Saturday, December 31, 2011

Annotated Convertible Promissory Note

If you are working on a startup, you know how difficult it can be to secure investment from venture capitalists. By the time they are ready to invest, they want you to have a product and some decent traction, so that their investment can go towards growing your business. That means that you have to find a way to keep your business afloat while you are engaging in market research, designing and developing the product, and while you are immersed in early customer acquisition. Most entrepreneurs are not in a position to bootstrap their venture during this initial period, which can easily span over several years (depending on the product), so they will often raise a bridge financing from friends and family, angel investors, or sometimes even from venture capitalists.

A bridge financing is generally implemented by means of a convertible promissory note (for simplicity, we'll refer to it as a "Note"). Notes come in a variety of shapes and sizes, and range from being very company-favorable to downright egregious. In this post, I will walk through a fairly typical and reasonably company-favorable Note. To follow along, download my Convertible Promissory Note form (use of the form is subject to the terms of the legal disclaimer at the bottom of the post). Also note that throughout this post I will refer to the company issuing the Note as the Company and to the purchaser of the Note as the Investor.

Let's start at the top:


This is called a securities legend. The reason that most convertible Notes will include this (or similar) language is because a convertible Note is a security, and securities laws apply to the offer and sale of securities. Securities laws are complex, so I will not try to explain them in this post. Suffice it to say that this language will depend on the state in which the investor resides, and that you should leave the tweaking or tinkering with this language to your attorney.

Section 1:

    1. Principal and Interest. For value received, the undersigned, [Company Name], a [state] corporation (the “Company”), hereby promises to pay to the order of [Lender Name] (the “Lender”) the principal sum of $[*] plus interest on the principal amount hereof, at the annual rate of [*] percent, and if such rate is determined to be usurious, then the rate shall be reduced to the highest legally permissible rate.

    [The term “Notes” shall refer to this Note along with all other convertible promissory notes issued by the Company in exchange for cash advances to the Company at any time from [Date Bridge Loan Begins] until [Date Bridge Loan Ends]. The terms “Lenders” may be used herein to refer to the Lender along with all other lenders, if any, who advance or have advanced funds to the Company in exchange for Notes.]

This section is pretty self-explanatory. Principal is the amount borrowed. Because convertible Notes are debt instruments, or loans, in addition to being securities, an interest rate accrues on the amount borrowed. States have laws about rates which are considered usurious, or illegal, and therefore you will see language in the Note specifying that, to the extent that the interest rate is deemed usurious, instead of invalidating the entire Note, the rate is reduced to the highest permissible rate.

You will notice that defined terms are underlined and displayed in quotes when initially defined and are thereafter capitalized to signify that the specific meaning attributed to the term in this Note should be used, and not a general one. For convenience, parts that need to be customized are shown in bold and are set off by square brackets in this form.

One more general point, before we move on: if you have seen other forms of Notes, you may have seen the bracketed second paragraph of Section 1 refer to a note purchase agreement pursuant to which all of the Notes are purchased. And you may be wondering whether a note purchase agreement is necessary. The answer is, there is no legal requirement to sell notes pursuant to a note purchase agreement, but depending on your Investors (and their legal counsel), they may request one. A note purchase agreement provides for representations and warranties of the Company, for one. It can also include other deal terms, such as multiple closings and/or payment by the Company of Investor counsel's fees, to name a few. If you are raising money from friends and family, you can safely save yourself the time and expense of preparing and signing an additional agreement. On the other hand, if the Investors ask for it, you shouldn't fight it, unless the amount of their investment is so small that it seems silly. :)

Section 2:

    2. Maturity. Unless converted as provided in Section 3, principal and any accrued but unpaid interest under this Note shall be due and payable on the date which is [twenty-four (24) months] after the Date of Issuance (the “Maturity Date”). Subject to Section 3 below, interest shall accrue on this Note and shall be due and payable on the Maturity Date. Notwithstanding the foregoing, the entire unpaid principal sum of this Note, together with accrued and unpaid interest thereon, shall become immediately due and payable upon the insolvency of the Company, the commission of any act of bankruptcy by the Company, the execution by the Company of a general assignment for the benefit of creditors, the filing by or against the Company of a petition in bankruptcy or any petition for relief under the federal bankruptcy act or the continuation of such petition without dismissal for a period of 90 days or more, or the appointment of a receiver or trustee to take possession of the property or assets of the Company.

There are a couple of things going on in this section. First, it appears to provide a deadline for when the funds must be repaid. Second, it provides the Investors with some protection, a way to accelerate the obligations under the Note in the event that the Company hits rock bottom before the Note is due.

First why does it only "appear" to provide for a deadline? Generally speaking, an Investor has no expectation that a Note (remember that we are only talking about convertible notes now) will be repaid. The reason that Investors loan money on a Note and not by purchasing stock has less to do with the advantages that an Investor has when it comes to getting his money out, and more with the ease and efficiency of using this method. Jumping ahead to Section 3(c) for a second, we realize that if the Note is still outstanding on the maturity date, it converts into common stock based on a pre-agreed formula. This means that the Company (almost) never has to repay its Investor.

Another way that maturity dates are sometimes handled in convertible promissory Notes is by making it a "demand" note, or a Note that must be repaid after a certain date upon the Investor's demand. This variation, depending on the formula used for converting principal on a Note to common stock, can be either less or more favorable to the Company than an automatic conversion into common stock. Of course, a demand Note works best with sophisticated Investors who are not going to demand to be repaid arbitrarily, when they'd like to get their money back, regardless of the financial health of the Company. I have seen this work really well when the Investors are working with the Company, allowing it some breathing room to get to a Qualified Financing (defined in the Note) after the initial loan term or to find another source of funds to repay the Investors. But this can also backfire with an impatient, inexperienced Investor.

The second point of Section 2 is self-explanatory. If the Company is doing so poorly that it's starting bankruptcy proceedings or another type of winding down activity, in other words, if they've given up, the obligation to repay the Note is accelerated and, assuming that there is no other senior debt, the Investor is first in line to be repaid out of whatever proceeds there are from the liquidation of the Company.

Section 3, my favorite and juiciest section of the Note:

    3(a) Conversion: Automatic Conversion in a Qualified Financing. Upon the closing of the first sale or series of sales of equity securities by the Company after the date hereof which results in proceeds to the Company (inclusive of the amount represented by the Note) in the aggregate amount of at least $[*] (a “Qualified Financing”), the outstanding principal balance of this Note together with accrued interest shall automatically convert on the date of the closing of such Qualified Financing, into the same securities issued in the Qualified Financing on the same terms and conditions applicable to the other investors participating in the Qualified Financing; provided, however, that the price per equity security applicable to the conversion of this Note (and other similar Notes) shall be equal to the lesser of (i) [*] percent of the price per security paid by the other investors participating in the Qualified Financing, or (ii) a price per share calculated at such time based on a $[*] pre-money valuation, rounded down to the nearest whole share; subject to the Lender executing customary stock purchase documentation (which execution shall not be unreasonably withheld).

Subsection (a) of Section 3 deals with the best case scenario--within the time frame contemplated by the Company and the Investor, the Company raises more money and the Note converts. There are a number of variables in this section. First, the parties need to decide how much money the Company needs to raise at a minimum to warrant automatic conversion of the Note. If the Note is for $150,000, and the company raises another $150,000 through sale of its stock, it's probably not enough because the Investors do not negotiate for any preferred stock rights at the time when they buy the Note. They are counting on the venture capitalists or the super-angels who are going to buy equity in a Qualified Financing on doing this for them. That means, that the amount that the Company raises which forces a conversion into the same security purchased in such round should be substantial. One million of new money is an amount I see frequently. However, it also depends on the initial investment amount. Notice that the amount is "inclusive of the amount represented by the Note". If an aggregate amount of $750,000 is raised via the Notes, then the Qualified Financing threshold should be at least $1,500,000 or even greater to be meaningful.

The other important variable is the extra bonus that the Investor gets upon a Qualified Financing for taking the early risk. There are several ways this can be handled, and our language exemplifies a best-of-both-worlds approach. It was once the case that Investors received only a discount of 15-20% off the preferred stock price in a Qualified Financing. This approach tends to be less common now, as Investors are asking for more upside for taking risk early.

Traditionally, Investors were not setting a valuation, with the idea that it was too early to tell. Now, Investors lending the Company money on a Note often request a valuation cap for conversion purposes (which is kind of like setting a valuation). If, upon a Qualified Financing, the Company valuation is lower than the cap specified in the Note, the Investors convert at the actual valuation in the Qualified Financing. However, if the Company valuation in a Qualified Financing is valued higher, even a lot higher, than the valuation cap in the Note, the Investors convert at the valuation they fixed when they invested.

