Recently highlighting those steps at the first fall meeting of the Technology Networking Group was Paul Guerre, a Grand Rapids lawyer.
In the meeting, sponsored by the Michigan Small Business & Technology Development Center, Guerre was discussing forming and funding a technology business.
“If you want to finance your business with venture capital,” Guerre said, “there are lots of things you need to do — long before the (venture capitalists) will even look at you.”
Guerre is a partner in the Grand Rapids office of Barnes & Thornburg, a 400-lawyer firm with seven offices.
Guerre has practiced law in West Michigan for the past 12 years, representing emerging companies as well as middle-market and large publicly traded companies. His work has concerned mergers, acquisitions, divestitures, equity offerings and securities law.
The people at the meeting with whom he shared the insights of that experience are founders and prospective founders of tech firms interested in financing their business with venture capital.
Guerre said people seeking venture capital must take five critical steps:
- Choose the right legal entity. Guerre said that while limited liability companies (LLCs) have become a more popular form of business entity form in the past decade, venture capitalists (VCs) tend to prefer the corporation structure.
He explained that’s because tax rules for LLCs are complex and can provide unwanted consequences for VCs and their own fund investors.
He said tax rules also restrict the use of tax-advantaged stock options in LLCs, which often are critical to attracting qualified management.
- Keep the capital structure simple. Guerre said he recommends that as entrepreneurs raise initial capital from friends, family or angel investors, they limit the type of equity they offer to common stock.
He explained that if a founder in the early stages of an enterprise creates a complicated capital structure by issuing preferred stock with rights, the price of venture capital participation probably will be to undo the arrangement. And that could likely be a step that would disappoint the expectations of originally investing friends, family members or angels.
- Comply with the securities laws. Guerre noted that every sale of a security must be registered with federal and applicable state securities agencies unless an exemption is available.
He explained that failing to properly exempt the sale of securities to early investors can give them a right of rescission — i.e., the right to say, “I want my money back.”
Guerre says such a situation also can scare VCs away.
- Keep the angels on your side of the table. Guerre said there’s another key reason for founders to resist angel investors’ requests for preferred stock with rights that rank it above common stock.
Issuing common stock to angels, he said, puts the owner and the angels on the same side.
“And you’ll want the angels on your side of the table when it comes to negotiating with the VCs,” he stressed.
- Start acting public. Guerre said venture capital will want access to ongoing information about the company and he advised owners to follow the public company model.
Owners should implement systems for timely and accurate reporting of financial statements on at least a quarterly basis along with a management’s discussion and analysis narrative that can be sent to investors, Guerre said.
“It’s good practice,” he added, one that is reassuring to VCs who — after all — are debating whether to risk their own investors’ money in an emerging business.
Guerre, a native of East Lansing, joined Barnes & Thornburg as a partner in July. Prior to that, he practiced with Warner Norcross & Judd, the last five years as a partner.
In addition to its office here, Barnes & Thornburg — the largest law firm in Indiana — has offices in Indianapolis, Chicago, Fort Wayne, South Bend, Elkhart, and Washington, D.C.