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This article by Bart Jackson was prepared for the January 8, 2003 edition of U.S. 1 Newspaper. All rights reserved.

Tyranny of the Term Sheet

Between that first Eureka! and the time he finally gets

the money to turn his dream into product, desperation can wilt even

the most eager-eyed entrepreneur. When an investor does finally knock

at the door, the novice business owner often willingly — even

eagerly — gives up too much control to secure the check.

In a role-playing scenario, the New Jersey Entrepreneurs Forum (NJEF)

presents "Term Sheets & Contracts: Successful Negotiation Tactics"

on Thursday, January 9, at 5 p.m. at McAteers Restaurant in Somerset.

Cost: $45, including dinner. Call 908-789-3424 or register online

at www.NJEF.org. Speakers are attorney Jared Silverman of West

Orange, a specialist in entrepreneurial law, and corporate legal

specialist Rick Pinto, partner in Princeton’s Smith Stratton.

In another take on the topic, the Venture Association of New Jersey

asks "What is a Fair Deal? What is the Right Formula for a Successful

Partnership Between the Venture Capital Investor and the Entreprenseur?"

at a meeting on Tuesday, January 14, at 11:30 a.m. at the Westin Hotel

in Morristown. Cost: $45. Call 973-631-5680.

"Once the entrepreneur is ready to launch his business, the term

sheet need not be his enemy," declares Silverman. "It’s proof

that you have a believable product with probable backing. It’s just

an agreement where you have to be very thorough."

For decades, Silverman has provided guidance for the one-man shop

right up to the largest companies as they seek to launch new ventures.

Silverman grew up in a Bronx household with an attorney father and

a mother who worked as a business executive for Macy’s. After obtaining

a bachelor’s and master’s degree in engineering from Columbia and

a law degree from New York University, he embarked on a varied corporate

career. As senior legal counsel, he defended AT&T against the government.

He then served as chief of New Jersey Securities, and he even directed

the New York Stock Exchange through its adoption of the Internet.

Silverman lives in West Orange, where he remains in private practice

and acts as a sponsor for NJEF.

Knowledge and planning are the entrepreneur’s best armor in entering

term sheet negotiations, insists Silverman. "You have to walk

in with a very solid idea of what’s a definitely deal breaker and

what’s maybe a deal breaker," he says. It also helps to know what

the deal breakers and maybe deal breakers for your investors are.

"It gives you a little place to apply pressure," says Silverman.

Knowing all of the issues is essential: You don’t want to be blindsided

by some unfamiliar demand. These considerations are legion.

Blocking rights. Typically, the investors want a much

tighter level of review than the entrepreneur is willing to endure.

Investors will probably want to name the legal counsel and some outside

auditor. Having these watchdogs overseeing their interests may be

reasonable, but some investors want to pack the board totally with

themselves or their agents. "The best way around this," says

Silverman, "is to present your backers with a totally unassailable

team — one whose sheer quality they cannot refuse."

Expenditure levels are among other blocking rights to be negotiated.

How much can you spend without being subject to the board’s review

— or your investors’ personal review? Personnel review, stock

issuing, new product expansion all construct a framework in which

the entrepreneur can operate with varying degrees of freedom. Investors

should never make the entrepreneur feel uncomfortable, untrusted or

restrained. "Keep him hungry, but not starving," says Silverman.

"So he’s always working 100 percent for you and the company. You

don’t want to create ill-will or force him to look outside the project

for money."

Anti-dilution. Entrepreneurs love to pay employees with

stock options. Every business starts cash poor and it’s a nice way

of easing the strain while encouraging worker involvement. Yet investors

do not want to see their stock drop to a less than controlling interest

as more and more folks are brought on board. Frequently a "no-work-for-shares"

clause will be presented as a blocking right. The entrepreneur should

have in place a flexible adjustment plan to calm investors before

entering negotiations. It’s a real point winner, since it shows consideration

for the backers’ position.

Hiring. Who can hire, and with how much review, frequently

becomes a definite deal breaker for the burgeoning startup firm. The

simplest and most effective approach is to kill them with quality.

Setting before investors not just incredibly skilled technical experts,

but a solid team of business advisors makes backers feel that you

are viewing this venture as a money making enterprise, not just a

dream. Once you have won their confidence with the startup staff,

negotiating freedom for future hiring should go more easily.

Intellectual property. Most businesses today launch with

intellectual property as their prime asset. In contrast to the bricks-and-mortar

era, new firms’ most valuable property now may be little more than

an algorithm. The company’s value is within the brain of the inventor.

Now, how much is that brain worth? Can the owner walk away and take

his idea with him? How long must he wait before joining up with a

competitor? Or at what point do the investors own enough of this intellectual

property to thank the inventor very much for patents rendered and

send him packing?

Exit strategy. Woven inextricably with the fate of intellectual

property at the startup is what happens in case of a buy out or bankruptcy.

Many an entrepreneur has come to the table expecting a lucrative buyout,

only to realize that his board, not he, controls how — and at

what price — he may sell his own personal shares. Similar problems

come when the successful firm wants to go public. Exits are always

a juggling contest between the investors and the main corporate officers,

yet a little foresight on the term sheet can avert expensive wrangling

down the road.

Due diligence. "This is where virtually no one plans

exhaustively enough," says Silverman. "I have a checklist

of 13 pages I lay out for entrepreneurial clients." Count on it.

Your investors will exhibit astounding diligence. Does your land have

proper environmental approvals? Will it require new licenses or zoning?

How exacting are your accounting procedures? How precise are your

market estimates? How immaculate are your records? Ever had any lawsuits?

Any outstanding debts in your family? Your entire life will go under

the investors’ microscopes.

Yet, if, after days of being pricked with your backers’ annoying inspections,

fending off their greed and haggling over minutiae, you survive with

a hefty piece of ownership, you have become a businessman. You will

have endured that special trial by fire that shows not just your technical

acumen, but also your character. Having passed muster with investors,

it is more likely that you will get that profitable product out on

time, to a willing market.

— Bart Jackson


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