested in hiring, etc. Additionally, a really good attorney will help you avoid some common mistakes with respect to incorporation, patent prosecution, equity/debt financing, etc. that a lesser attorney may inadequately do. Avoiding such initial mistakes can save you money in the long run and ultimately prove to be cheaper for you overall. So go forth you brave entrepreneurs, lawyer-up, and build great companies here in OC.

Well, it’s that time of year again as I’m all packed and ready to schlep up to Rancho Palos Verdes for Wall Street Journal’s D: All Things Digital conference this year, D8.  As I packed this morning, I had to laugh as every year I debate whether to attend and always end up registering after remembering the “one key meeting” I had the year before (that I probably wouldn’t have had otherwise).  This year I’m excited to have a number of meetings to discuss one of my portfolio companies, My Damn Channel, as they seem to have become the belle of the ball of late and truly are producing some remarkable content these days.  You’ll know whether I find the conference useful again by whether I blog from it.  If I don’t, then it means that I’m too busy to do so (or I ran into IT issues of some sort).  Until next time, aloha.

Well, for those few brave (bored) souls that care about these such things I’m finally back from the land of “no time to post to my blog” having finally fired myself as CEO of one of my portfolio companies and closed the sale of our first portfolio company (not one in the same).  I will talk about both in due time, but wanted to reach out to the masses first to ask a few questions I’ve been pondering lately:  1) lots of talk about oil spill(s) in the press these days…but not much about the world’s broader water problems in general and I’m wondering, why?; 2) it’s 2010 and we, as a society, have split the atom, gone to the moon, and can communicate with each other worldwide through multiple mediums but seem to have a healthcare system that is paper-based, why?; and, finally, 3) assuming you’re not in the camp that thinks the world will end in 2012, what do you think will be mankind’s greatest achievement in the next decade?  From my admittedly myopic perspective, the pace in which multidisciplinary solutions are being invented has been accelerating rapidly in the last couple of years and we seem to be living in major thematically converging times (yet still can’t solve basic problems).  Anyway, look for more of my thinking out loud now that I have some time to do so…

I’ve been buried since December but can see the light at the end of the tunnel. Stay tuned for my “return to OC VC”…

It was somewhat of a bittersweet moment last night when one of my readers somehow tracked me down through my “bat email” last night to see why I haven’t posted in awhile.  Leaving aside how this person found me, I thought I’d write a bit today.

First and foremost, happy holidays to all.  Enjoy this time with your family & friends.  Having said that, this brings me to my second topic today.  The difference between friends and acquaintances.  So much of social media is geared around one’s “friends”, but people seem to misuse the term “friends” in everyday conversation and I’m wondering whether social media is exacerbating the problem.  Here’s a challenge - look at the definitions of “friends” and “acquaintances” below and then go back to your Facebook, Friendster, Twitter, or other such favorite social media network and see how many of your “friends” would qualify as friends rather than acquaintances under the definitions below.

Friends:

Acquaintances:

4.	(used with a plural verb) the persons with whom one is acquainted.

So, what percentage of your friends are actual friends rather than simply acquaintances?  50%?  25%?  10%?  Here’s an even more alarming exercise.  How many of them did you know prior to the social media explosion (i.e., through means other than social media)?

Anyway, just thought I’d share what was on my mind these days since I haven’t done so in awhile.  Hope your holidays are happy and you are able to spend them with your family & friends (how ever you define them).

I have been looking at the “water sector” (broadly defined) for awhile now but haven’t seen many investments being done thus far… so I was pleased to see fellow local VC, SAIL Ventures, announce that they recently made such an investment.  In fact, I reached out to Walter Schindler and asked him to send me a brief Op-Ed on the company for my readers as one of the things I’m looking to do more of is to have guest bloggers of relevant interest to my readers.  So, without further adieu, tell us about your fund’s latest water investment:

“SAIL’s latest investment is in a company with breakthrough technology in the area of industrial waste water recycling.  MicroMedia Filtration (MMF) represents a remedy to the growing global problem of industrial waste water. According to the World Bank, 80 countries are now experiencing water shortages severe enough to have an impact on the health and economic output of their populations.  2 billion people - roughly 40% of the earth’s population - do not have access to clean drinking water or sanitation. In the midst of this emerging water shortage, many industries simply waste water or recycle waste water inefficiently.  MMF’s unique process changes how wastewater is treated. This system has an 80% smaller physical footprint, can be built at half the capital cost, uses 85% less electricity, resulting in clean water with virtually no greenhouse gas emissions. MMF is a win–win –win – recycling waste water more efficiently, allowing a greater supply of drinking water, and using less energy at lower cost.”