One other small point on this section: as you will notice, it provides for the conversion of principal and interest. Financings generally never happen on the date they are supposed to and get moved by a day and then another day and another day. This means that the interest on the Note changes and, therefore, the number of shares into which the Note converts changes. Most likely, this also affects the price per share for preferred stock in the Qualified Financing. For simplicity, the Note can provide that the principal only converts and the interest can either convert or be repaid at the option of the issuer. Sometimes, this little tweak can save a lot of attorney hours.

    3(b) Conversion: Optional Conversion on a Change of Control. In the event of a Change of Control (as defined below) prior to repayment in full of the Note, immediately prior to such Change of Control, the outstanding principal and any accrued but unpaid interest on each Note shall convert into shares of the Company’s Common Stock at a price per share equal to the quotient obtained by dividing (x) [*] by (y) the sum of (1) the total number of shares of Common Stock outstanding (assuming full conversion and exercise of all convertible or exercisable securities but excluding shares issued upon conversion of the Note, and any other notes that are issued by the Company) and (2) shares of Common Stock issuable to employees, consultants or directors pursuant to a stock option plan, restricted stock plan, or other stock plan approved by the Board of Directors; provided, however, that in the event of a Change of Control, in lieu of converting this Note into shares of the Company’s Common Stock pursuant to this Section 3(b), the Lender may elect to accelerate the Maturity Date of this Note such that the outstanding principal and any accrued but unpaid interest shall become due and payable as of the date of the Change of Control. Before the Lender shall be entitled to convert this Note into shares of the Company’s Common Stock pursuant to this Section 3(b), the Lender shall execute and deliver to the Company a common stock purchase agreement reasonably acceptable to the Company containing customary representations and warranties and transfer restrictions. The term “Change of Control” shall mean the sale, conveyance or other disposition of all or substantially all of the Company’s property or business, or the Company’s merger with or into or consolidation with any other corporation, limited liability company or other entity (other than a wholly owned subsidiary of the Company); provided that the term “Change of Control” shall not include (a) a merger of the Company effected exclusively for the purpose of changing the domicile of the Company, (b) an equity financing in which the Company is the surviving corporation, or (c) a transaction in which the stockholders of the Company immediately prior to the transaction own 50% or more of the voting power of the surviving corporation following the transaction.

Section 3(b) describes what happens to the Note in the event that the Company is sold prior to the maturity of the Note. In the event of a successful exit, the Note will convert at some pre-determined valuation into common stock. In the event of a bad exit, the Investors have the option to accelerate the Note and be repaid out of the proceeds.

This provision tends to be left out of Notes with friends and family and generally is found in more heavily negotiated Notes with sophisticated Investors. Another way that a premature sale of the Company is sometimes handled is by providing the Investor with a multiple return on his investment (like 3X the principal amount). If you are not working off a term sheet provided to you by the Investors, and are providing a draft Note to your Investors, I would leave this out for simplicity's sake. If they ask for it, you can add it.

    3(c) Conversion: Mandatory Conversion into Common Stock on Maturity. If no Qualified Financing or Change of Control occurs by the Maturity Date, then the Note shall automatically convert immediately prior to the Maturity Date into the right to receive a number of shares of Common Stock of the Company equal to [formula for calculating the number of shares], rounded down to the nearest whole share.

If Section 3(a) was the best possible scenario, then Section 3(c) is the second worst scenario (after the winding down of the company provided for in Section 2). The Notes have matured and there is no money to repay them, there has not been a decent-sized equity financing, and the Company has not been sold.

Sometimes mandatory conversion of Notes on maturity is into preferred stock of the last issued series, if applicable, or into the next series, created just for this purpose. If the Note converts into preferred stock, then the parties need to think through the rights of the preferred stock now, since there will not be a bonafide third party investor to negotiate these rights as there would be in a Qualified Financing. Having to agree on preferred rights at the time of the bridge financing complicates matters, which is why I prefer conversion into common stock. The main question is, at what valuation will the Note convert in that case? I have seen cases where the Note provides that it will convert into as many shares as are necessary for the Investors to own 55% of the Company. That's pretty egregious, but it's also the Investors' way of saying "you have failed and we are taking over."

Keep in mind, by the way, that Notes, like any other agreement of the Company, can be amended (subsequently changed) with the mutual consent of the parties. So even if your Notes provide for mandatory conversion on maturity and even if that conversion is not on terms that you love, when your Notes are getting close to maturity, if your Investors still believe in your and think you just need more time, they may agree to amend the Notes to extend the term. Legal documents are frequently amended to fit the reality of the business. But while it is technically possible, the trick is being on good terms with your Investors, so that they are motivated to amend the Note and keep your Company in business.

Section 4:

    4. Mechanics of Conversion. As soon as practicable after conversion of this Note pursuant to Section 3 hereof, the holder of this Note agrees to surrender this Note for conversion at the principal office of the Company at the time of such closing and agrees to execute all appropriate documentation necessary to effect such conversion, including, without limitation, the applicable stock purchase agreement. The Company, at its expense, will cause to be issued in the name of and delivered to the holder of this Note, a certificate or certificates for the number of shares or other equity securities to which that holder shall be entitled on such conversion (bearing such legends as may be required by applicable state and federal securities laws in the opinion of legal counsel for the Company), together with any other securities and property to which the holder is entitled on such conversion under the terms of this Note. Such conversion shall be deemed to have been made immediately prior to the close of business on the applicable date set forth in Section 2 above, regardless of whether the Note has been surrendered on such date, provided that the Company shall not be required to issue a certificate for shares to any Lender who has not surrendered such Lender’s Note. No fractional shares will be issued on conversion of this Note. If upon any conversion of this Note a fraction of a share results, the Company will pay the cash value of that fractional share.

Section 4, as its name suggests, walks through the mechanics of the conversion. The main takeaway is--the Investor will have to turn over the Note to get shares. Even though the conversion is automatic, the Company does not have to issue a share certificate until it has received (and cancelled the note). Some Notes will provide more detail around the process for dealing with lost, stolen and destroyed Notes. I like to keep Notes simple and don't include this. Bottom line is, it can be worked out if it comes up.

Section 5:

    5. Payment. All payments hereunder shall be made in lawful money of the United States of America directly to the Lender at the address of Lender set forth in Section 7(e), or at such other place or to such account as the Lender from time to time shall designate in a written notice to the Company. The Company may not prepay the outstanding amount hereof in whole or in part at any time, except with the written consent of Lender.

    Whenever any payment hereunder shall be stated to be due, or any other date specified hereunder would otherwise occur, on a day other than a Business Day (as defined below), then, except as otherwise provided herein, such payment shall be made, and such payment date or other date shall occur, on the next succeeding Business Day. As used herein, “Business Day” means a day (i) other than Saturday or Sunday, and (ii) on which commercial banks are open for business in [City, State].

The main takeaway from this section is that the Note cannot be prepaid without the consent of the Investor. Why not? If it could be prepaid, and there was a lucrative sale of the Company in the works, the Company could repay the Note and leave the Investor without the upside. The same is true for a Qualified Financing. In a convertible Note, the investors bargain for more than just interest as their upside. But terms are negotiable, so if you'd like to try to make the Note prepayable by the Company without penalty and without Investor's consent, go for it. Depending on the specific terms of your Note, that might be the right approach.

Section 6:

    6. Representations and Warranties of Lender. The Lender hereby represents and warrants to the Company and agrees that:

    (a) Authorization. Lender has full power and authority to enter into this Note and such agreement constitutes its valid and legally binding obligation, enforceable in accordance with its terms.

    (b) Purchase Entirely for Own Account. This Note (and any securities issued upon conversion of the Notes, herein, collectively, the “Securities”) has been purchased by the Lender for such Lender’s own account, not as a nominee or agent, and not with a view to the resale or distribution of any part thereof, and such Lender has no present intention of selling, granting any participation in, or otherwise distributing the same. Such Lender does not have any contract, undertaking, agreement or arrangement with any person to sell, transfer, or grant participation to any person with respect to the Securities.

    (c) Disclosure of Information. Such Lender acknowledges that it has received all the information that it has requested in connection with the purchase of the Securities. Lender further represents that it has had an opportunity to ask questions and receive answers from the Company, as well as to consult their own legal, tax and other advisors, regarding the information provided and the terms and conditions of the offering of the Securities.

    (d) Investment Experience. Lender is an investor in securities of companies in the start-up or early development stage and acknowledges that it is able to fend for itself, can bear the economic risk of its investment and has such knowledge and experience in financial or business matters that it is capable of evaluating the merits and risks of the investment in the Securities. If other than an individual, such Lender also represents it has not been organized for the purpose of acquiring the Securities.

