2009 Recruiting Update

We have been receiving a massive number of resumes the past few months. If we haven't gotten back to you, please know we've recorded your interest.

We are looking for VP and Associate level candidates and possible a few interns for 2009 summer.

As always, please see the jobs page for submission guidelines.

Communicating with Advisors

It is commonly known that lying or withholding information with your lawyer is one of the dumbest things you can do. Full disclosure provides the 360 degree view necessary for a lawyer to provide a thorough defense strategy. If you fail to communicate the whole picture, not only will your attorney not have a plan to overcome your shortcomings, you also risk having your advisor blindsided with new information at trial presented by the other side. Not smart.

Your M&A advisor requires the same level of disclosure. Hiding skeletons, whether they relate to past owners, founders issues, balance sheet, debt problems, or employee issues, you must communicate with your advisors. If issues are discussed early, some can be solved, others alleviated. At the very least you will get a professional opinion on the potential effect on a transaction. Due diligence will uncover these issues even if you fail to communicate them up front. If a buyer unearths a skeleton in due diligence you are going to be dealing with trust and ethics questions that could easily end interest.

Negotiation Style

There is a common misconception that to be a good negotiator you need to be tough, mean, and hard-nosed. Negotiation can be confrontational and the stakes can be extreme. You don't!

Confrontation is not a good environment for negotiating. Most people are intimidated by the prospect of having to barter to begin with. Create a pleasant environment for the other party and show respect and genuine interest for the other parties concerns and values. Treating the other side with respect means less defensiveness and more rational, reasonable communication. Better yet, build a reputation as someone who is honest, prepared, and intelligent, and deliver on that every time.

Why Risk It

Entrepreneurship is an extremely rewarding way to fuse work and passion, but it can also be risky. People valuate and deal with the risk in different ways. In general I think entrepreneurs are of a similar risk profile to the average person, maybe even slightly more risk averse. Most are constantly working to reduce any risk in the equation and are uncomfortable with risk in general.

What defines the entrepreneur's difference is an altered perception of the riskiness of the venture, underlying values that justify known risks, and the willingness to act.

Perception of risk:
I may question the likeliness of success in starting a company that sells widgets due to competitive concerns, size of market, reliance on other's technology, and weak barriers to entry. Another person may see opportunity in these same variables: a proven market, vertical oriented with a familiar customer base, low startup costs building on a proven platform, and first mover potential to counter low barriers. Perception is the key. Risk is not quantifiable here, it's subject to the lens of the viewer.

Values:
Probably cleaner to talk about this as the benefits side of the cost/benefit equation. Entrepreneurs value variables at different weights than you might normally observe. Independence, ownership, passion, and purpose are weighted heavily. Infrastructure, order, and specialization get low marks.

Even "failure" and "success" means different things. An entrepreneur may see the failure of a company as a means for learning, networking, and gaining visibility to new opportunities. Success may mean freedom to choose hours, work from home, or work on a passionate interest full time. Even a lackluster growth year can be a success when working on something you love and truly care about.

Action Orientation:
Moving quickly means making assumptions and trusting your instincts on a limited set of data. To do this, you need confidence. Confidence helps lower the perception of risk. Successful entrepreneurs believe in their plan, their team, and the opportunity. Believing in your ability to lead and maneuver helps to mitigate perceived execution risk, while again, making the risk appear manageable.

Risk it because you're passionate, confident, and committed. The process itself can be the reward.

Funding a Growth Company

Typical Sources of Capital:

• Bootstrapping: friends, family, customer and personal money.
  
• Angel Investment: high net worth individuals, various levels of sophistication.
  
• Traditional Venture Capital: early, mid and late stage.
  
• Corporate Venture Capital: key distribution partner, technology partner.
  
• Private Equity: minority and majority.
  
• Public Markets: USA and abroad.
  

PROS/CONS:

Bootstrapping:

PROS: Teaches you to focus on cash flow first, creates lean/mean startup culture, ties your short term success with real customers and real requirements.

CONS: If your business model benefits from rapid growth (first mover models, etc), bootstrapping can be too organic and slow. Competition can react and catch up rapidly in some cases.

Angel Investment:

PROS: Money is cheaper than with early stage VCs, can get experienced former entrepreneurs involved early, often bringing relevant sector experience. Angels can move quickly.

