Building Your Startup Team: Complementarity and Chemistry

Most professional venture investors believe the best predictor of startup success is the quality of the team. Good teams can and do fail, but as team quality drops below “awesome,” the chances for success drop very fast. Thus the cliché that most investors will gravitate to an “A” team with a “B” opportunity over a “B” team with an “A” opportunity.

There are a lot of reasons team quality is so critical to startup success. The incredibly stressful startup environment is the biggest. Startup teams need to accomplish difficult goals with minimal resources in terms of time, capital, and people. Additional stress accrues as outside forces – competitors, markets, technologies, etc. – evolve and force teams to make significant adjustments, often including basic “pivots” (business model, for example) on the fly.

If the extraordinary stresses of the startup environment explain the importance of getting the team right, they also offer a clue to what makes a superior startup team. At the foundational level, what separates the superior startup team from the merely good startup team is complementarity and chemistry.

Complementarity is pretty straightforward in concept, if not always in execution. Within the confines of available resources (financial) and the constraints of team chemistry (more later), you need to make sure the team includes top-tier players at the mission critical startup tasks (i.e. the tasks that need accomplishing in the current round of funding), as well as the flexibility to successfully “wing it” with respect to important ancillary functions.

The trick to building a complimentary team lies in recognition of, and dealing with, the well-established HR principle that when people get to choose who they work with – or who works for them – they tend to choose people like themselves. Now, if you are a founder, and thus most likely very confident of your own near-perfection, that might not seem like a problem. If you’ve got perfection, why not clone it if you can?

Consider if Apple had been founded not by Jobs and Woz, but by Jobs and … Jobs. If you know the Apple story, you know what a catastrophe a Jobs/Jobs founding Apple team would likely have been.

The bottom line is that however perfectly suited you may be for leading your startup to fame and fortune, building a team of clones is seldom the best way to go about it. Instead, look for people with different skill sets. And as much or even more so, different personalities and perspectives on business, technology, and life. The most successful startups – even those like Apple in the years after Jobs returned from exile that were dominated by a leading personality – build leadership teams with diverse skills, experiences, perspectives, and personalities. Just ask Tim Cook.

And that leads to the second, and harder to execute, aspect of assembling a superior startup team: chemistry.

It’s not enough to assemble a team that “covers the waterfront” in terms of skills, experience and personality. You need to make sure those folks can also form very strong bonds with each other (thus the “chemistry” analogy). Because in the constantly changing world of the startup, relationships between key players on the team are going to be under almost constant stress as company circumstances evolve and people have to adjust to changing opportunities and challenges. As anyone who studies morale in the military will tell you, folks in foxholes are motivated more by their loyalty to the folks around them than to “the cause” as such.

On that last point, one of my favorite quotes from an entrepreneur came when he was asked what he would tell his team at the beginning of his next startup journey. He replied: “Folks, we are going on a very long and difficult journey. On this journey, we will carry our wounded – and shoot the deserters.”

The quality of the team has long been the most important factor for most venture capital investors, for good reasons. As you think about assembling your team, particularly in the early days, don’t make the mistake of hiring folks because they look like you, or because they are a perfect skills fit. Look more for folks who compliment your skills and personality – and that look like the kind of people you want on your side when the going gets very tough. Because it almost certainly will, likely many times.


Things Entrepreneurs Should Know (About Venture Capitalists)

If ever there was a prototypical “love-hate” relationship, there is a good chance it was between an entrepreneur and a venture capitalist. It’s the perfect kind of relationship for the love-hate dynamic: lots of pressure; big egos; mutual dependence; and over-lapping but different and evolving relationship objectives and constraints. Unfortunate as it may be when things get ugly: surprising it isn’t.

While ugly entrepreneur/VC relationships are inevitable, there are more of them than there should be. As both a VC and a VC-backed entrepreneur I’ve seen a lot of entrepreneur/VC relationships get ugly that shouldn’t have; or at least shouldn’t have as soon as they did. Many times, entrepreneur/VC relationships break down when one side – and it is more often the entrepreneur side – doesn’t appreciate some of the realities that shape the attitudes and requirements of the other side.

And so this brief review of some of the realities of the world venture capitalists inhabit, and how those realities impact their relationships with entrepreneurs. Some are deeply ingrained in the nature of the venture investing business; some seemingly arbitrary rules of thumb. And yes, in almost every case subject to the occasional exception that most often proves the rule.

