Newsletter of the Private Equity and Venture Capital Committee
  Preferred Returns
Join the Committee Online

Message from the Chair

Featured Articles
  Delaware Insider:
Drafting a Mandatory Put Provision for Preferred Stock after ThoughtWorks

  Why Private Equity and Venture Capital Firms Should Care About Intellectual Property Assets
  What You Need to Get Done Now If You Want to Sell Your Company in 2012
  2011 Market Review
  Managing Secondary Market Transactions With Transfer Restrictions
  Trends in Terms of Venture Financings for the Life Sciences Sector (Fourth Quarter, 2011)
  Trends in Terms of Venture Financings for the Technology Sector (Fourth Quarter, 2011)

Heard on the Listserve
  Dilution from Employee Equity in PE Acquisition
(January 2012)

  Unlicensed Finder located in US but all activities Offshore
(January 2012)

  Issues at the Cusp of Being an Affilliate and Rule 144 and Section 4(1)/(1 and 1/2)
(January 2012)


Spring 2012 Meetings

Articles and Authors for Preferred Returns

Committee Leadership

Editorial Board:

Eric S. Wilensky
    Morris Nichols Arsht & Tunnell LLP
    (302) 351-9169

William (Ken) Maready, Jr.
    Regional Editor (Southeast)

Raymond Walheim
    Regional Editor (Mid-Atlantic)

Samantha Horn
    Regional Editor (Canada)

Francesco Portolano
    Regional Editor (Italy)

  Message from the Chair
   
Mark Danzi, Committee Chair I look forward to seeing many of you at our Committee's spring meetings from March 22 - 24, 2012 in conjunction with the ABA Business Law Section's meetings in Las Vegas, Nevada. We have a terrific schedule of meetings, programs and events.

Notably, we are very excited to have Vice Chancellor Donald F. Parsons, of the Delaware Court of Chancery, joining us at our full Committee meeting on Friday, March 23 from 3 - 4:30 PM. Vice Chancellor Parsons will discuss recent Delaware legal developments relevant to private equity and venture capital practitioners. Our Committee meeting also will feature Committee updates, presentations regarding other recent developments and our usual roundtable discussion on current market trends and emerging issues. Our full Committee meeting is a great opportunity to catch up on important developments and meet other members of the Committee.

Our Angel Venture Capital, International, PE/VC Funds and VC Transactional Issues and Documents subcommittees all will be holding separate meetings as well, and we are sponsoring and co-sponsoring two exciting programs. Click here for a full schedule of our meetings, programs and events.

We'll also be hosting our traditional Thursday evening dinner. This year we're joining with the Young Lawyers' Committee to mix things up a little. Cocktails will be at 7:30 PM and dinner at 8 PM at Taqueria Canonita Restaurant. Taqueria Canonita has an outstanding reputation and is located in a beautiful space along the "canal" in The Venetian. Click here for more information.

As always, I encourage you to call or e-mail me with questions or suggestions for the Committee.

Warm regards,


Mark Danzi
Chair, Private Equity and Venture Capital Committee
mdanzi@hwhlaw.com


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  Featured Articles
   
Delaware Insider: Drafting a Mandatory Put Provision for Preferred Stock after ThoughtWorks
C. Stephen Bigler and Jennifer Veet Barrett
An exit strategy frequently bargained for by venture and other equity investors is the right to require the corporation to redeem their stock under designated circumstances. Such "mandatory put" provisions are intended to create a contractual right in investors to have their stock redeemed and their investment returned. Since stock is equity, not debt, state corporation law limits the ability of the corporation to redeem its stock if its capital is impaired. This limitation is often incorporated into the terms of the put, which mandates that upon demand by the stockholder or some specified date or event, the corporation "shall redeem [the preferred stock] out of funds legally available therefor."


More...



Why Private Equity and Venture Capital Firms Should Care About Intellectual Property Assets
Bruce W. Burton and Scott Weingust
It is well established that intellectual property ("IP") assets - including patents, trademarks, trade secrets, and copyrights, among others - generate what economists would refer to as "excess profits" to their owners, causing relatively high levels of returns compared to other asset classes. Similarly, it appears that today more than ever, on average, IP assets are likely contributing more value to corporations than any of their other assets. In 1975, only 17 percent of the market value of the S&P 500 companies was represented by intangible assets. In contrast, in 2010 intangible assets represented 80 percent of the market value of the S&P 500 and we believe that much of this value represents legally-protected IP assets including patents, trademarks, copyright, and trade secrets, among others.


More...