CONS: Angels can be hard to locate and their approach with regards to both strategy and involvement can vary greatly.

Traditional Venture Capital:

PROS: Significant amount of capital available, can often participate in multiple rounds. Good venture partners can help bring other investors to bear in later rounds. Allow you to achieve significant scale. Strong expertise, focus on home runs.

CONS: Expensive money. Venture money is best targeted for companies looking to "change the world". Can be influenced heavily by the market's perceptions, as well as their LPs feelings about the market, state of current fund, etc.

Corporate Venture Capital:

PROS: Can help position the company for a future exit. Access to beneficial terms from corporate partner (supplier, technology, distribution). Can be fairly "cheap" money.

CONS: Wide variance in approach, can take a long time to execute in some cases. Intellectual property concerns.

Private Equity:

PROS: Large dollars are possible at near M&A valuations. Typically later stage money with more focus on execution. Can offer partial or full liquidity to founding team.

CONS: Can limit flexibility with business model. Many private equity firms don't want market and technology risk and will shy away from change in strategy.

Public Markets:

PROS: Strong branding benefits with public. In some markets, can be important message to customers about staying power. Liquidity potential for employees, management, and investors.

CONS: Huge costs associated with regulation, filing, compliance. Can be a distraction from running business for long term health.

Final thought: Entrepreneurs should dictate the type of funding strategy, not the investment community. Flush out your growth plans, your exit and liquidity preferences, and your distribution and partnership strategy before going to "market" for capital.

The Disclosure Dilemma

One topic that comes up frequently with entrepreneurs is when and to what extent a company should disclose intellectual property (IP). IP comes in many forms: technology, marketing plans, partnership and alliance strategy, even HR strategies. Often this core information collectively drives a significant portion of the strategic advantage of the business. So what happens when that large, cash rich, market leading competitor decides they are interested in discussing a buyout?

Role of the Non-Disclosure

As most of you know, non-disclosure documents are difficult to enforce in the best of cases, being both expensive and uncertain. Although most M&A banks will insist on interest parties signing them, they bring little real consolation to the business owner. (M&A and law firms need to cover their bases in the process irrespective) The safest way to protect yourself is to properly stage the deal process to vet interest and gain certain soft commitments before opening up.

Validate Interests

Use your advisors to help assess the authenticity of the interest. One of the main advantages an advisor has in the deal is the number of times he or she has been through similar transactions. Buyer behavior often raises red flags regarding the level of true interest vs. fishing expeditions. The type of questions, follow up, too much interest too soon, etc lead to questions that can be explored further and qualified. Examples of ways to do this include: requiring term sheets earlier, gaining reciprocal disclosures from the buyer, and raising the cost of being in the process. In extreme cases, companies ask for some money when the letter of intent is signed as compensation for costs associated with due diligence and exclusivity. This can be another way to raise costs and qualify a prospective buyer.

Communicate the Value

Once the letter of intent has been signed and real due diligence begins the challenge is to deliver the IP message clearly. Holding back key value points will work to reduce the probability a transaction will occur and predictably reduce the buyers perception of the value of your company, and hence the price they are willing to pay. Fear that the buyer will steal source code or ideas is real, but the decision to move forward requires taking that step. If you don't feel comfortable enough to open the doors fully, you may want to slow down the process and further raise their costs/commitment required to hang around.

Each situation is different, fight to find some mutual trust before moving through the due diligence process and find advisors who have the experience to read between the lines on your behalf.

Corporate Culture

Corporate culture is discussed a lot in the startup sphere where entrepreneurs embark on the journey to create a better place to work, free from legacy corporate bureaucracy and inefficiencies. In 1999 this discussion often included beanbags, ping pong tables, and catering. Today it is work life balance, flat corporate structures, and remote working environments.

At the core, corporate culture is nothing more than the environment employees live in day to day. Are your employees racing to work to get started on "their" project? Are people happy, contributing outside their job description, finding ways to build the culture themselves?

How does a healthy culture start? Conventional wisdom is that it starts from the top, but how? Is it messaging? (the always comical corporate mission statement) Is it enthusiasm about the product or service being provided? (A derivative of both having something that is capable of being deemed exciting and hiring people who agree.) Other variables that seem to make sense; clear goals, capable employees, management that communicates clearly, positive feedback from the market, fair pay, fairness.

