Category Archives: IPO/Going PUblic

Startup Hack – Go Best of Breed

What is best-of-breed?

In business, best-of-breed is a term used mostly to describe high quality firms and relationships. For instance a best-of-breed law firm would be a larger, more established company with a brand of which many people are aware. Best-of-breed is a very important concept to consider because it will give your startup credibility. And by definition since startups are early-stage, credibility is unbelievably important as you move your company forward. However there are a trade-offs (below), which must be considered when you are deciding to go best-of-breed or not. Generally best-of-breed firms are more expensive, so you’re trading dollars for credibility.

Examples of startup best-of-breed relationships:

  • Law firms
  • Accounting firms
  • Venture capital firms or angel investors
  • PR firms
  • Office locations (City or area within a City)
  • Suppliers/Vendors
  • Partners

To provide some real world examples, I will illustrate how a software company in Silicon Valley might look for best-of-breed relationships. This list is used just to provide some examples and is by no means complete or exhaustive. There are plenty of best-of-breed firms across every industry so the best-of-breed list below is only a small percentage of great companies out there:

Law firms

  • Cooley – https://www.cooley.com/index.aspx

Accounting firms

Venture capital firm or Angel Investors

Investment Banks

PR firms

Office locations (City or area within a City)

  • In Silicon Valley, an early stage best of breed location could be anywhere from Morgan Hill to San Francisco. Even some East Bay locations like Fremont can work. The key is if you want to go best-of-breed, you need to have an address in an area where people believe you will be able to succeed. A suggestion might be to take an office either in an area known for early-stage culture, or if there is not one available nearby, taken office in one of the larger cities. It will help for credibility. A best-of-breed example is Sand Hill Road. Most people know that the top-tier venture firms are located on that street in Menlo Park.

Suppliers/Vendors

  • This is completely industry-specific. However, if you’re choosing a supplier, if they have a brand name and are known to be the best at supplying that service or product, it will be helpful. As an example, I was working with a company that manufactured a consumer product. We chose a medium-sized manufacturing partner that had enough of a brand, people believed that the partner would be able to produce the number of units, and at the right quality and price we needed. Also the partner was in the United States so our argument was that we could go and visit the manufacturing plant to make sure that everything was on track. The choice was to stay in the US and then look at possibly off-shoring manufacturing at a later date. Investors like this strategy because they felt that we would have more control initially, even if the costs were slightly higher. We’ve all heard horror stories for startups and larger companies, where products were delayed in shipping or at the port. For an early stage company this could be a fundamental problem (see my article on “hard times” which describes how to handle fundamental problems).

Partners

  • Partners are also industry-specific. For instance if you’re going to have a database partner, you might want to think about going with Oracle or SAP. If you’re going to use cloud services, obviously Amazon is a good choice. I think you get the idea.

Best-Of-Breed Tradeoffs

Negatives

Higher Cost

As mentioned above, by choosing best-of-breed partners, you are making trade-offs. First, usually best-of-breed partners charge more. The reason is they are trying to protect their brand. So in the event that you are not satisfied, they realize that negative sentiment social media can harm the brand so they will work harder to ensure that they meet the agreed upon expectations. Therefore, theoretically best-of-breed partners should provide higher levels of service and be very responsive in the event of problem crops up. It is assumed that best-of-breed partners are larger and have grown to be that size due to the fact that they were able to provide high value and quality to a lot of other companies prior to yours.

Slower Speed

Second, sometimes best-of-breed partners may operate at a slower pace. Generally they are busy with more customers, and therefore you may or may not get the speed and attention that you may really want. However, if the relationship is “good enough”, then it’s worth staying best-of-breed. I found that working with larger best-of-breed partners sometimes can be slow, but if you work with the partner and let them know your concerns, sometimes you can speed things up. As an example, one of the larger law firms used by a startup I was advising, seem to be slow. So we brought on an additional attorney from a single office to help speed some of the work that needed to be done so that the larger firm could focus on more strategic issues (and continue to provide brand, via best-of-breed). To give you some metrics, when trying to set calls or meetings with the larger firm it would take from 3 to 5 days to accomplish the call or meeting. The smaller firm would simply pick up the phone and usually we could get the same meeting within a few hours. You will have to decide how to manage the situation to make sure you can keep your startup moving at the appropriate pace.