What You Need to Get Done Now If You Want to Sell Your Company in 2012
Jeremy D. Glaser
One of today's most discussed political topics is the expected expiration of the Bush tax cuts after December 31, 2012. If Congress doesn't act, among other things, the individual U.S. federal income tax rate on long-term capital gains will increase on January 1, 2013 for those earning more than $200,000 per year from 15% currently to 23.8%. (An approximately 60% increase in the rate!) Furthermore, California Governor Jerry Brown intends to seek a referendum to increase the individual tax rate on millionaires from 10.3% to 12.3% after this year - a 20% increase.


More...



2011 Market Overview
Courtesy of Houlihan Lokey
Includes:
  • M&A Market Overview
  • Capital Markets Overview
  • Financial Sponsors Overview
  • Recent Public M&A Transaction Terms
  • 2011 Purchase Agreement Study



More...



Managing Secondary Market Transactions With Transfer Restrictions
Andrew M. Johnston and Ryan J. Greecher
The traditional approach of many venture capitalists has been to acquire a large equity stake in a promising start-up and to incentivize the start-up's officers and employees in part by issuing them some stock or stock options in the company, with the intention (and hope) that these people will work harder to make the firm succeed because their economic interests would be aligned (for the most part) with those of the venture capitalist. The employees would have very few alternatives for selling their stock before the venture capitalist could.


More...



Trends in Terms of Venture Financings for the Life Sciences Sector (Fourth Quarter, 2011)
PricewaterhouseCoopers/National Venture Capital Association Money Tree™ Report based on data from Thomson Reuters
Life sciences venture capital funding rises year over year, but quarterly performance falls short.


More...



Trends in Terms of Venture Financings for the Life Sciences Sector (Fourth Quarter, 2011)
PricewaterhouseCoopers/National Venture Capital Association Money Tree™ Report based on data from Thomson Reuters
Fourth-quarter Technology venture capital investment increased 10 percent year-over-year, but decreased 15 percent quarter-over-quarter.


More...



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  Heard on the Listserve
   
Dilution from Employee Equity in PE Acquisition (January 2012)
Mark Danzi writes: We're representing a financial sponsor in a fairly plain vanilla leveraged acquisition. A key employee of the target is receiving cash for most of his shares, but also rolling over a portion of his shares for equity in the new holdco. A subordinated lender is receiving a warrant for an agreed upon fully diluted equity percentage at closing.

The sponsor and the key employee had detailed negotiations regarding the employee incentive option pool and who would suffer the dilution of that pool. To bridge the final gap, the sponsor and key employee agreed they would split 50/50 the dilution for the final 2% of the pool (i.e., each of sponsor and key employee giving up 1% of their equity to fund the final 2% of the option pool).

As we approach closing, the final 2% has not been allocated and is not anticipated to be allocated until post-closing. Ordinarily, I would anticipate either (a) the final 2% would not be issued to sponsor or key employee and would remain available for issuance under the company's equity plan and be included in the fully-diluted capitalization - thereby keeping all security holders at the pre-agreed fully diluted capitalization if and when the final equity is issued under the plan, or (b) the final 2% would be issued to sponsor and key employee and any future equity incentive awards would be dilutive pro rata to all security holders (except perhaps the subordinated lender if its warrant has an evergreen provision).

Alternative (b) is not an option due to commitments to subordinated lender and other security holders regarding sponsor and key employee suffering the dilution from the final 2%. The sponsor would like to avoid option (a) so that it and the key employee will have the sole benefit of the final 2% if it's never issued to employees.

We have occasionally seen this done in different ways and have brainstormed various ways to engineer this result, but they all seem fairly cumbersome. We're curious if anyone has suggestions for an elegant way to handle this or if anyone considers there to be a prevailing market practice in this scenario?


Joel Greenberg: The sponsor and key employee could each receive a portion of their equity in the form of a separate class of common stock with a share of the equity that shrinks by up to two percentage points as the remaining options are issued; the new class would convert into regular common stock on the basis of its share of the equity at some point in the future after the contingency with the option pool is resolved.




Unlicensed Finder located in US but all activities Offshore (January 2012)
Steven Todd Anapoell writes: Does anyone have insight on the following:

US Issuer intends on raising capital through the sale of limited partnership interests to offshore investors under Regulation S. Issuer has been approached by unlicensed finders located in the United States (who are not in the business of raising capital) that have relationships with offshore investors and want to be compensated for the introduction. Finders have represented to issuer that "(1) all communications with potential investors will take place entirely offshore (i.e., both finder and investor will be offshore during such communications), and (2) that all communications will be directed only to non-U.S. persons who are located outside of the U.S."

