With thousands of emerging technology companies as their clients, lawyers in the Silicon Valley feel the breezes in the Venture Capital market well before the data tells us which way the wind is blowing. We like how the breezes have filled the Silicon Valley’s sails.
Dow Jones VentureSource tells us that the wind continues to blow strongly for venture capital investments in 2010 and early in 2011. The first quarter of 2011 was the strongest first quarter for venture capital investments in the US since pre-economic crisis 2008. We meet with new founders on a daily basis who are close to receiving term sheets for early stage investors, and many of our later stage companies are raising significant financing rounds using from high profile financial and corporate investors.
In our corner of the world in the Silicon Valley, although activity was down from the frantic pace set at the end of 2010, with 190 deals closing on a total of US$ 2.3 billion, down from 229 deals raising approximately US$ 4.4 billion, VCs and lawyers remain very busy in the second quarter, closing large numbers of both “stealth” and highly publicized financing transactions, acquisitions and preparing an increasing number of late stage companies for their initial public offerings.
We see significant activity across all industry sectors, with particularly interesting trends in the online/digital media space, as well as in cleantech related fields. There were nearly 50 reported transactions in the first quarter in online/digital media companies in the first quarter of 2011 with a total value of nearly US$ 550 million. For companies in the internet and digital media sector, access to very early stage capital is easily accessible in the Silicon Valley. What remains unsettled is the preferred structure for such transactions. Conventionally, investments of less than US$ 1 million are often structured as convertible debt, rather than as a purchase of Preferred Stock at a fixed price. Convertible debt can defer difficult valuation decisions until the time of a larger institutional investment round. We often encourage very early stage companies to consider convertible debt, as the documentation is simpler, and as a result, quicker (and cheaper) to draft and negotiate.
The negotiations around convertible debt transactions center around the warrant or conversion price discount “sweetener” to incentivize the investor to make an early investment. The most contentious part of the negotiations is often around a conversion price “cap” that puts an upper limit to the price at which the debt investor would see their note converted into Preferred Stock. These sorts of negotiations can decrease the relative benefits of a convertible debt round, because they require the founders and the investors to agree upon a future valuation of the new company. As a result of this shift towards conversion price caps, some early stage investors have moved back towards priced Preferred Stock rounds, although the complexity (and associated legal costs) remains a challenge for smaller investment rounds. Time will tell how far the pendulum swings.
As we approach the second half of 2011, we remain excited and encouraged by the state of the venture capital market, and the direction venture capital funded companies are moving. I look forward to providing you with updates over the coming months from the ground here in Silicon Valley on the trends that we hear in the winds.
Zum Autor: Gregory Heibel ist Partner bei Orrick, Herrington & Sutcliffe. Vom Büro der Sozietät im Silicon Valley aus berichtet er an dieser Stelle regelmäßig über Trends und Aktuelles aus dem amerikanischen Start-up-Standort Nummer 1.