Delegation/Abdication

Another problem going best-of-breed is usually that you will sign with one of the brand name partners or company leaders, and then you could get delegated, relegated or abdicated to a junior. This happens a lot and you need to be very aware of it. I had a company that was going public recently and we hired a PR firm. We hired the firm specifically for the capabilities of the practice leader who was well known in the industry. It wasn’t long when the practice leader no longer joined the weekly conference calls and we were relegated to his underling. Due to our own mismanagement, we then found that over 50% of the weekly calls were then further delegated further so that we only had the junior associate participating. So we went from the practice leader through one of the directors, down to the least experienced person. Again this was our fault for not managing the situation and demanding that we stay in touch with people at the right level. Realize that any best-of-breed service firms are there to optimize their own margin while providing the highest quality service. Optimizing margin means if you can put a junior associate on an account without requiring hours from your top leaders (at higher costs), you will drive more to the bottom line. As a startup, you need to be aware of this practice and manage the situation closely to ensure that you get all of the attention you deserve.

Positives

Investors like It

By choosing a best-of-breed partner, you are establishing credibility for your company. First, investors will like the fact that you have chosen name brands assuming the costs are affordable. For example, I use Wilson Sonsini in a lot of deals because they provide top intellectual property and corporate guidance, but additionally investors really like the fact that Wilson is involved. Of course you could use some of the other firms above which are best-of-breed just the same. I use BayTech Web design for my digital properties as they are best of breed in Silicon Valley.

Realize that investors are looking to reduce risk. In any early stage company there are a variety of risks including market risk, technical risk, management risk, legal risk and more. As an investor looks towards a company, the first and foremost question is “will I lose my money?” This is a fundamental question that needs to be answered. We have all seen the scams that seem to continually occur.

Investors want to know that their risks are mitigated (as much as possible)  and for example, legal risk is significantly reduced by a firm like Wilson Sonsini. Wilson will ensure all of the investment paperwork, intellectual property, and corporate structure is locked down and in place. Now, you could choose a small firm, or maybe an individual attorney who could be excellent. Their work might be outstanding, fast and less expensive. However they don’t carry the brand. I have also used strategies where I have used specific individual attorneys in combination with larger best-of-breed firms. This way you can offload a lot of the more inexpensive, more mundane legal work to the individual attorney, and save the more important strategic legal work (such as intellectual property), for the brand based firm.

Best-Of-Breed – Breeds Best-Of-Breed (sorry, I just had to say that)

In many cases it’s hard for an early stage company to attract best-of-breed firms. Just because you are willing to pay a best-of-breed firm, does not mean they will take on your case. I recently had an experience with an enterprise software firm that was white hot as a startup. In other words they were becoming a “Silicon Valley darling.” However, when we approached some of the top Silicon Valley or San Francisco offices of a variety of PR firms, four out of the five of them either said they were too busy or not interested in taking on the project based on the company’s early stage status. I’m sure they questioned whether or not the startup was willing to pay their fees, and whether or not the startup would eventually succeed. So, startups are risky so in some cases best-of-breed firms may be less interested in associating with the firm in that early stage and would be happy to jump on the opportunity once the company has seen more success.

The point here is that if you have a best-of-breed partner, the other partners will realize and also believe that you must have something good or important if the other best-of-breed firm signed on. For example, if you sign a top law firm, and you let your potential venture investors know about it, they will be more comfortable that you have made some initial, right moves. Also, if you sign top venture, then the PR firms might be more interested in working with your firm. I think you get the point here. The more best-of-breed partners you attract, the more credibility you have, and thus it’s easier to attract the best-of-breed outliers that may not otherwise have been interested in you at that moment.