    (e) Restricted Securities. Such Lender understands that the Securities are characterized as “restricted securities” under the federal securities laws inasmuch as they are being acquired from the Company in a transaction no involving a public offering and that under such laws and applicable regulations such securities may be resold without registration under the Securities Act of 1933, as amended (the “Act”), only in certain limited circumstances. In this connection, such Lender represents that it is familiar with SEC Rule 144, as presently in effect, and understands the resale limitations imposed thereby and by the Act.

    (f) Accredited Lender. Lender is an “accredited investor” as that term is defined under the Act.

    (g) Further Limitations on Disposition. Without in any way limiting the representations set forth above, the Lender further agrees not to make any disposition of all or any portion of the Securities unless and until each of the following have been satisfied:

    (i) There is then in effect a Registration Statement under the Act covering such proposed disposition and such disposition is made in accordance with such Registration Statement, or (i) the Lender shall have notified the Company of the Proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition and (ii) the Company shall have obtained an opinion of counsel, reasonably satisfactory to the Company, that such disposition will not require registration under the Act.

    (ii) If such transfer is not being made pursuant to Rule 144 or a registration statement under the Act, the transferee shall have agreed in writing, for the benefit of the Company, to be bound by this Section 6.

    (iii) Notwithstanding the provisions of paragraphs (i) and (ii) above, no such registration statement or opinion of counsel shall be necessary for a transfer by the Lender which is a partnership to a partner of such partnership or a retired partner of such partnership who retires after the date hereof, or to the estate of any such partner or retired partner or the transfer by gift, will, or in testate succession of any partner to the partner’s spouse or to the siblings, lineal descendants, or ancestors of such partner or spouse, if the transferee agrees in writing to be subject to the terms hereof to the same extent as if he were an original Lender hereunder.

    (h) Foreign Investors. If Lender is not a United States person (as defined by Section 7701(a)(30) of the Internal Revenue Code of 1986, as amended), Lender hereby represents that it has satisfied itself as to the full observance of the laws of its jurisdiction in connection with any invitation to purchase the Securities, including (i) the legal requirements within its jurisdiction for the purchase of the Securities, (ii) any foreign exchange restrictions applicable to such purchase, (iii) any governmental or other consents that may need to be obtained, and (iv) the income tax and other tax consequences, if any, that may be relevant to the purchase, holding, redemption, sale or transfer of the Securities. Lender’s payment for, and his or her continued beneficial ownership of the Securities, will not violate any applicable securities or other laws of Lender’s jurisdiction.

    (i) Standoff Agreement. Lender agrees, in connection with the Company’s initial public offering of its equity securities, and upon request of the Company or the underwriters managing such offering, not to sell, make any short sale of, loan, grant any option for the purchase of or otherwise dispose of any shares of the Securities (other than those included in the registration, if any) without the prior written consent of the Company or such underwriters, as the case may be, for such period of time (not to exceed one hundred eighty (180) days) from the effective date of such registration as may be requested by the Company or such underwriters; provided, that the officers and directors of the Company who own stock of the Company also agree to such restrictions.

    (j) Legends. It is understood that in addition to or in place of the legends currently on the Securities, the Securities may bear any legend required by the laws of the State of California, including any legend required by the California Department of Corporations and Sections 417 and 418 of the California Corporations Code or other applicable state blue sky laws, and a legend referring to the restrictions on transfer described in this Section 6.

Section 6 is a long section that I am actually not going to spend a lot of time on. These are representations of the Investor and most of them are mandated by securities laws. Note that my sample Note does not contain any representations by the Company, but if your investors are represented by legal counsel they will likely either add Company representations to the Note or add a note purchase agreement to the transaction documents(as discussed earlier in this post).

Generally, Investors are asked to complete an accredited investor questionnaire at the same time when they are sent a draft of the Note (unless you know that they are not accredited, in which case you should consult with your attorney to make sure there is another securities law exemption that can be used).

Section 7:

    7. Miscellaneous.

    (a) Assignment. This Note, and the conversion rights described herein, shall not be assignable by the holder without the prior written consent of the Company, which consent shall not be unreasonably withheld. Subject to the restrictions set forth in the foregoing sentence, the rights and obligations of the Company and the holder of this Note shall be binding upon and benefit the successors, assigns, heirs, administrators and transferees of the parties.

    (b) Waiver and Amendment. Any provision of this Note may be amended, waived or modified upon the written consent of the Company and the [Lender][Lenders holding Notes with cumulative outstanding principal amounts representing at least a majority of the total principal amount of all Notes, so long as such amendment, waiver or modification applies equally to all Notes].

    (c) Interpretation. Whenever possible, each provision of this Note shall be interpreted in such manner as to be effective and valid under all applicable laws and regulations. If, however, any provision of this Note shall be prohibited by or invalid under any such law or regulation in any jurisdiction, it shall, as to such jurisdiction, be deemed modified to conform to the minimum requirements of such law or regulation, or, if for any reason it is not deemed so modified, it shall be ineffective and invalid only to the extent of such prohibition or invalidity without affecting the remaining provision of this Note, or the validity or effectiveness of such provision in any other jurisdiction.

    (d) Jurisdiction. The Company and each Lender hereby (i) submit to the exclusive jurisdiction of the courts of the State of California and the United States Federal courts of the United States sitting in the State of California for the purpose of any action or proceeding arising out of or relating to this Note and any other documents and instruments relating hereto, (ii) agree that all claims in respect of any such action or proceeding may be heard and determined in such courts, (iii) irrevocable waive (to the extent permitted by applicable law) any objection which it now or hereafter may have to the laying of venue of any such action or proceeding brought in any of the foregoing courts, and any objection on the ground that any such action or proceeding in any such court has been brought in an inconvenient forum and (iv) agree that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner permitted by law. This Note shall be governed by the law of the State of California, without regard to choice of law principals.

    (e) Notices. Any notice required or permitted by this Note shall be in writing and shall be deemed sufficient upon receipt, when delivered personally or by courier, overnight delivery service or confirmed facsimile or confirmed electronic mail, or three business days after being deposited in the U.S. mail as certified or registered mail with postage prepaid, if the notice is addressed to the party to be notified at the party’s mailing or email address or facsimile number as set forth below or as subsequently modified by written notice.

    To the Company:

    To the Lender:

    (f) Arbitration. Any claims arising under this Note, except for any such claims for which injunctive relief is sought, shall be resolved in binding arbitration with a duly authorized representative of the American Arbitration Association (“AAA”) in accordance with the provisions hereof and thereof. Either the Company or the Lender may submit the matter to binding arbitration before the AAA in [San Francisco County, California], which arbitration shall be final and binding on the parties and the exclusive method, absent agreement between the Company and the Lender, for purposes of determining the ability of the Company or the Lender to satisfy such claim. All claims shall be settled by a single arbitrator appointed in accordance with the Commercial Arbitration Rules then in effect of the AAA (the “AAA Rules”). The arbitrator shall render a final decision pursuant to the AAA Rules within thirty (30) days after filing of the claim. The final decision of the arbitrator shall be furnished to the Company and the Lender in writing and shall constitute the conclusive determination of the issue in question binding upon the Company and the Lender, and shall not be contested by any of them. Such decision may be used in a court of law only for the purpose of seeking enforcement of the arbitrator’s decision. The prevailing party shall be entitled to reasonable attorneys’ fees, costs and necessary disbursements in addition to any other relief that such party may be entitled. For purposes of this Agreement, the prevailing party shall be that party in whose favor final judgment is rendered or who substantially prevails, if both parties are awarded judgment.

    (g) Counterparts. This Note may be executed in two or more counterparts, each of which shall be deemed an original and all of which together shall constitute one instrument.

    (h) Entire Agreement. This Note is the entire agreement between the parties hereto relating to the subject matter hereof and supersedes any prior arrangement or agreement, written or oral.

Section 7, the last section in our Note, is what is sometimes referred to as "General Provisions," or boilerplate. This is not to diminish the significance of this section--it certainly contains a number of very important provisions--they are just not as interesting for the Company founders to read about.

I will just make a note here about Section 7(b), the amendment provision. If you are selling multiple Notes (and using that bracketed paragraph in Section 1), it is in your best interest to think carefully about this section. Most agreements, as I've mentioned, can be amended by mutual consent of the parties. However, if a Company has issued 10 Notes, having to chase down 10 signatures to amend the same term in all those Notes (whether it be the threshold amount for a Qualified Financing or the Maturity Date) can be a nightmare. It can be especially silly if one of the Investors loaned $500,000 to the Company and the others, in total, merely $100,000. For the situation where a substantially identical agreement is entered into by the Company with multiple parties, I always advise my clients to allow for amendment, on the Investor-side, by a majority-in-interest.