Bay Capital Recruiting Update

We are happy to announce the 2007 recruiting season was a success. We've added 11 people in the Vice President, Senior Associate, Associate, and Analyst positions. We may be adding 2 more VPs in the fall, but this puts us on plan for 2008. Thanks to the team members who helped interview and make this recruiting year a success.

Negotiation and Creativity

Another key negotiation fundamental is creativity. Thinking broadly, outside the normal construct of price and predefined terms to expand the number of potential synergies allows for a larger set of positive outcomes. An example of this came out in a recent negotiation on behalf of one of our clients. Without getting into the details, there were significant value drivers for the client that didn't require a bump in cash compensation to obtain. In fact, they are much more valuable than even the equivalent cash!

Creativity when brainstorming solutions is a good start, problem solving at the table uses the same framework in real time to close the deal. Preparation is the container for being ready to see the possibilities on the fly.

Some of the things I try to keep in mind before a negotiation:

• Empathize: What is motivating the other party's decision maker? Money? Affirmation from a boss? Promotion? Fear of failure? Fairness? Historical experiences?


• Standards: Are there any favorable standards you can point to that will help you be more persuasive? Most people think of themselves as fair, using a third party standard can be helpful. Negotiation is about pursuasion, try to be prepared with all the historical info you can.


• Alternatives: At what point does a deal make sense? Sometimes no deal is the best deal. Write down your walk away and take it along. If you get confused, ask for a break and read it.


• Linkage: One of my favorites. Can the current proposal be linked to other deals or proposals. Often times there are other interests outside your current discussion. You can also sometimes create leverage here by coupling a small issue with larger more important issues. (Congress is good at this!)

When to Sell

I'm asked at least once a week what the right criteria are for choosing to sell a business. Even within our current client base, which has companies valued all over the map, from $1m to $50m+ there are similar questions and concerns around liquidity and timing.

Liquidity: 10 years ago founders of small companies had limited options for liquidity. Today there are many options for full or partial liquidity from the startup stage of a business through the growth stage, all the way to IPO. Knowing when to diversify as an entrepreneur is a tough decision. (This section deserves it's own post and I'll try to follow up with one soon.)

Timing: Selling a company is not unlike selling stock in a market. There is uncertainty around market conditions, competitive pressures, and the future. Most financial advisors will encourage you to plan and not try to time the market. There is a tendency to not want to sell a business when it is growing and in a good market. The implications are clear. When growth slows, your price decreases. If the market slows, the price will also decrease as the market for your firm gets smaller.

It's difficult to know the optimal time to sell a company. During liquid markets such as this one, companies with 2-3 year profitable growth have an outstanding opportunity to structure a variety of transactions. Exploration of the options is the only real way to understand how your companies story fits into the broader deal market.

Bay Capital Partners Signs 5th and 6th Clients of 2007

We're extremely pleased to have signed 6 new clients through our first couple of months in 2007. Press release is on our website here. Tags for client industries below:

SME software, e-commerce, community, scientific modeling, enterprise software, health and wellness.

Job Postings

Associate

Bay Capital Partners is seeking Associates to join both the San Francisco and New York City offices. Associates work includes research, overall deal support, analyst and intern coordination, and deal flow management. Associates work directly for a General Partner and have tremendous visibility into the operations and day to day strategy of the firm.

Associates typically have 1-4 years of work experience and come from a variety of industries and backgrounds.

Critical skills: Efficient, hard working, trustworthy, comfortable communicating with high level executives, web proficient.

To apply: financejobs@baycappartners.com

Preparation in a Negotiation

Negotiations have some of the largest impacts on outcomes in business and in our personal lives. I find that most of the time clients are not used to adequately preparing themselves for important negotiations. Many seem to rely on their gut feeling and intuiting to steer them through. Although those are both important factors, this is usually a mistake.

Adequate preparation should include several meaningful steps.