High Cost Should Generally Equal High Quality

When you go best-of-breed, you expect the highest quality and you also expect to pay for it. Now, there are plenty of exceptions where this does not occur, however if you manage the relationship correctly you should get the results you deserve. Note that just because a firm is best-of-breed, it’s not “automatic”. With any good relationship, it requires solid management and expectation setting on both sides.

Best-Of-Breed Has Your Back

Again, if you manage the situation correctly, and you’re utilizing all of the right people, processes and systems from your best-of-breed partner, the cost-benefit trade-off should be positive. You may find that best-of-breed partners actually begin to think strategically for you. They bring you solutions and strategies that you may not have thought of, or they may improve your existing solutions and strategies. A top partner should be an expert in their area and therefore you are getting the best advice possible. They should be able to predict landmines ahead, and optimize your resources for the best result. Startups are by definition, resource constrained. Therefore any partner that can help you ensure that your resources and assets are deployed correctly and optimally is valuable.

IPO Pitfalls

Going public is neither for the faint of heart, or the inexperienced. This is a major corporate strategic move which could lead to significant benefits and also could ruin your entire organization.

Pitfall one: not doing your homework

The first step to going public is to conduct a great deal of research, or get advice from someone who has experience taking companies public. Becoming a public company is like running an entire separate organization with his own constituents. Public companies are into businesses: first is their standard business delivering a product or service, and second is the business of being a public company. The amount of legal, financial, business consulting, compliance and communications activities are immense. Don’t get me wrong, I’m not trying to scare you away from becoming a public company, however you really need to commit to the process (see pitfall three, below).

Also as part of your homework, you should talk to a few public company CEOs. Understand what they go through on a daily, weekly and monthly basis. I think you will find about half of them will say they wish they would’ve never gone public and the other half are happy that they did. No doubt being a public company is much harder than being a private company. So you have to fully understand what you’re up against, and the level of communications and compliance you will need moving forward. You will spend a lot of money each year, and you will have significant personnel costs just to maintain your public status. By understanding what you will be getting into, you will be able to make the correct decision on remaining private or going public.

Pitfall two: your company is not ready or is not the right company to be public

Not all companies are designed to be public companies, and even if they are, it may not be the right time to go public. The best way to figure this out is to discuss being a public company with your team of advisers including legal, business and finance. The reason is, going public isn’t some magical path to money. Many people I talk with only focus on liquidity and forget about the actual business. There is no shortcut to creating wealth via a public company. You need to have a fundamentally great company with huge growth potential including spot-on execution. I talk with a lot of people who are just focused on how soon they can have a $10 stock trading and be worth millions. This is only the end result of a few years or more of very hard and precise effort. Sometimes we hear about companies that become very valuable more quickly, but there are an order of magnitude more companies that try to go public and fail.

Pitfall three: not committing to the process

I can’t tell you how many companies I’ve worked with that have started the process and have questioned themselves midstream after tremendous costs have been sunk into the process. Fortunately most of them have continued on with the process but a few of them cut it short throwing the money away that had been invested so far. Be sure to engage your Board of Directors and advisory boards to make sure that everyone is committed to seeing the entire process all the way through. This has worked in a variety of cases where entrepreneurs have freaked out midstream, but the board or others brought them back around to understand why they ever started the process of going public in the first place.

Pitfall four: not engaging all of the entities that can help

Once you have done your research, or have spoken with experts, then you need to look at the types of businesses and individuals whom with you need to surround yourself. I have an entire section you can view here. Of course by engaging all of these experts this will help you to avoid pitfall two above, committing to the process.

Pitfall five: every deal is custom which = difficult

In my experience, every single going public process is custom. While many of the processes and tasks are the same, undoubtedly there are a variety of significant differences, which can cause delays, cost extra, or even sometimes ruin the entire process. Again, be sure to get all of the top advisers to help you through all of these issues.