Stay tuned for more guest bloggers in the weeks to come and feel free to write me with suggestions.

I am writing to you today as a concerned citizen with a truly global perspective who also happens to be a co-founder and managing director of a small (~$30M) venture capital fund that invests in promising seed and early-stage technology and life science companies in Southern California.  I want to relay to you my deep concern regarding S.1276 (a.k.a. the “Private Fund Transparency Act”) and any other such legislative proposals that will, unnecessarily, impose new regulatory burdens on the venture capital industry whole-scale.  I truly believe these proposals will negatively impact the venture capital industry’s ability to fund and nurture the innovative start-up companies that have been and continue to be critical to U.S. economic growth as well as our country’s ability to effectively compete in the global market.  To put the importance of venture capital in perspective, the venture capital industry has created over tens of millions of jobs for the U.S. economy just during my lifetime and venture capital backed companies now make up a significant percentage of our GDP.

I have spent a good portion of the past decade in the emerging markets of China, India, Russia, and Brazil/Argentina and have been amazed at the lengths to which these countries have been actively changing their regulatory, financial, and entrepreneurial ecosystems to encourage venture capital all while we, as a nation, seem bent on hindering it.  While I am an educated man and understand that your analysis thus far has led you to believe that certain gaps in the regulation of U.S. banks and capital markets have been to blame for the subprime mortgage crisis and global financial calamity triggered after Lehman Brothers filed for bankruptcy a year ago today… I can only assume that the pending legislation in question is simply a result of our government asking and answering the third of three fundamental questions (1 how did the systemic financial crisis we are in occur?; 2 how do we fix it?; and, finally, 3 how do we prevent it from happening again?).  As the road to Hell is also surely paved with good intentions, I ask you to consider this letter (and others like it) as you continue to analyze and discuss attempts to prevent future systemic financial meltdowns.

As for my particular issue, I am opposed to the current language submitted that would regulate “private pools of capital” as part of the financial industry regulatory overhaul effort.  S.1276, if enacted as it currently stands, would require investment advisors to private funds, including hedge funds, private equity funds, venture capital funds, and others, to register withe the Securities and Exchange Commission (SEC).  I believe that, in the House of Representatives, Chairman Barney Frank is expected to introduce this legislation imminently.  While these proposals are typically referred to as “hedge fund registration rules”, they are much more than that and are truly unnecessary with respect to venture capital funds and I would like to take this opportunity to explain why.

While I use my own venture capital fund as an example throughout this blog post, it is merely included to illustrate the impact to small venture capital funds and the companies they invest in.  The potential impact is far greater and I think you will find that the vast majority of venture capital firms like mine (which is clearly not a hedge fund or a buy-out fund) would be forced to register as investment advisors with the SEC.  While this process is often portrayed as simply “filling out a form”, it implies a number of obligations with complications as well as a significant investment of financial and human capital resources.

If adopted, the current proposal would be an undue burden on the small yet significant venture capital industry as a whole, on that our industry and country can ill afford under the current economic circumstances and - more importantly - one that would not in any way help to prevent future systemic financial risk.  For comparison, last year venture capital funds only averaged 8.5 principals per firm and held approximately $197.3 billion in aggregate assets… whereas hedge funds held approximately $1.3 TRILLION in assets (See Hedge Fund Intelligence Ltd., United States: The End of an Era?  Global Review 2009).  By categorizing venture capital funds under this “private fund” umbrella, we are being asked to shoulder a burden that, in addition to the issues already addressed, does not benefit the government in terms of identifying or preventing systemic risk.

While I will not speak to the nature of the other fund entities here and now, venture capital funds should not be regulated under this legislature for several fundamental reasons:

1) Venture capital funds do not use leverage/debt like banks, hedge funds, and buy-out funds typically do and they do not engage in any lending of credit like banks do.  For example, my fund “calls” committed capital from its investors (a.k.a. “limited partners”) over the 10-year term of our fund to purchase preferred shares of private companies and we do not rely on debt the way banks, private equity, and some hedge funds typically do.  In fact, we are contractually prohibited from using debt in such a way pursuant to the terms and conditions of our limited partnership agreement.  Our financial risk is therefore contained and limited to ourselves, our limited partners, and our portfolio companies, and any resulting loss is limited to the amount of the investment only.