  1. Venture Capitalists are Fiduciaries. Venture capitalists manage money entrusted to them by their own investors (commonly referred to as “Limiteds”). That makes them fiduciaries, and that, in turn, means they are legally bound to act solely in the best interests of their Limiteds. Thus, as much as they may like and respect their portfolio entrepreneurs, their Limiteds have first call on their loyalty. A VC with any integrity at all (and you surely would not want to work with a VC lacking integrity, right?) will, when faced with a choice of doing the best thing for her Limiteds or doing the best thing for her portfolio company, pick the Limiteds every time.

    The fiduciary character of the VC/Limited relationship manifests itself in all sorts of ways beyond the obvious “should I invest more capital to save this company that I want so much to succeed, or would that be a bad move for my Limiteds” sort of situation. For example, entrepreneurs are often bemused by the emphasis VCs put on dotting every “i” and crossing every “t” in the deal documents. Well, that’s because while they personally might think a particular “t” does not need to be crossed, they have to think of their Limiteds – more specifically, what their Limiteds might think if not crossing that particular “t” turned out to be costly.

    More generally, being a fiduciary makes VCs very sensitive to making and managing deals within the real if not always well-defined parameters of the then current market. So, for example, I once knew a very prominent VC who thought that the whole idea of anti-dilution price protection was silly (I actually agree with him on that). That said, he got it in every deal he did for his fund. Why? Because if he didn’t his Limiteds would want to know why every other VC got it for their Limiteds, and he didn’t get it for them.

    The bottom line here is that entrepreneurs are well-advised to remember that as much as they may think of their VC as their VC, she is in fact first and foremost her Limiteds’ VC. And if she is any good at all, as much as she may like and respect you, in terms of her priorities her Limiteds are at the top of the list.

  2. Venture Capitalists are … Entrepreneurs. You heard that right. VCs are entrepreneurs just (well mostly) like you. They put together a business plan and take it on the road to raise money from mostly very sophisticated institutions. If they deliver the goods, they will likely find it easier to raise capital for their next fund. If they don’t they will probably find themselves in another line of work.

    Beyond just generally helping you have some empathy for VCs, realizing how their life and yours have so much in common should tell you something about their nature. Look in the mirror. Do you have a big ego? Are you often wrong but never in doubt? Are you a tenacious bulldog when it comes to building your business? Do you have at least one serious personality … quirk?

    Well, so does your VC. Which is to say, as difficult as you may find them to work with at times, you can be pretty sure they feel the same way about you.

  3. Venture Capital Funds Pivot, Too. If there ever was a startup that evolved exactly according to plan – from the first money in to the exit – you can be sure it was one of those exceptions that proves the rule. The same goes for venture funds. VCs leave funds unexpectedly. Markets evolve, and investment strategies evolve with them. Unexpected opportunities and challenges come up, and with them changes in resource (capital and people) allocation. Stuff happens and funds change, just like startups.

    When stuff happens at a VC fund, portfolio companies can suffer. One of the saddest VC/entrepreneur stories I know involved a company where I was an angel investor and director. The entrepreneur was really good, and really wary of brining a VC into the business. He bootstrapped and invested most of what he had made in a prior deal. Finally, with a good product, cash-flow positive operations on $5 million revenue, and great press, he concluded (rightly, in my opinion) that to come out as a leader in the market and really scale the business he needed to bring in some capital.

    So, he took $10 million from a very reputable venture fund at a good price, working with a partner who had followed the company and made noises about wanting to invest for several years. The first three months post-close were fantastic. And then .., the VC left the fund for greener pastures. The fund assigned a junior associate to the deal, and started looking at how to get out sooner rather than later. The company ultimately failed, largely, I believe, because what looked like such a sweet entrepreneur/VC pairing turned sour.

    Ok, the general point is that your relationship with your VC and her fund will evolve. Sometimes for the better. Sometimes for the worse. It pays to stay attuned to what is going on in your VC’s life, and her fund’s life. Is her star – and the funds’ – rising or falling? How much dry powder does the fund have? How much of that is for your deal? How is the rest of your VC’s and her fund’s portfolio doing? Knowing all of this, of course, doesn’t mean you have a lot of influence on it. But it can give you some inkling about how your relationship with your investors is going to evolve, for better or worse.