I am uncomfortable with any use of unlicensed finder having a presence in the U.S. despite representations that no communication regarding the issuer will occur through use of the US mails or any other means or manner of U.S. commerce. However, presuming this is the case, does anyone have any precedent that could be referenced to support my perspective that not advisable to undertake? I have provided the client with a copy of the Dilworth Capital Management, LLC No-action Letter dated December 9, 2004, but, as you might expect, because the facts are not on all fours, client wants more.


Peter J. Bilfield: I have included the link to the SEC's April 2008 Guide to Broker-Dealer Registration below.

http://www.sec.gov/divisions/marketreg/bdguide.htm

I believe the support for your conclusion lies in Section II.D.6. There is a corresponding interpretative release link in that section as well.




Issues at the Cusp of Being an Affilliate and Rule 144 and Section 4(1)/(1 and 1/2) (January 2012)
Carl N. Duncan writes: I have, for me at least, a unique fact pattern:

  • The sole director and officer of a publicly traded company—and largest shareholder—resigned as director and officer ("Client") of the company ("Issuer") on October 19, 2011 pursuant to an October 10, 2011 Stock Purchase Agreement the new controlling shareholder of the Issuer pursuant to which he sold the bulk of his stock ownership in the Issuer. However, since that time the Stock Purchase Agreement was cancelled, the result of which being that the Client is still the majority shareholder of Issuer.
  • Client, who originally acquired his shares in a shareholder exchange some three years earlier, then entered into a separate October 30, 2011 Settlement Agreement pursuant to which he transferred a portion of his Convertible Preferred Shares (the "Shares") in the Issuer to the landlord (the "Landlord") of property used by Client for his other business activities in settlement (otherwise unrelated to the Issuer) of Client's delinquency on the leasehold.
  • As a result of the several actions outlined, Client as of today's date is neither an officer nor director of the Issuer and has reduced his holdings of common to some 6% of the Issuer. Nonetheless, his remaining Preferred Shares are convertible into an additional 50%+ of the Issuer's common.
  • Because the Issuer was previously a shell, Rule 144 is not available to the Landlord.
  • At no time has Client sold common in the Issuer or sold or transferred any of his Convertible Preferred.
  • With the passage of 90 days since the forgoing action and the three plus years the Shares were held by Client, I am leaning toward issuing a clean Section 4(1) opinion in favor of the Landlord as of January 31, 2012 believing (even if the Landlord intends to sell the Shares once cleared) the following:
    • But for the ownership question, Client is no longer an affiliate of the Issuer, having had no control of Issuer for months.
    • The Shares are not being acquired for distribution as they have "come to rest" (See Ackerberg v. Johnson, CCH Federal Securities Law Reporter, 1989-90 Dec. Paragraph 94,850--8th Cir. 1989)--and thus:
      • The Landlord is not acquiring from an "issuer" pursuant to '33 Act Section 2(11) (which defines controlling persons as issuers); and
      • The Landlord is not an underwriter unable to utilize Section 4(1).
    • Rule 144 glosses (such as the following) do not obtain since, after all, Rule 144 is a safe harbor and not the exclusive mechanism for resale:
      • Client was previously an affiliate and therefore the Shares remain "restricted securities";
      • The holding period starts on the date of acquisition or the date of the Settlement Agreement; and
      • The Section 4(1) exemption is not available for the resale of any securities of an issuer that is or was a shell company, by directors, executive officers, promoters or founders or their transferees.
    • Both the Landlord and Client are at risk.
    • Any other conclusion would (especially in the post-Feb. 2008 not a shell era), I submit, basically disenfranchise shareholders generally and former officers and directors specifically!
Your insights would be welcome. Were you to disagree, have you alternative suggestions?


Stephen M. Goodman: It seems that your entire analysis is predicated on the view that your client is not an "issuer" for purposes of Section 2(11) because has not been an affiliate or otherwise in control of the company since October 2011. However, you yourself concede that the assertion of no control is "but for the ownership question". Section 2 of the 33 Act defines "Control" as "the power to exercise a controlling influence over the management or policies of a company, unless such power is solely the result of an official position with such company." There is nothing in your facts to indicate that someone else actually controls the company since your client's resignation. The fact that he retains Preferred Stock which could convert to majority ownership supports the view that his lack of "control" is only on paper. If he is still in fact in control, then I think your theory fails.