I find Notes to be a fascinating subject, and I could keep talking about them on and on. If you have further questions, you must have more than a mere philosophical interest in the subject. Call (650-298-6014) or email me, and we'll talk through the details of your specific bridge loan financing.

Inna Efimchik

White Summers  Inna Efimchik at White Summers Caffee & James LLP, specializes in assisting emerging technology companies in Silicon Valley and beyond, providing incorporation, financing, and licensing services as well as general corporate counseling.


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Friday, May 27, 2011

10 Things Not To Do In Your Social Sharing | Polyvore Shares Lessons Learned

Earlier this week I went to an event at Hacker Dojo, a coworking space in the heart of Mountain View. It was my first event there, and while I had certainly heard the name before, on more than one occasions, embarrassingly enough I did not know it was a coworking space. So anyway, that was exciting!

The presentation, by Jonathan Trevor of Polyvore, a social commerce company with some 10 million unique visitors per month, goes to the heart of the big, burning question at the heart of every (internet) startup: how do I use social media to get consumer eye balls on your product and, ultimately, traction?

There are many things you can do wrong in this area, which is a science (or perhaps an art) evolving right before our very eyes. In his presentation, Jonathan walked us through some of the common misconceptions about social media as a tool, using examples from Polyvore's own experience. You can find the slide deck for his presentation posted here, but for a more narrated version, keep reading.

Misconception 1: I know what's going on

Never assume that you understand the way social sharing is working or that it is working the way that you think it is. You might think Facebook is the way to attract the most users via social sharing. Or Twitter? Jonathan was surprised to find StumbleUpon to be one of the better organic disseminators. StumbleUpon? I know, I haven't used it either, but apparently it's big, in the right circles.

Measure, instrument and iterate to try and get a better picture of what's going on. You can use Google Analytics, or collect your own data and run SQL queries, whatever suits your fancy. The better that you are at measuring, instrumenting and iterating, the better, more effective, product design you will have.

Don't limit yourself to measuring on your own site. To the extent possible, try to do this on third party sites as well. There are even applications for that, like (love the name!).

Misconception 2: I'll focus on the CTR on my site

While CTR (click-through rate) is obviously important on its own, it's even more important as part of a larger social sharing loop. Getting people to "like" your page is not enough, if it is not bringing return traffic to your site.

Once one of your users clicks the Facebook "like" button, or posts content generated on your site to Tumblr, or tweets one of your pages, who sees that content? How many of those who see it are interested enough to follow the link to your website? How many of those who follow the link to your website become a user? This may seem like an obvious point, but it's easy to get caught up in improving CTR on your site, losing sight of the big picture.

Misconception 3: Users want to share

Sure, users want to share, but not all the time. They are inundated in their web browsing experience with all kinds of social sharing buttons, so much so that they've become little more than noise.

What's important in getting people to shares is to align intent with, well, sharing... To use Polyvore as an example, when their users browse sets by other users, maybe they'll "like" those, but there is not an impetus to share. On the other hand, when users create their own sets, sets that they've spent time on and take pride in (hopefully) they want to scream about it from the rooftops. The breakdown of sharing between their set viewers and set creators is 25% to 75%, which is staggering considering how many viewers there are and how many fewer users are creating sets. And it's a good example of how powerful it is to align users' intent with your own.

Misconception 4: One size fits all

There are different kinds of users that you need to think about as you are designing your website.

Bloggers don't share as often (and certainly when it comes to the same service), and they will have a bias against sharing something that already exists (old news). If they can create something original with your product, they are more likely to share it. There is a way to optimize your website for bloggers.

Social sharers, on the other hand, share often and freely. If it's easy to do (e.g., no login required, one-click), they'll do it. There is a way to optimize your website for social sharers, and that's going to look different than a website optimized for bloggers.

One size does not fit all.

Misconception 5: All shares are equal

Not all social shares are equally valuable. Shares on Facebook and Twitter, in theory at least, reach a lot of people, those the viewership may actually be quite small. The environment is noisy. And the content there is short-lived. Perhaps most-importantly, though, it is a low match to reader interest.

When bloggers write about your site, it adds SEO value. There are fewer bloggers than social sharers, but the content is richer and last longer. Finally, there is a much better correllation to reader interest.

Misconception 6: Users can read

Well, maybe users can read, but they don't and they won't.

Polyvore ran tests where they manipulated the amount of text on the same dialog, leaving the pictures and graphics intact. They found that changing or even removing the text altogether had no impact on the users' choices in the dialog.

Misconception 7: Wizards are better than complex forms

We might think wizards are better than complex forms because we know that complex forms are bad. But really, they are both bad. If you can, simplify a complex form into a simple one, instead of breaking it up into a wizard.

Keep in mind that every time there is a new dialog box with a cancel option, you are going to lose users. It's just too easy!

Misconception 8: More networks is better

There is a lot of overlap between networks. And placing 50 buttons on your site just creates noise and clutter. A user doesn't want to sift through all those buttons to find the networks she wants to share on. So how many networks do you really need to get 90% coverage? Maybe up to three? More than that is probably too many.

Misconception 9: Make complex simple ... by hiding

For whatever reason, I think this is my favorite point of the presentation. Simplifying by hiding really works, said Jonathan. If you hide options behind tabs or "advanced" links, users won't find them. So rather than be clever and hide additional features, consider whether you need them in the first place. If you do, find a way to integrate in a simple and graceful way.

Misconception 10: That there are 10 misconceptions

And so we come full circle to where we started: this is an evolving field, where new discoveries are made every day and negated the next and where no truism stays true for long. It is up to today's entrepreneurs to redefine all the conventions of web design and user experience. And I can't wait to see what you come up with!

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Tuesday, May 10, 2011

Runway Program by Innovation Endeavors | Giving Entrepreneurs Runway to Launch Their Next Big Company

Undeniably, being in the Silicon Valley gives technology startups a huge boost. This is the place that has amassed the most talent, the most VC dollars, and the best ecosystem for launching. Whatever else may be said for its ridiculously high cost of living (and cost of labor), employer-unfriendly laws, and, take your pick, nasty traffic or seismic uncertainty, I doubt there is another place that can boast so many startup incubators, accelerators, and coworking spaces as the San Francisco Bay Area. The links page on my website features 14 different organizations in this category, and I am sure it is not exhaustive. (In fact, if you are aware of anything I've omitted, please let me know.)

Yesterday, I met for coffee with Corey Ford, Director of Runway Program, a paid six-month entrepreneurship program based out of Innovation Endeavors, to learn more about their project. Here's what I learned.


Runway is pre-team, pre-idea. You should consider applying if you are (1) entrepreneurially-inclined and think you have the skills, whether on the technical, business or design side, to be an entrepreneur, (2) are willing to commit at least 6 months, full time, to building a company in Palo Alto, (3) are interested in a collaborative process to identify a problem and develop a solution that is a viable business opportunity. (You should also be authorized to work in the United States for any employer.)

Runway is not for entrepreneurs who already have a business solution they are committed to and are just looking for cofounders. It is also not an ideal fit for established teams, as the application process is for individuals and considers each applicant individually (though established teams may apply individually and indicate a preference to work together).


If you are itching to start a company and fit the criterial above, you can submit an application to the program. Applications for the August program will only be accepted for another couple of weeks (deadline is May 23, 2011). There is no cost to apply.

Each application will be individually reviewed filtered on values and on disciplines. Some of the applicants will then be selected to do a mini-project, to test their entrepreneurial skills, followed by interviews. The finalists (less than 20 in all) will meet at a Final Team Weekend and will work on small group projects, observed by Runway program coordinators. Final selection of program participants will be made following another interview round.


Runway gives entrepreneurs "the cushion, connections, and coaching [they] need to take the entrepreneurial leap and succeed." The inspiration and culture for the program has its roots in the Stanford

The winners, working in self-selected groups of ~3-4, will incorporate a company, receive initial funding of up to $150,000 from Innovation Endeavors (in the form of a capped convertible note) and will proceed to work over the next 6 months, with the mentorship and support from Runway program coordinators, on identifying their business idea and building a business around it.

"Nothing comes from the top down," said Corey during our meeting. "We catalyze the entrepreneurs. The direction comes from them."

At the end of 6 months, which is the financial runway of the Runway companies, they will need to look for venture funding. Innovation Endeavors will not lead the round, but they will help with introductions and may participate along-side the lead investors.

Take Away

This program is obviously not for everyone, and not even for every talented entrepreneur. But I think this can be a great opportunity for some of you out there, so I wanted to help spread the word. More information can be found on the Runway Program website, and you can schedule your own meeting with Corey Ford here.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Monday, May 9, 2011

Preincorporation Agreements | What Are They? | Do We Need Them?

