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This article was prepared for the January 9, 2002 edition of U.S.

1 Newspaper. All rights reserved.

Courtship by Contract

From that marvelous circle dance between investor and

inventor comes the stuff of which great businesses are made. If the

term sheet is artfully drawn, both sides will marry, move forward

and prosper. If not, the enterprise will founder, regardless of how

grand the idea or lavish its cash infusions.

Attorneys Rick Pinto of Smith, Stratton, a firm with offices

at 600 College Road East, and A. Jared Silverman of West Orange

present a role-playing workshop "Termsheets and Contracts"

Thursday, January 10, at 6:30 p.m. at McAteer’s Restaurant in

Somerset.

Sponsored by the New Jersey Entrepreneurs Forum, the event costs $40.

Call 908-789-3424.

"For every one invention that makes its way into profitable

production,

an armload of drawings sit moldering in the patent office," says

Pinto. For the past 23 years, Pinto has mentored entrepreneurs in

joining that select few and helping them realize their dreams. A

native

of Morristown, he holds a bachelor’s degree from Yale with a major

in psychology (a useful tool in dealing with entrepreneurs, he

claims).

After completing the University of Virginia Law School in l978, he

moved to the Princeton area, and joined Smith and Stratton, where

he now heads that law firm’s business and finance practice.

The most successful entrepreneurs, in Pinto’s experience, all feel

the pinch of time. "It is better to make a good deal today, rather

than the very best deal a year from now," he says. "After

all, a year from now you might not be here." Determining how to

float today’s best possible deal amid a sea of options requires an

education most new entrepreneurs lack. Here are some of the points

to keep in mind.

Learn where valuation lies. Typically, most inventors

over-value the technology and their own product or service. If it

can’t be installed and profitably sold, most investors would rather

invest in pet rocks.

Pinto sees a four-point valuation for most emergent firms, starting

with a thorough business plan. Second comes the validation of your

market research. Do these numbers reliably predict probable sales?

Only third in the valuation structure does Pinto place intellectual

property and patents. Equally important is the management that will

be launching this show. "A good investor will be betting on a

good jockey as well as a strong horse," says Pinto.

At this point Silverman, an attorney who also holds an engineering

degree, joins in. He agrees that solid, validated market research

is essential in getting funding, and says most entrepreneurs enter

the whole negotiating process with the wrong frame of mind.

Funding is just the start. "This is not pay day,"

Silverman says. "The deal is not to just get a check, but to

launch

a business. It is the start of due diligence and time for managers

to earn their pay by translating intellectual property into a unique,

salable product."

Emphasize your track record. Part of what makes a new

firm’s deal attractive to investors is its ability to meet

profitability

goals on time. Silverman notes that investors are lured by aggressive

milestones, but most are skeptical about a fledgling’s ability to

deliver. Any track record, however short, goes a long way toward

boosting

investor confidence.

Be willing to give up some ownership. Pinto says most

entrepreneurs shop for funding with a frightening innocence. Many

think only "what percent of my company must I give up for how

much cash?" In fact, probably the greatest blunder start-ups make,

he says, is turning away offered funds strictly on a fear of the

amount

of stock they must yield to investors.

On the other hand, Pinto says, investors come to the table with their

own attitudes and hidden agendas. The wise entrepreneur will bring

to the term sheet a whole range of options suited to their needs —

and to his own. Investors will probably want preferred stock over

common. How should shares be linked to valuation? What are the

conversion

rates, the dividend provisions? What liquidation and conversion terms

can be safely, yet attractively, offered? Offering several investment

menus not only broadens your scope of potential funders, but displays

your business knowledge.

Be careful about giving up control. You are more likely

to lose control of your company on the term sheet clauses than on

the flat percentage of the business that you give to investors. This

second-most-frequent entrepreneurial blunder, as Pinto calls it, takes

many subtle forms. Veto power can be ceded to investors on many

important

issues, thus slowing corporate reaction time and hemming in

management.

And unequal board representation can restrict the founders more

stringently

than stock control.

Silverman’s main worry is that control and actual stock percentages

will slip away through casual promises. "You can start the day

with 5,000 shares in your firm," he says, "and at the end

of the day, by making various off-hand remarks, you may have given

away the crown jewels."

— Bart Jacks


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