2) Venture capital funds neither trade in the public markets nor use complex financial tools such as derivatives or swaps like hedge funds do.  Like the vast majority of venture capital funds, my fund operates as a private, closed-end, limited partnership governed by an agreement wherein our limited partners meet the SEC’s requirements of being both “qualified” and “sophisticated” (i.e., such limited partners must have substantial net worth and be educated enough to appreciate the risk associated with investing in venture capital funds).  Additionally, my fund (and most other venture capital funds) is prohibited from purchasing public equities pursuant to our limited partnership agreements; therefore, we only purchase shares in private start-up companies through private, SEC regulated transactions.  While a few of the larger venture capital funds have admittedly evolved and now purchase public equities privately through PIPEs (Private Investment in Public Equities), I think you will find the vast majority of venture capital funds do not.

3) There are no third party positions to be taken in venture capital in that no other entity aside from the limited partners and general partners of our funds and company founders are investing.  We are closed funds with a set term and are not open to the public.  Venture capital loss is strictly limited as any losses do not extend beyond our limited partners pro-rata.  Simply put, venture capital funds are private investments (i.e., do not act as a source of liquidity for the financial system) and only provide equity capital to a select few portfolio companies through private investments.  Venture capital funds do not pose any systemic risk to capital markets.

In summary, the venture capital industry does not meet a single criteria listed by Treasury Secretary Geithner as indicators of systemic risk, yet we are being swept into the proposed language.  To reiterate, if a venture capital fund or one of its portfolio companies goes under, the loss is limited to the amount of investment and would not affect the broader markets the way a failed hedge fund, buy-out fund, or bank might.

While I applaud the efforts to address systemic risk and the activities that were at the root of our nation’s devastating financial distress, and appreciate the difficulties associated with bringing legislation to bear as an ex-attorney, the venture capital industry played no role and should not be targeted.  Now is not the time to increase the burden on an industry that has been and continues to be central to our great nation’s ability to fund entrepreneurs, build start-ups, create high-paying jobs, and produce revolutionary technology and products that better our lives in so many ways.

Bottom-line:  Venture capital should not be included in the Privacy Fund Transparency Act (or any other such legislation) and I urge you to take these concerns forward on behalf of both your constituents as well as our nation as a whole.  For any Representatives or Staffers actually reading this, I would be more than happy to discuss this matter further.

Despite the odds, My Damn Channel continues to produce the goods and prove just what a “small, extremely focused, capital efficient rebel-media-army” can do…even in a downturn of today’s magnitude.  If you aren’t already hip to the MDC crew, check ‘em out at www.mydamnchannel.com.  If you like what you see, please make sure to spread the viral love!

For those of you that know me, you know I have always been a big fan of disintermediation (i.e. removing the middleman or intermediary) - both from a cost reduction perspective as well as from an operational efficiency perspective.  In fact, I am always intrigued by start-ups claiming to truly disintermediated an industry in a novel way and have actually invested in a few over the years.  My post today results for two reasons 1) several readers pointed out that I have not posted recently and 2) there is a real potential downside to disintermediation for start-ups that needs to be mitigated.

The downside to disintermediation is that, by practicing it, you are cutting someone out of the picture in some way…and such ways tend to cause materially negative economic consequences to the disintermediated…and such displaced companies (individuals) tend to react antagonistically towards the cause of their new economic pain.  So, what’s a start-up to do if they are attempting to disintermediate one or more “giants” with significantly more resources?  In a word, partner.  Consider developing channel partnerships rather than taking on the Goliaths with a direct sales force…consider ways to create true “co-opetition” such that you can partner with incumbant in one area and compete in another.  At one of my previous employers, we used to joke that it takes an oligopoly to bust a monopoly.  So all you start-ups out there attempting to disintermediate an 800lbs. gorilla or two, partner up!

Well, I was going to write a post about angel funding to go along with my “Start-Up Tool Kit” post from this past Thursday (see post immediately below)…but I’m a BIG believer in not inventing the wheel for the sake of doing so.  I will, therefore, simply point you to a great piece I found by fellow SoCal VC Mark Suster about Angel funding called “Angel Funding Advice“.  I agree with what Mark has written and implore you to read it if you’re an entrepreneur looking for your first financiers.  We VCs see far too many deals to invest in a company with encumbered cap tables…unless we are convinced that it will be substantially more than worth our efforts to do so.