Recently I have had several entrepreneurs ask me about preincorporation, or founders', agreements. To be honest, this surprised me. In the Silicon Valley emerging technology company practice, preincorporation agreements are fairly rare. But since the question came up, I thought I would share my thoughts on the matter with a broader audience.

So what is an preincorporation agreement? In simple terms, it's an agreement among co-founders about the terms on which they wish to incorporate their business. Why are preincorporation agreements rare? Instead of sitting down with an attorney to formulate the terms of the agreement, it is generally more efficient and cost-effective to use that attorney's time to incorporate the business on the terms you and your co-founders agree to. Essentially, incorporating sooner saves on the cost of drafting a solid preincorporation agreement that can withstand being challenged in court in the worst case.

That said, when might you wish to draw up a preincorporation agreement? The only time when a preincorporation agreement makes sense is in a situation where a group of co-founders is beginning to work on a project and decides to put off incorporating the venture for some time (perhaps 6 months or a year). While I would generally discourage this course of action, there are instances where the co-founders may, having weighed their options, decide to delay forming a company. To improve your venture's chances of survival through a long preincorporation phase, it is prudent to enter into a preincorporation agreement, stating both the obligations of the co-founders' in the interim period, and the terms on which they wish to incorporate the venture at a future time.

The terms that go into a preincorporation agreement are really up to the founders. The more detailed that they make the original agreement, the less they have to discuss/ negotiate/ argue over later, when the time comes to form and operate the company. Of course, the flip side of that coin is, if you get very specific and circumstances change (which is very likely to happen), everyone needs to agree to amend the agreement, and that can be its own can of worms.

Generally, you can think about the agreement in phases: (1) preincorporation, (2) formation, and (3) post-formation / operating the company. Below is an outline of some of the terms you may wish to include in each of the categories, keeping in mind that your individual business may have different needs and requirements.

(1) Preincorporation
  • Time commitment by each cofounder (pre-formation)
  • Deliverables / project description for each cofounder
  • Initial expenses / capital contributions by each cofounder
  • Consequences for any cofounder who fails to comply with the above terms
(2) Formation
  • Company name, state of incorporation, whether to reserve the name
  • Deadline to form the corporation
  • Authorize shares & founder stock grants, vesting, restrictions
  • Board of Directors
  • Officers
  • Ancillary agreements (e.g., to sell stock, transfer IP, account for bootstrapping funds, etc)
  • "S" status election for corporation
(3) Operations
  • Time commitment by each cofounder (post formation)
  • Positions of cofounders in the company, salary (if relevant)
  • Distribution of initial capital by category of expense
  • Authority to write checks
  • Authority to enter into contracts
Beyond these timeline-centered categories, the cofounders should think through the term and termination of their agreement. What happens if they don't incorporate by the time they state in the agreement? What happens if one of the cofounders wants out either before or after producing the preincorporation deliverables? Who owns the intellectual property generated during the preincorporation phase by the individual cofounders?

You can see that the level of detail and complexity of this agreement can be quite high. If it is not, how valuable will this agreement be in settling disputes among cofounders? If it is, how much time and expense will it take to put together the agreement? Bottom line is, unless there is a really good reason for you to put off incorporating once you've embarked with your cofounders on an entrepreneurial venture, skip the preincorporation agreement and take the plunge by incorporating.

And, my shameless plug at the end: whichever course you choose, or to discuss the best course for your company, Emergence Law Group is available to help.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Saturday, March 26, 2011

Women Entrepreneur Panel

Last week, I was very fortunate to attend a wonderful event graciously organized by the MIT Club of Northern California. As a Cal (UC Berkeley) alumnae through and through (undergraduate and law school), I was nonetheless able to attend, which I appreciated very much. [Is it just me, or does Cal not have a very strong alumni association here? Perhaps it's the home turf problem--we don't feel a need to coalesce because there are so many of us here in Northern California...]

Participating in the panel discussion were Amy Pressman (co-founder of Medallia), Carol Realini (founder of Obopay), and Wendy Lung (of IBM Venture Capital). Moderating the discussion was Sramana Mitra (founder of One Million by One Million).

As usual, I cannot hope to cover everything that was discussed in this very interesting and informative session, so I will try to touch on some of the topics/points, that really stood out to me.

  • No one funds concepts anymore. There are no more VC term sheets based solely on a PowerPoint (or a white-board) presentation to be had. That means, a business has to make its bootstrapping dollars stretch to cover product development and even initial customer acquisition.
  • Bootstrapping is healthy for the business. White we can bemoan the point above ad infinitum, the fact of the matter is that bootstrapping can force a young enterprise to stay narrowly focused on quality and on those things that add value. VC money can be a moral hazard! So easy to spend without any personal accountability. But when the money in play is that of the entrepreneur, his close friends and family, the purse strings stay tight, growth occurs when it is supported by infrastructure, and risks are minimized (as much as they can be in a startup).
  • Contained growth. In fact, being forced to grow at a slower rate (one supported by the revenues) allows a fledgling company to "catch up" to its growth, building the infrastructure and maintaining the culture.
  • Simple is better. An entrepreneur's life is hard enough, so whenever possible, the advice of the panelists was, simplify. If your business model can support bootstrapping, it is much simpler to operate without outside capital. The entrepreneur continues to control the board. The consensus required to get big things done is that of a smaller group. The pressures are different--a bootstrapping entrepreneur does not have to have an exit in 8 years.

Early Customer Acquisition

Since, as we said before, it is generally no longer possible to get funded based on a PowerPoint presentation alone, a company needs not just to develop a product, but to prove that there are customers willing to pay for it. The unavailability of funding early on places added significance on early customer acquisition. So what are some effective ways to get early customers?

  • Alumni networks. Once you identify your ideal customers or the "lead users" for your industry (see a case study out of MIT for a discussion on lead users), look for relevant contacts in your alumni (or other) network.
  • Customer input. It is essential to engage customers (or prospective customers) early, to take their input. (This is straight out of Steve Blank's The Four Steps to the Epiphany.)
  • Listening. When you are an evangelist for your new product, there will be plenty of people who have something to say about it. Not all of it will be feedback that is pleasant to the ear; not all of it will be encouraging; and, importantly, not all of it will be constructive. You have to listen to all of it. And you have to filter, based on who the feedback is coming from, their experience, expertise, and credibility. Naturally, feedback from domain experts and customers is more valuable than feedback from your hair stylist. An entrepreneur must develop thick skin and be ready for rejection--entrepreneurship is not a popularity contest.
  • Utilizing Channel Partners. Building channels is expensive. If you can build channel partnerships (like with IBM), your company valuation goes up. But beware--large channel partners can slow you down as well, as they don't operate in startup mode. It is very important to find stage-appropriate channel partners, starting with younger, more flexible companies to partner with.

Raising Capital

  • How much? When going out for investment capital, determine how much capital you need, then add a little on top because you are probably a little optimistic.
  • It's a process. Getting funding is always painful, whether you are a first-time entrepreneur or a seasoned one. The difference is that you can become more efficient about it.
  • Think outside the box. Sometimes the economy is such, or you are in the kind of market, that tradition VC capital funding is impossible. The trick is, not to get single-threaded about the funding process. Think of alternate funding methods and alternate investors. This can come in the form of institutional investors or channel partners. Stay persistent and creative.


It is a well-known fact that when it comes to building a business, it's not what you know, it's who you know. In today's world of information excess, the only way to get noticed is via introductions, and the only way to get relevant introductions, is to have a broad, active, and "well-networked" (for lack of a better term) network. How does one go about building a network?

  • Follow up. Sometimes you think that an introduction to a particular person is going to be determinative, and then nothing comes of it. And at other times, you may get business or referrals or something else extremely valuable to you from someone you had not expected. So, as a rule, follow up with everyone. You never know who your most valuable connections may turn out to be.
  • Meaningful Connection. It is not enough to swap business cards. We all know where those usually end up. You need to share about yourself--about your passion, your business, maybe something personal, that will stay with the person you are talking to. And, of course, you need to find out about them. Not in a way that's intrusive or obnoxious. Different people will have different comfort levels with sharing. But to the extent that they are willing to share, you should get them to talk and see if there is anything of value that you can offer.
  • Know what you want. When you are utilizing your network, don't just ask for an introduction. Have specific questions. It's more genuine. And it will yield better results.
  • No free lunch. This is kind of obvious, but no less important, all the same. You have to give something to get something. When you are networking, don't expect people to just give you business or referrals. Be proactive about offering something to them first (as a gesture of good will), whether access to your network or to information in your possession. Sometimes it's the thought (or the willingness to give) that counts more than what you've actually given.