Furthermore, it appears that if your client is not in control, the landlord must be, since you don't mention any other shareholders. In that case the Landlord "controls" the company today and would himself be the potential underwriter for 2(11) purposes unless he waits much longer than three months before he resells. SEC v. Olins, 2010 WL 900518 at *2 (N.D. Cal. Mar. 12, 2010) (citing the Ackerberg case you cite) states, "Ordinarily, when inquiring as to whether the subject securities were acquired with "a view to" distribution, courts look to whether the defendant held the shares for a period of more than two years. See [SEC v. Hedden, 796 F. Supp. 432, 437 (N.D. Cal. 1992)] (describing test as "a two year rule of thumb") (citing U.S. v. Sherwood, 175 F. Supp. 480, 483 (S.D.N.Y. 1959); see also [Ackerberg v. Johnson, 892 F. 2d 1328, 1336 (8th Cir.1989)] (citing same)."




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  Spring 2012 Meetings
   

THURSDAY, MARCH 22, 2012

PE/VC Committee Dinner w/ Young Lawyers' Committee
7:30 p.m.
Taqueria Canonita Restaurant (Located in The Venetian)

FRIDAY, MARCH 23, 2012

International Subcommittee Meeting
1:00 p.m. - 2:00 p.m.
Anzio Room, Promenade Level
Toll-free dial-in number (U.S. and Canada): (866) 646-6488
International dial-in number: (707) 287-9583
Conference code: 6304783957

Angel Venture Capital Subcommittee Meeting
1:00 p.m. - 2:00 p.m.
Anzio Room, Promenade Level
Toll-free dial-in number (U.S. and Canada): (866) 646-6488
International dial-in number: (707) 287-9583
Conference code: 6304783957

PE/VC Full Committee Meeting
3:00 p.m. - 4:00 p.m.
Octavius 14 & 15, Promenade Level
Toll-free dial-in number (U.S. and Canada): (866) 646-6488
International dial-in number: (707) 287-9583
Conference code: 5045658147

SATURDAY, MARCH 24, 2012

Dodd-Frank Changes to Investment Adviser Regulation
8:00 a.m. - 10:00 a.m.
Milano II, Promenade Level
Sponsored by State Regulation of Securities Committee
Co-Sponsored by Private Equity and Venture Capital Committee & Federal Regulation of Securities Committee
Summary: This program will discuss various changes to the Investment Advisers Act of 1940, as amended (the "Advisers Act") made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), related regulations adopted by the Securities and Exchange Commission and the changes to the state and federal division of investment adviser regulation.

Unique Legal and Practical Considerations in Private Equity Acquisitions of Small and Lower Middle Market Companies
10:30 a.m. - 12:30 p.m.
Milano VIII, Promenade Level
Co-Sponsored by Middle Market and Small Business Committee & Mergers and Acquisitions Committee
Summary: Acquisitions of small and lower middle market companies by private equity funds often involve unique legal and practical considerations. This program will explore these considerations from both the private equity and company perspectives. Panelists will share their experiences and market approaches on tackling the difficult issues, managing the process and getting these deals closed.

VC Transactional Issues & Documents Subcommittee Meeting
12:00 p.m. - 1:00 p.m.
Palermo Room, Promenade Level
Toll-free dial-in number (U.S. and Canada): (866) 646-6488
International dial-in number: (707) 287-9583
Conference code: 2458399301

VC & PE Funds Subcommittee Meeting
2:00 p.m. - 3:00 p.m.
Palermo Room, Promenade Level
Toll-free dial-in number (U.S. and Canada): (866) 646-6488
International dial-in number: (707) 287-9583
Conference code: 2458399301



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  Articles and Authors for Preferred Returns
   
The Editorial Board is collecting articles for future newsletters which are circulated to our members worldwide. Please send your submissions to Eric S. Wilensky at EWilensky@mnat.com.

Articles should be 1500 words or less, and on any topic of interest to practitioners in the private equity and venture capital sectors. From short scholarly articles, to practice tips, reviews/summaries of a Section program, life in the trenches, interesting pro bono projects, humorous looks at life and the law, or even how you balance work and personal life. We appreciate your help in making this newsletter a success.


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  Committee Leadership
   
Committee Chairs:
Chair: Mark A. Danzi

Vice-Chair: James W. Childs Jr.

Subcommittees:
Angel Venture Capital: Yoichiro Taku

Private Equity and
Venture Capital Funds:
Vicki Lynn Martin Odette

International: Samantha Horn, Francesco Portolano, and Sajai Singh

Programs: Paul "Chip" Lazard Lion III

Venture Capital Transactional Issues and Documents: Herbert Fockler

Publications: Eric S. Wilensky



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