For instance, I had a recent public process where two highly experienced securities attorneys, two highly experienced chief financial officers, and two other very experienced C level executives all had different opinions on how to handle a very specific an accredited investor question. In this exact instance, the company had some unaccredited investors that had to be either paid off in cash, or they needed to sign specific unaccredited investor questionnaires along with strategic advisors in order to meet the SEC requirements. One group of New York attorneys recommended a certain direction which initially agreed to by the group, then was later refuted due to the process being inaccurate. This is a perfect example of how even with a great group of experts, there still can be varying opinions and doubt. Again, my best advice is to surround yourself with the highest quality entities and individuals to reduce as much risk as possible.

Pitfall six: not budgeting enough to get through the process

Going public costs money. Pure and simple. This process can cost as little as $100,000 and as much as $1 million. Between advisors, attorneys, investment banking costs, filing costs, financial advisor or audit costs, public shell costs and more, you have to be prepared to spend a great deal of money. In addition, if you are going to really create a nice following after you are public, you will have investor relations costs.

I recommend that you raise capital privately as part of the going public process. If your business already spends off reasonable cash flow, you might be able to afford it out of operations. However, if you do not have the cash flow, you should consider raising $1 million or $2 million to cover all of the fees and staff to go public. The good news is that I have found if you are going public, you have created in imminent liquidity event which makes it easier to raise capital. Nonetheless, you need to be realistic about budget to ensure that you don’t surprise your team and the board.

Pitfall six: trying to liquidate shares too quickly

 

This pitfall is more insidious than most. Many entrepreneurs I speak with want their millions of dollars quickly and are forgetting about their investors and the SEC. Generally as a CEO or founder, you need to think about holding onto your shares and not selling them until your investors have had a chance to liquidate their holdings, and you sell your shares in compliance with SEC requirements. For example, if you own more than 10% of your company, which as a founder is likely, you are restricted as to when you can sell your shares and how much you can sell at any given time. Rule 144 usually locks up employees and insiders for six months to a year. In addition, sometimes investors like to have you locked up longer to make sure they can get their capital out. Solid securities legal counsel will help you through this process. But if you are going to be the founder or CEO of a publicly traded company, you need to think about holding your shares at least one year after you are public. Then per SEC rules you can liquidate some stock on a regular basis.

Additionally, there are rules that govern other large shareholders, as well as your employees and c- level executives. Be sure to get good counsel to understand how everyone handles their stock.

Pitfall eight: forgetting about support for your stock after you go public

This is probably one of the most important sections on this page. Many entrepreneurs think going public is tantamount to going through the process, becoming a public company, and then automatically having investors discover your small cap company and buying up the shares. If you go public on one of the larger exchanges like the New York Stock Exchange or NASDAQ, via a large investment bank like Morgan Stanley or Goldman Sachs, most likely you will be large enough to get analyst coverage, press, and generally have people hear about your company and offerings. However most companies that go public, and certainly the types of companies I am writing for here, are about small-cap offerings. In this case, you need to build in both aftermarket support for your stock, and solid investor relations. This includes a myriad of activities that you need to take on two promote your company in the appropriate and approved fashion (definitely seek securities legal counsel here) to ensure that plenty of investors are buying your stock on the open market. A good investor relations firm will help as well.

When companies forget this entire section, it’s the same as the adage that was used both for Internet websites and the movie “Field of dreams”, “build it and they will come.” So once you are trading no one is going to show up unless you go out and find them. Small-cap companies just are not well-known enough to gather a lot of public support.

Summary: all of the above information are just some of the pitfalls you face when building a public company. There are others as well. However this is not designed to dissuade you from going public but rather arm you with the information so when you make the decision you’ll understand how to get through the landmines. The upside of going public can be amazing which includes liquidity for investors, employees and other constituents, easier private capital raises due to imminent liquidity, and access to plenty of capital after your public (assuming growth). Additionally, stock becomes like cash and can be used as currency. A great way to continue to build value for your company.

 

 

 

 

IPO/Public Company Basics

So you are thinking about an IPO for your company?

Well certainly don’t take this lightly as it is a major decision for your company. I call this a “fundamental” decision since it encompasses a path that should take a lot of thinking before executing, and also it’s difficult to turn back once it started.