Overall, this was a very frank and insightful discussion, with some amazing, smart, and very successful female entrepreneurs. I would like to thank the organizers for putting this together and the panelists and moderator for participating.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Thursday, March 17, 2011

Hack Your Funding | Hackers & Founders Event with Naval Ravikant

"There are no shortcuts to getting funding," admitted Naval Ravikant, the man behind AngelList and Venture Hacks, at tonight's Hackers and Founders event at Microsoft.

But at least, for the first time in some 30 years, the past few years have seen innovation in funding, which ought to change the way that entrepreneurs approach their companies and fundraising. Naval calls this change "the rise of the entrepreneurs."

So what's changed?

We're in an age of "free leverage," as Naval calls it. The barrier to entry is obviously significantly lower than it was when he was building his first company. Naval had raised $8 million in Series A funding based on a whiteboard presentation, which seems incredible today. The company then proceeded to burn through the cash quite rapidly to build a product. These days, there are IP platforms given away (e.g., Facebook), labor platforms (e.g., YouTube, Quora), and ... now capital platforms (e.g., AngelList).

Because we're now in a world where a group of strangers, who met on a startup bus some 5 days ago can arrive at South by Southwest with a working product and customers, the best way to think of startups of today is as working in continuous mode on all fronts. That means continuous deployment (as opposed to releases that take from a month to a year to launch), consultants for discrete projects through sites like Mechanical Turk, Elance, or TaskRabbit (instead of employees), and ... continuous fundraising!

So what's important when raising money in this climate? (In order from most to least important...)

Traction. Most important is traction, says Naval. You've got to show that you can get customers because that's very hard to predict early-stage. If it will take investment dollars to build the product that can go in front of customers, at the very least you need to have done your homework and tested the market, whether by doing Facebook or Google ads or other surveys.

Team. After traction, the next most important thing investors will consider is the team. Or, as Naval puts it "you." Don't take it personally. If you can make investors swoon with your elevator pitch, you have it made. But if there's something about you, your background, or your perceived ability to execute that the investors just don't buy, they won't buy. And what's worst, this is the thing they will be most reluctant to tell you.

Social Proof. If you've got traction, and a great team, the next hurdle is social proof, or branding. Are there "brand name" investors interested in or that have already invested in your company? Did your team go to "brand name" schools (think Harvard or Stanford)? Did they work for "brand name" companies (think Apple or Google or Facebook)? Do you have high quality "branded" advisors? Are "brand name" companies using your product? Before approaching investors, the more of these that you can nail an affirmative answer to, the better!

Product. Product is king, but comes fourth in this lineup, because if it's really king, you'll be able to show massive traction, which is the first line of inquiry.

Market. If the market is not big enough, it can be a turn off for investors. Which is not to say that companies cannot create a market where there wasn't one before. It's just harder to predict.

Pitching. You'll need to have (1) a high concept pitch, (2) an elevator pitch and (3) a presentation (~ 10 slides). Notice this comes last on the priority list for funding.

Though there are no real hacks to get funded, here are a few pieces of advice Naval has for improving your experience:

(1) If you want money, ask for advice. Don't take up a lot of the investor's time. Don't ask for in-person meetings. But if you can establish a dialog by email or phone where you receive advice and follow up in a month or two with your progress, get more advice, then follow up again, your chances of getting funded improve over someone merely pitching.

(2) Get "branded." See the point above about social proof. Investors are pattern-seekers. If they see familiar names, they get excited.

(3) Don't get attached to a single investor. Talk to multiple investors without committing to one immediately. If there's interest, you can leverage that to get to a higher valuation and better terms. And there is more than one good investor out there. This will obviously not apply to every company--only the ones lucky enough to generate serious investor interest.

(4) Raise continuously and reward first-movers. This is a new concept in fundraising. But putting together a major round saps everyone's resources. And today companies can get built with much less. So taking in money in smaller chunks, continuously, at higher valuation with each successive investment, is the way to go. Why not offer a Groupon special to the first investor, a 50% discount, proposes Naval. Not a lot of companies are recognizing the need to reward first-movers with significant discounts, but Naval thinks the industry is moving towards this.

(5) Put it online. Cast a wide net. Get qualified leads. And no, this does not mean that you should put up an "Investors" tab on your website, offering to sell your stock to any taker. That would violate SEC rules and get you in a lot of trouble fast. But using resources like the AngelList can be a great way to reach many investors at once.

(6) Investors are users, too. So provide them with something visual that they can love and understand immediately. If you have a product they can test-drive, excellent. And if not, provide screenshots or a demo.

Excellent presentation by Naval in all. I've only covered some highlights from the talk above, but slides should be available on slideshare for those interested.

Thank you, Naval, for taking the time and preparing a thoughtful and interesting presentation!

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Thursday, February 17, 2011

Predictive Analytics | Ownership & Use of Data

If you click on the by-now very familiar Facebook "Like" button above, which I hope you will do by the way, when you next visit your Facebook page you might see ads for attorney services or invitations to startup-related workshops. That's predictive analytics in a nutshell.

With the explosion of data (which is now cheaper than ever to store and to process), predictive analytics has become a hot and growing field. The data is being put to uses as diverse as forecasting traffic, recommending movies, predicting clicks, preventing fraud, and even classifying a fading pitcher.

It was on the topic of predictive analytics that MIT/Stanford Venture Lab (VLAB) held a very well-attended and insighful panel discussion, featuring Omar Tawakol of BlueKai, Scott Burke of Yahoo, Matthew Barkoff of Badgeville, and Theresia Gouw Ranzetta of Accel Partners, with Michael Driscoll of Metamarkets serving as moderator.

Without attempting to provide a word-for-word transcript of the presentation, let me cover a few of the interesting points that stuck with me as well as my own thoughts/interpretation.


Before predictive analytics, how did advertising companies know who to target? They used proxies. A zip code for an affluent neighborhood may serve as a proxy for the kind of discretionary income that the homeowners have in that neighborhood. A TV show might be a proxy for the target viewer of that TV show. So companies would sell (and still do) direct mailing packages into specific zip codes based on the demographics of those zip codes, or offer advertising time during TV shows, as a few examples.

But how much do you really have in common with your neighbors in terms of the kinds of products and services that you are interested in? Or with the other viewers of your favorite TV show? Not very much I would guess. Proxies are obviously a very imperfect method of directed marketing.

Cue: enter predictive analytics to save the day. :)

Data Collection

Predictive analytics obviously needs data to feed its algorithms. So where does that data come from?

A portion of the data is collected by online service providers.

When you search on Yahoo or Google or Bing for designer shoes, baby cribs, corporate gifts, European cruises, or wedding photographers, the company providing the search engine capability aggregates that data to know what your interests, hobbies, and buying patterns are in order to place more relevant and therefore more expensive advertising in front of you while you search.

Amazon, formerly a large online book store and now a supermart for everything under the sun, from video-on-demand to Halloween costumes to high-end electronics, amasses a huge amount of data over time about the shopping habits and preferences of its frequent shoppers. [Though to be honest, I have not seen them put the data to good use with their shopping suggestions, which never seem to inspire, just mho.]

And finally, social networks like Facebook or Yelp know as much as you are willing to share about everything in your life from where you went on vacation, to your favorite restaurants, to the kinds of networking events that you attend.

The common trend in these three examples: the data is provided by the users, whether consciously or not.

And I, for one, don't see anything nefarious in this. [Gasp!]

Rather, I think of it as a kind of implicit pay-to-play. Only the currency to play isn't cash; it's personal information.

Which leads us to the next point.

Data Ownership

Following the logic from above, if the price for using free services like Facebook, Yelp, or Google search is the personal data collected while using the services, then ownership of the data rightfully transfers to the service provider at the time of use.

However, because the pay-to-play is only implicit and because of the... well... rather personal nature of personal information, the transfer is probably more akin to a limited license than a full assignment, to throw around some legal jargon.

[Please note that the theoretical legal framework I am suggesting is artificial and fictional, and is only meant to faciliate discussion, not provide a legal opinion on the underlying transactions. :) ]

Data Use

If, following the premise above, the license is indeed limited, the big question is, what can the companies that collect the data do with it?

And I think the answer is, to the extent that the data is anonymized and handled properly and securely, they can sell it to advertisers/advertising agencies (via data marketplaces like BlueKai, for example). The caveat for data being "anonymized" and "handled properly" and "securely" is supposed to protect against broad typoes of misuse of the information, including identity theft.

But short of that (misuse that is), how bad is it really if the marketing aimed at us is (even incrementally) more relevant to our interests than the same amount of marketing that is instead total junk?

