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.

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.

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.

Most of you know I am a “reformed” or “recovering” (take your pick of adjective) attorney and have written before about them in my posts (e.g., click here).  Most of you also know that I am friends with so many great attorneys that I never play favorites — I simply send people to My Attorney List, based on what type of attorney they need, and let them pick based on their own preferences… so I feel a bit weird writing about a particular firm’s offerings, but this struck me as something my readers would appreciate so I felt compelled to share.

Orrick recently launched what it is calling a “Start-Up Tool Kit“… a set of “resources designed to aid start-ups and their founders on the journey from the ‘garage’ to the global marketplace.”  Maybe I shouldn’t have been, but I was (pleasantly) surprised to see such a big firm offer this.  Way to go Orrick!  Along these lines, folks can also find useful model legal docs and resources on the National Venture Capital Association’s website here.  My recommendation would be that Orrick’s tool kit and the NVCA’s model docs are great places to start the process, but are in no way a substitute for a good corporate counsel (see my previous post on the matter).  Happy Lawyering!

I was at D7 the other week and spent a fair amount of time discussing the “value of free” with attendees.  The juxtaposition of traditional media and consumer Internet hinges on this concept so I thought I would explain a bit about what I am referring to.  At the risk of oversimplifying here, a vast majority of consumers expect information/entertainment (a.k.a. “content”) on the Internet to be free in that they are not accustomed to paying for the content the Internet provides them.  In fact, there is a whole generation of consumer digital denizens that only know the “Web 2.0 / free” world of the Internet.  This poses a potential problem for the related industries: how do we make money if the consumer of what we produce/source/distribute expect that it will remain free?

The answer has historically been that the value exchange for such content was simply this: I provide you with my (valuable) time and you provide me with the content to occupy such time.  In the exchange, you then sell advertising against my time based on my gender, age, socio-economic status, and other such demographics (a la broadcast television through most of its history).  This has historically worked reasonably well for all when there were finite choices for content.  See where I’m going here?  That’s right, this model becomes a bit challenging as the sources of content outpace the Total Consumers Time (a.k.a. “TCT” - calculated as the total number of targeted consumers multiplied by the daily total number of minutes they spend on line).  The issue has become somewhat exacerbated  the past couple of years as the rise of social media and Web 2.0 tools has turned these consumer into creators of content themselves such that all consumers may someday become creators of content on-line.  Additionally, the number of minutes consumers spend creating content and consuming consumer created content (a.k.a. “User Generated Content” or “UGC”) only lessen the TCT…which, in turn, negatively affects the advertising revenue of the “professional” content creators and distributors.  The primary current solution is to spread advertising budgets across more and more content sources such that even when annual ad budgets increase, they are allocated across a broader spectrum of destinations…for the time being.  Less you think I’m against consumer Internet, I’m not.  Not even close…

The power of the Internet and all it entails is that it is becoming easier to qualitatively and quantifiably measure the reach and impact of advertising relative to an advertiser’s targeted demographic.   Furthermore, advertising is changing to take advantage of such technical capabilities and the sophistication of tech-savvy consumers and is becoming much more interactive.  More and more brands are exploring “branded entertainment” and looking to develop certain deep psychological associations with their products and services based on where and how they advertise.  While I strongly believe that this will, eventually, lead brands away from UGC to high-quality professionally-produced content for the bulk of their advertising budgets, I’m really curious to get all of your thoughts on this matter.  So, what do you think about the “value of free” and where online advertising is headed???

A fellow SoCal VC and friend of mine, Peter Lee, recently joined Baroda Ventures and has just launched his own blog as well.  Please visit it here and support him in his efforts.

As you might imagine, I am constantly asked out to raise capital from VCs and what VCs are looking for.  In fact, I am asked so often that I wrote a piece about it awhile back titled Hope is Not a Strategy simply to be able to point folks to the post.  Well, I recently had an “epiphany for a post” while at D7 this week and spent the short drive home thinking about it some more.

Let me first set the stage.  We were at lunch and sitting at a table of 8.  To my left was an entrepreneur (to his left was Rupert Murdoch) and to my right was a VC friend of mine.  The entrepreneur and Rupert were in a discussion and, at one point, the entrepreneur leans over and asked my friend what he will invest in.  My friend’s response: “whatever I happen to be interested in.”  The response may seem flippant at first, but let me explain why it isn’t and why more entrepreneurs should pay attention to what VCs are interested in and only target those with an expressed interest in companies in their areas of interest.

One of the frustrations entrepreneurs commonly lament is that it is so hard to get a meeting with a VC.  Well, we VCs are extremely busy and very sensitive to the “return on time” factor as to how we allocate the hours of any given day.  Here in SoCal, there are so few of us (by comparison to Silicon Valley and New England and despite the population of SoCal), that the matter is further exacerbated.  So, what does this mean?  It simply means that we allocate our time towards areas of interest.  We are all looking for the companies that meet the general criteria I list in the above referenced post so it is even more important to learn what we are interested in…and understand that our areas of interest may (and likely will) change over time based on numerous considerations.  As I was thinking about this matter, I called a friend/entrepreneur I know and discussed the matter a bit with him and he quickly suggested that while my thoughts here were solid, I overlooked the fact that it can be very difficult for entrepreneurs to determine which VCs are interested in what and that their websites can provide clues but tend to be deficient to the degree that I’m talking about here.  Good point.  In fact, I’m hereby declaring to make some changes to this blog to clarify my interests and will also make some changes to our fund’s website in the coming weeks that hopefully helps explain a bit more about what I/we are interested in…so stay tuned.