IPO Pitfalls

What to think about if you are considering an IPO, reverse merger, reverse triangular merger, or reverse takeover:

1. Advisers – Seek out proven, trusted advisers who can help you with this process. Taking a company public is not for the faint of heart, and the amount of resources necessary to get it done should demand that you get the best advice possible. This includes financial, legal, accounting/audit, business, and more. For the companies that we’ve taken public, we’ve always sought out the best possible advisers.

2. Size/state of your company – There are reasons to have a public company and their reasons that you should not take your company public. For larger companies, that have valuations over $100 million, you can look towards some of the large investment banks such as Goldman Sachs or Morgan Stanley. They will give you an assessment as to whether or not you should go public and if they can help. For smaller companies, it’s more difficult as sometimes the decisions aren’t as clear. For instance, you may have a reason to go public that includes the fact that you want to use public markets to bring in capital. Or you may want to use equity to buy another company.

3. Going public costs money – yes, it takes money to make money. Even for a small cap company to go public you should probably have at least $100,000 set aside to cover legal, accounting, and other advisory expenses. In some cases if you have an interesting offering, some of your service providers will take equity in lieu of cash. This will keep your cash burn down. Either way, you have to have enough money to get through the process which can take anywhere from four months to one year, and cost anywhere from $100,000 up to $1 million.

4. Reverse merge or IPO? For smaller companies wanting to fall forward on public markets, you will need to make a decision as to whether or not you go public via a reverse merger (also called a reverse takeover or triangular merger) or to conduct a standard IPO. Reverse merge will require that you find a public vehicle, either in operating company, or a non-operating company that already has a ticker symbol. Make make no mistake, this is a very dangerous area and I would highly advise that you gain significant counsel when looking at buying a company that is already public. Many of these companies are wrought with financial landmines and legal traps that not only could have you losing all of your money, but also you may owe money that you didn’t even know about. Again, find an expert who can help you.

5. What are the steps to going public? Since we are largely talking about the more difficult small cap companies (if you call Goldman Sachs or Morgan Stanley they will take care of most of it for you), here is a list of items to think about:

  • Make your initial decision – IPO or Reverse merger?
  • If a reverse merger, locate a shell company and secure it
  • With either of the above, hire legal counsel and merge your company into the shell, or have an attorney file you S-1 with the securities and exchange commission. If you reverse merge you may have to file a super 8K with the Securities and Exchange Commission as well.
  • Find someone to help you market the company such as an investor relations firm or small cap IPO expert who can help you understand what the markets will do with your stock.
  • Be aware that once your stock is public, and there is liquid stock available, any number of people in the market can start buying and selling it. You will have no control over this. So it is important that you have a very strong strategic direction to ensure that your company is successful while your shares are being traded.
  • Again seek out expertise to make sure that your stock doesn’t get decimated by somebody buying large chunks and dumping them.

Here are some successful small-cap reverse merge companies that we’ve worked on:

Software Toolworks:
– Initial reverse $0.01 per share
– 908,000,000 shares outstanding
– Raised $2,000,000 plus warrants
– Reverse Split 150:1 when the stock was at $0.04 to get to $6.00
– Split 2:1 when the stock was $22.00 (after $100 million raised at $17.00)
– Sold for $462 million, (all cash) April 1994.
Intermix (Myspace)
– Raised $7 million at $1.00 plus warrants
– $10 million pre-money April 1999
– Sold for $580 million, (all cash) to Rupert Murdoch, September 2005.
Interclick
– Capital raise at $1.00 per share plus warrants
– $10 million pre-money April 1999
– Sold to Yahoo at $9.00 per share (all cash) November 2011.
Propell
– Raised $600,000 at $0.01 in April 2012
– Stock now at $0.17.
Zagg
– Raised $3 million plus warrants at $10 million valuation, August 2007
– Currently trades at $175 million market cap.
Akeena Solar
– Raised $6 million at $20 million market cap, May 2007
– Traded at $400 million market cap, Jan. 2008
– Currently trades at $4 million market cap.