Your Options

Not every website with let you do this, but a growing number of websites, Yahoo, Google and Bing among them, will let you manage how that website perceives your interests (and, therefore, the kind of advertising you might expect to see).

If you are interested, at the very bottom of the Yahoo home page, click on "About Our Ads" and then proceed to the gray "Manage" button to see the kind of categories Yahoo is using to assess relevance in placing ads on your pages. Very similar process on Bing. For Google, click on "Privacy" at the bottom of the page, then on "Ads Preferences Manager."

The Future

I don't have a crystal ball, but I would not at all be surprised to see more companies allowing greater transparency and user customization of interests used as a basis for interest-based advertising. Maybe that's the next evolutionary step in advertising, in fact, following proxies and black-box predictive analytics.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Tuesday, February 15, 2011

Entity Formation | Do You Really Need an Attorney?

The early-stage startup community is about being lean and about being frugal. It's not 1999 anymore. Company founders have to be realistic about the amount of time they may need to stay in operation before getting funded and they have to stretch their bootstrap dollars as far as possible.

And the best place to save money is eliminating obvious overhead items, like legal fees, right?

I talk to a lot of entrepreneurs in the idea stage, pre- company formation. "How early do I need to engage an attorney?" I am often asked. "Do I really need an attorney to form my company, when I can get incorporated on Legal Zoom for a few hundred dollars?"

The answer to the first question is easy--start working with an attorney as early as possible. It will help you avoid a number of pitfalls to which first-time entrepreneurs especially are very susceptible.

As far as the second question, here's my take on it.

Legal Zoom will get you incorporated, that is true. And, by the way, you could incorporate your company yourself, too, for even less than the cost of Legal Zoom. And get an EIN online in 10 minutes (maybe even less). Some big law firms have been adding their entity formation forms to the public domain, so the forms are out there for the taking. Why?

Because the reason to retain a startup lawyer isn’t because they can file a standard piece of paper on your behalf. It’s because with the help of a good startup lawyer your business has a higher chance for success.

As far as Legal Zoom goes, keep in mind that they don’t actually issue shares. Founders should be issued shares as early as possible, while the value of the company is at its lowest. And the shares they are issued should be restricted shares that vest over time (4 years is fairly standard). They should also be subject to the company’s right of first refusal. In addition, the founders should transfer their intellectual property to the company at the time of the issuance of the shares and in consideration therefor.

In order to issue shares subject to these restrictions and conditions, the corporation needs to execute stock purchase agreements with the founders. Legal Zoom, on the other hand, will provide you with board resolutions authorizing the stock issuance and blank stock certificates, with the idea that you can issue those to yourselves.

At the time when the corporation issues shares to the founders, in addition to building in the provisions discussed in the previous paragraph, the corporation needs to make a securities exemption filing in California and the founders need to file an 83(b) election with the IRS. Legal Zoom does not handle any of that (because they haven’t issued the shares).

The bottom line is, when you retain corporate legal counsel, you are hiring an experienced advisor who will guide you and help you avoid underwater rocks. If you use Legal Zoom to incorporate, or if you incorporate yourself, you still need to go to an attorney to take care of other "formation" matters.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Monday, January 31, 2011

Tim Ferriss on Marketing, Self-Promotion, and Productivity

It's not every day that you get to sit only a few feet away from a celebrity and listen to his tales. I suppose here, in the Silicon Valley, there is a higher per capita ratio of self-made millionaires and other persons of note than in some other places. (No disrespect intended to any other places.) But it is still an experience that I seek out and savor. And not because I am a groupie. :) But because, even if success isn't transmitted virally--unfortunately, if someone sneezes on you, you don't get rich--then perhaps, at least in part, it can be transmitted orally, or, more precisely, verbally, by way of educating us.

And so it was with great interest that I listened to Tim Ferriss's story and his advice to young entrepreneurs that he shared at ZURB's soapbox in Campbell last week. (Video and podcast from the meeting are available on ZURB's blog.)


The first step, says Tim, is to identify customers who would be able to evangelize on your behalf. Once you identify this group, you must design your product for these customers.

When he was starting his nutritional supplement company, BrainQUICKEN, Tim identified his ideal initial customer demographic as computer-savvy, health-conscious males, 18 to 35 years old. The group of initial supporters and evangelists must believe the messenger before it believes the message, says Tim. Groups which identify you as a member, whether alumni associations or just groups with the same demographic to which you belong, will find it easier to trust you as the messenger.

Once you identify the group of initial customers, putting money into the product they will love is where you are best-served.

As I was listening to Tim, I was impressed with how similar his approach was to that identified by Jeff Smith at his presentation just the day before. For all the different opinions that there exist about running a business and succeeding, it was refreshing to see some uniformity.

So once you have designed a product for that initial group of customers, how do you get the word out? When Tim's first book, 4 Hour Work Week was about to be published, Tim identified some 15 blogs that were frequented by his target demographic, and he set himself a goal to have at least half of them cover his book. Then it was about meeting these bloggers at conferences, having drinks with them, and getting them excited about the book. You can't "sell" to these people, advises Tim. There has to be genuine interest.

It is also very difficult to have a blogger or a journalist write about your product in a vacuum. It sounds like an endorsement and makes the piece look "bought." To get the attention of bloggers and journalists, you need to show something newsworthy, like a trend. Sometimes, to be able to show a trend, you might even go so far as helping competitors get on the radar.

From blogs, you can build up to print. From print to radio. And if you can do well on the radio, you might be invited on TV. But you wouldn't be well served to be covered by any of these media too early, before you are ready. Also important to remember is that brand name media is not necessarily the most effective marketing. The effectiveness depends on the strength of the endorsement and the duration.

You should maintain a primary social media tool, where your community of fans and supporters can feel connected. For Tim, it's his blog. He uses Facebook and Twitter solely for directing traffic to the blog. Whatever your social media tool of choice may be, however, you need to police the community to make sure that people feel comfortable sharing. "I treat it like my living room," says Tim, "and there is nothing I enjoy more than deleting a 5-hour message of hate in one stroke." A policy of no tolerance for abusive behavior is extremely important.


What's the secret to being productive?

A lot of us start the day with email. It's easy. Chris Sacca once said, "Email is a task list created for you by someone else." How very true! Email is a reactive workspace, and that's not productive.

Tim suggests, finding that one thing on your to-do list for the day that is most important, the one thing that, if it was the only thing you did that day, it wouldn't be a bad day, and probably the one thing that you least want to do, and then doing that one thing for the first hour of the day, before you ever open your email.

Beyond that, here are a few other tips to being more productive:
  • Try to minimize the number of decisions that you need make on a day-to-day basis.

  • For repeatable situations, set policies.

  • Allow employees to think for themselves. Don't make simple decisions for other people.
Reading List

During his presentation, Tim referenced many books that he enjoyed and recommended. Among them were:

  • Letters from a Stoic by Seneca

  • 22 Immutable Laws of Marketing by Al Ries and Jack Trout, and

  • Do More Faster: TechStars Lessons to Accelerate Your Startup by Brad Feld and David Cohen
Tim is especially influenced by Seneca, and says he rereads Letters from a Stoic a few times a year. Most importantly, Tim tries to follow Seneca's admonition (1) not to overreact to things outside your own control, and (2) not to get attached to things that can be taken away from you. Good lessons for all of us to remember.

Thank you, Tim Ferriss, for an interesting discussion, and thank you, ZURB team, for your soapbox series.

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Saturday, January 29, 2011

4 Tips for Business Success | Getting Your Mobile App to Top the Charts

What does it take to build a successful technology startup? Is it about a great idea? An amazing group of people? Being in the right place at the right time? There are as many answers as there are entrepreneurs, yet it's a question on the mind of anyone who has ever decided to take the plunge and work on a startup.

Last week at a Startup Grind meetup hosted by Derek Andersen of Vaporware Labs, Jeff Smith, co-founder and CEO of Smule shared his formula for business success. Smule, if you have not heard of it, is the creator of some of the most popular, chart-topping social music-making applications for the "i" platforms (iPhone, iPad, etc).


As history teaches us, best technology does not always win in the marketplace. Jeff argues, however, that the best product does win!

But what about the best marketing? What about a really well-funded company that beats out its competition by flooding the market with advertising? (Anyone else thinking of LivingSocial versus Groupon?)

Here's Jeff's point: the best product is one that prioritizes the user's experience. Having identified the core group targeted by the product, the development for such a product is focused on (1) how likely they are to use the product, and (2) how likely they are to recommend it. Word-of-mouth, after all, is a tremendously powerful distribution channel. But this word-of-mouth, viral marketing will only work well for the product that really grips the customers.