1. What am I trying to gain? -or- What problem am I trying to solve?


2. Who am I negotiating with? Who is the decision maker? Who are my allies? What are their interests?


3. What alternatives do I have? What is the minimum I will take to have a deal?


4. Are there any precedents that would suit this negotiation?

Once you have a clear vision of who you are negotiating with, brainstorm options that will both meet their interests and your stated goals. Often price is the center of the negotiation, but rarely is it the only important point. Expand the pie by creating value outside of price.

Preparation builds confidence and also provides you with the supporting materials and intelligence to persuade the other party that you are being both reasonable and that you are informed. Not all negotiations will conclude with a deal, but knowing why it makes sense to walk away comes from research and preparation.

2008 M&A Outlook

Some key points and thoughts garnered from the recent Deal Journal report: Strong prediction that multiples will stabilize after several years of increases, with strategic buyers making perhaps a more aggressive play for bolt-ons while private equity players continue to look for opportunities to bring what is a still a significant amount of capital to bear on the market.

Mid-Market Investment

The cutoff for deals that look to continue to be active during a tighter lending market seems to be $500 million and lower. Nevertheless, it's at this price point and below where the real action for 2008 will be, thanks to a tightening down of leverage levels and remaining economic hurdles in the big-market landscape. After many years of steep increases in valuations-where generous terms drove leverage multiples as 8-12x EBITDA look to anticipate stable pricing for the foreseeable future, with companies valued under $500 million financed at multiples in the range of four to six times EBITDA.

Private Equity – Not Going Anywhere
Private Equity will remain a player, having collectively raised $300 billion in 2007, which is $46 billion more than in 2006. Terms and leverage might not be as easy as 2007

Multiples
Multiples will probably hover in the same range-four to seven times adjusted cash flow-even though demand is expected to tick upward. Buyers remain cautious, even skittish, and the smaller the deal, the more challenging it will be to close the transaction.

Sweet Spot Scarcity
Meanwhile, sellers with revenues between $10 million and $20 million with good earnings remain in a very strong position. However, acquisition opportunities in this sweet spot are scarce. Hence, the renewed focus on strategic acquisitions under $10 million. Now more than ever it is critical to have the right advisor on your side if attempting to raise capital or be acquired. The intricacies of the financial and strategic dealscape are becoming more and more complex, and more and more often we are seeing unrepresented sellers leaving money on the table.

Angel Investing up 10.8% in 2006/2007

Alarm:clock is reporting that angel investment dollars were up almost 11% last year. Total startups invested in only rose 3%, which equates to a 7.5% growth in average investment. Healthcare and software were the top two categories invested in.

The University of New Hampshire study cited as the basis for the post also points out that:

“While angels continue to represent the largest source of seed and start-up capital, market conditions and the capital gap in the post seed investing stage are requiring angels to engage in more later-stage investments. New, first sequence, investments represent 63 percent of 2006 angel activity, indicating that some of this post seed investing is in new deals."

This is consistent with my market observations as well. As fund sizes grow, larger and larger investments need to be made to employ the capital. This movement "upstream" leaves a gap for smaller more targeted investments. Both angels and startup venture funds appear to be filling that void.

Middle Market Update

A couple excerpts from recent Venture Capital Association reports:

Corporate Venture Activity
Corporate venture capitalists invested $1.3 billion into 390 deals in the first half of 2007, representing the highest percentage of corporate venture deals and dollars since 2001.

Q3 Deal Volume
In the third quarter of 2007, total disclosed venture-backed M&A dollar volume reached the highest level
since 1Q 2001, when 37 disclosed deals accounted for $7.7 billion in value. Additionally, the average deal
size for disclosed venture-backed M&A transactions has not reached 3Q 2007 levels since the fourth
quarter of 2000. The Technology sector dominated the venture-backed M&A landscape, with 45 deals with disclosed values of approximately $3.8 billion. The Computer Software/Services and Internet Specific industries saw 17 and 15 transactions, respectively. The Internet Specific sector reached $2.2 billion in disclosed deal value – 59 percent of the overall value within technology businesses.

Source: NVCA.org

Thoughts

Despite the headlines about a tightening credit market, capital is still very much in play. The increase in corporate investments and M&A activity have helped keep the market liquid. There is still a lot of middle market targeted private equity and venture capital powder out there.

Having PE, VC, hedge fund, corporate buyers, and a healthier IPO market all competing for deals will help sustain the mid term investment landscape.