And it is a much more mature market now in mobile apps than it was just a few years ago. If customers were blown away by Smule's first app, the Sonic Lighter (a virtual cigarette lighter), today's customers won't be as easily impressed.

In working on a new product, Jeff's team tests the premise by asking itself, "What's the 20-second YouTube teaser for this product?" or "What's the 20-second demo?" If the teaser or the demo doesn't grab the user in those 20 seconds, viral distribution will not work.

Is a teaser or a demo really a good proxy for the product, you might ask. Isn't this exactly the case where great marketing wins? Though Jeff did not elaborate on this point in his presentation, I think he would say that the teaser or the demo is the product essence, not a clever marketing reel. And the main reason for that is that with viral distribution, the majority of the time the 20-second demo is not going to come from the company, but from a fan showing the application to a friend off his phone.

"The best products," says Jeff "are developed by developers who are close to what the user is doing."

Cumulative Value

Jeff's next point was very straight forward--don't let your developers convince you to start from scratch each time, for each new iteration. Build on the existing code, even if it seems like it would be easier to start from a clean slate, even if the existing code looks convoluted and messy. Whatever its other failings, existing code works! Build on that. Don't let that value slip away.


"Empower your customers with all their creativity," says Jeff. Take a look at this YouTube video posted by one of the fans, using Smule's app Ocarina. Amazing, isn't it? This video, being a fan video, cost Smule nothing to produce and nothing to distribute. But it has been viewed almost 500,000 times. According to Jeff, Smule has been able to map a direct correlation between traffic for YouTube videos featuring an application and application sales.

Listening to the customers, hearing and acknowledging what the customers want, is key. The biggest mistake, says Jeff, is to think you know better than the customer. Everyone in the company has to be thinking about the customers. Making the customer the focus, lowers customer acquisition cost, and allows those funds to go to product development and enhancement.


Simply put, the company's ability to recruit and retain top people is going to be directly related to the company's success. I doubt there is anyone out there who would dispute this correlation.

Jeff focuses on building Smule's culture around creativity, not discipline. This has its own drawbacks, to be sure, but it works to help create chart-topping products. In hiring, says Jeff, they aren't looking as much at the skill set. First and foremost they care about the attitude.

Thank you, Jeff, for a great, insightful presentation. Your PowerPoint was inspiring! [For those who weren't there, there were just the four words spread out over the four slides: product, cumulative value, customers, and team.] ;)

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.

Sunday, January 16, 2011

The Science of Building a Successful Startup

There are those who say that the majority of startups are doomed to fail. And there are those who believe that startup success is all about luck--being in the right place, at the right time, with the right idea.

Mike Cassidy, the founder of four technology startups, all with successful and very successful exits, has reduced building a successful startup to a science. His secret (which he shares openly): speed as the primary business strategy.

I heard Mike speak at The Entrepreneurs' Club (TEC) event on January 12. Recognizing that these strategies will not work for every entrepreneur, every business, or in every industry, I still found Mike's story and the premise very interesting and compelling. In the days following the event, even before I had had a chance to blog about it, I found myself sharing the presentation highlights with friends and clients, over and over again.

So why is speed so important?

  • It builds morale, for one. When employees have milestones they are helping meet every day and when objectives are being met all the time, it motivates them to do even more and to do it even better.
  • It also makes it difficult for competitors (especially bigger, slower-moving competitors) to catch up.
  • The press loves companies with momentum. A good write-up from a well-read publication saves a lot of advertising and marketing dollars, and a lot of time!
  • Finally, momentum drives higher valuations from a fund-raising perspective. The trajectory of a company moving very quickly is hard to map.

Timeline. A typical startup might take roughly two years to get from idea to first customers. Mike's timeline requires about 4 months, with 2 weeks allotted to exploring ideas, 1 day [gasp!] to raising capital, another 2 weeks to hiring a team and opening an office, and 3 months to building a product. Admittedly, this may not be possible for every company, but in the consumer Internet space it can be done.

So what does it take to speed everything up?

Fundraising. Most startups will not be able to get funded in one day, especially those founded by first-time entrepreneurs. But Mike's strategy for getting funded quickly may still help to speed up (or even make possible) a funding.

  • Raise money when the conditions are in your favor - in other words, when you are about to, but haven't yet, signed a major deal or there is another significant and predictable event about to happen in the life of the company that is going to raise its valuation. Mike is not worried about leaving money on the table by raising before, not after, the valuation changes. Getting funding and getting it quickly is worth more to him than getting the most money on the best terms. In addition, Mike's philosophy is to make sure every dealing results in people continuing to want to do business with him, and part of that is not being bent on winning a negotiation.
  • Get all decision-makers in the room - before taking a meeting with the VCs, Mike requests that all decision-makers be present, so that a decision can be reached the very same day. His track record demonstrates that this approach can work, for some executives and some companies. Some VCs, however, are turned off by an entrepreneur who rushes them and his own decisions, so if you're going to add this strategy to your repertoire, use at your own risk and peril.
  • Synchronize the timing of competing offers - startups that have the luxury of doing so, can turn up the pressure on the VCs to act and act fast by scheduling all their pitch meetings in one day. With the caveat that most startups would consider themselves lucky to be able to get in front of more than one VC in the first instance, it's certainly a strategy bound to put the pressure on the VCs to produce a term sheet.
  • Bring "if/then" contracts with customers to the meeting - an "if/then" contract is essentially a conditional indication of interest in becoming a customer. For example, "If you build an application with this functionality and specification, we will buy a license to use it." The bigger the account, the more impressive the potential client, the further it will get you. The "if" part of the contract is the action plan, and in the presentation you need to be able to show the VCs exactly how you are going to accomplish that "if" in the proposed time. According to Mike, "if/then" contracts go a long way towards convincing the VCs that you are the real deal.

Hiring. Just as Mike likes to get funded in one day, he likes to hire in one day as well. Not just anyone, of course--Mike is very picky with his hires. He looks for very experienced developers, not recent college grads, and he looks for people referred through and known in his network. But if he finds that great candidate, Mike checks his references while the candidate is proceeding with the interviews and, before the candidate leaves, presents him with an offer. He also asks for an answer by 9am the next morning. And until that offer is accepted, Mike pursues and woos and doesn't let up. He is relentless.

He also expects his hires to hit the ground running. No filling out IRS forms on day one. No reading through manuals, waiting for computer station to be set up, or twiddling your thumbs. That just kills all the momentum, all the great energy that an employee brings with her on the first day. The paperwork and manuals are given to the employee before the first day of work. The computer, email, accounts are all set up ahead of time, too. On their first day of work, Mike's employees receive a list of goals, projects and deliverables, and it's off to the races.

Of course, picking those perfect candidates is no easy task. Mike looks for hard-charging individuals, people who take ownership, but who are not stubborn. He also maintains a culture where no one looks back. Once a decision is made and all the voices have been heard, everyone gets behind it and works to make it happen. If it turns out to have been the wrong decision, there is no blame, no looking back. Everyone just moves forward. And if that's the culture, says Mike, people get used to it.

Product Development. Not surprisingly, given his speed motto, Mike believes in incremental development. He builds out his products module by module, one release quickly following the next. Another way to approach product development is to hit the market with a product that is rich and compelling, as you only get one first impression. But this approach calls for a longer development cycle and more capital upfront.

Business Development. "Probability of a deal ever closing declines by 10% each day it doesn't close," says Mike. So he pushes hard to close deals and not allow them to go stale, even if that means leaving something on the table. Some of his pressure tactics to elicit faster action involve using calendars and maps to show limited, even vanishing, supply, and encroaching competitors. Scarcity, after all, creates demand (and panic).

Marketing. Public relations is faster than marketing, is Mike's approach. All of his companies have been featured in major industry publications. If you can create a buzz with the press, the proverbial (or actual) phones ringing off the hook, who needs marketing?!

Changing Direction. As soon as you decide it's not working, you have to be fast to change direction, says Mike. Indecisiveness will only sap the resources of the company, sabotaging its chances of making it with either the old or the new idea.

But how do you come up with the "right" idea? It doesn't matter, says Mike, if you have a really strong team. You want to get into a space that is changing and happening, and learn rapidly. The "right" space will be something you enjoy and are excited about. You should have a network of people that you like to bounce ideas with, to help you find the right space. And, of course, look for pain points.

Can anyone replicate Mike's success using his business strategy? I think not. It takes a special kind of person, with amazing efficiency, organization, and even brilliance for building startups. But as with any success stories, there are valuable lessons to be learned.

Thank you for sharing, Mike! Your presentation was an inspiration!

Inna Efimchik

Emergence Law Group  Emergence Law Group, specializing in assisting emerging technology companies in Silicon Valley and beyond, provides incorporation, financing, and licensing services as well as general corporate counseling.