  4. Venture Capitalists are Business Partners not just Investors. Entrepreneurs are all over the map on the notion that VCs bring more value than just cash to the table. In my view, good ones do. But that really is not the issue here. The issue is that whether or not you think your VC has anything to offer besides money, you can be sure your VC believes she does, and in any event she is going to have some serious things to say about how you manage your business. And it doesn’t really matter how much of your company she owns: as folks who have run afoul of a bank loan covenant can attest, you don’t need to have an ownership interest to have a controlling interest.

    The point here is that you should be very careful, as you put together your deal with a VC, not to get so focused on the economics that you miss the management implications of the deal terms. Make sure you talk with your lawyer about control issues like class voting rights; Board seats and observer rights; fiduciary obligations (which can cut different ways in different circumstances); any voting agreements or side letters with investors; and most of all the extent and nature of the “Protective Provisions” in the deal documents. You’ll almost certainly find that there will be things you will not like in these areas, some of which you will likely not be able to change. But you can often change some of them at the margins at least, and even when you can’t it is better to know about the realities of control before your VC asserts them at a crucial moment.

  5. Venture Capitalists Don’t Do NDAs. Having been a serial entrepreneur I get why entrepreneurs think VCs should sign Non-Disclosure Agreements. Having been a VC as well, I get why VCs don’t do NDAs. And, well, the VCs are right. If they signed an NDA with every entrepreneur they took a business plan or pitch from, you can be sure they would spend most of their lives in court defending claims that they “borrowed” some entrepreneur’s idea and used it in another deal. (And that does – very rarely, I think – happen).

    Now, the VCs don’t do NDAs shtick would be a really big problem if it did not have such an easy solution: don’t tell a VC, until a term sheet is signed and final due diligence is in process (if then), anything that is really proprietary. If that seems impractical, consider this: You can sample my secret sauce without me sharing the recipe. For example, I can show you data demonstrating how my device detects metal fatigue, and likely even tell you some of the concepts about how it works, without telling you anything that would allow you to recreate my device.

    Seriously, there is no reason to share real, valuable proprietary information in your business plan or pitch to VCs. You can have a “black box” at the heart of your value proposition if you have sufficient indications of credibility (team, data, etc.) surrounding it. How strong those indicators need to be depends on how extravagant your claims are for your black box. If you have a device for sampling someone’s breath and diagnosing an infection, put a credible scientist beside it with some relevant literature and some early data and you’ve told me more than enough to get my due diligence going. If your telling me that your black box violates the second law of thermodynamics (I’ve seen plans like that a couple of times), you’ll likely have to show me a lot more: perhaps, say, that Stephen Hawking is your CSO.

  6. The 20-50% and 10x Rules. Valuation is what most entrepreneurs focus on in negotiations with VCs (often to the detriment of equally important issues like control and exit provisions). Entrepreneurs, of course, want higher valuations (thus less dilution), and can be very creative coming up with fancy spreadsheet forecasts and financial analysis.

    I must say I have seen some very slick spreadsheets supporting valuations for startups. Most of them, though, confuse precision with accuracy, and fail to deal with two fundamental realities of how VCs look at valuation. And in the process, provide a plethora of trivial details for folks to pick apart.

    The first valuation reality, and probably the best known, is that a Series A investor’s approach to valuation is very practical and simple: show me a model, from my investment to the exit, that I can believe in and that gets me at least $10 back for every $1 I invest. What they want to see is a list of likely buyers; the metrics for the likely sale; and some sense of how much additional dilution they will suffer to get there.

    That is a “big picture” kind of analysis that just doesn’t require a very detailed spreadsheet. It’s an analysis that places a lot more importance on the accuracy of assumptions than their precision, and limits the number of cells in the sheet to debate about. So why not save the time and expense of the finely detailed and precise spreadsheet model that reaches a conclusion only loosely correlated with what the investor thinks is important?

    The more overlooked valuation rule is the 20/50 rule. Most VC investors want to see an A round where the investors acquire at least 20% of the company, but no more than 50%. VCs want some minimum stake that reflects their centrality to the business. Most of them think that minimum is 20%. That may be arbitrary and capricious, but it is what it is.

    On the other hand, most VCs don’t want to see the founders and their team give up more than 50% of the equity in the A round because they want the founders and the team to have sufficient incentives to maximize the valuation of the company well past the A round. Again, 50% may be just a number, but it is pretty commonly “the” number in terms of maximum dilution at the A round.

    The trick with the 20/50 rule is how it can impact valuation when the size of the VC Fund is mismatched with the size of the needed A round investment.

    Most venture funds have a rule that limits how much of their capital can be deployed in any one company. That number is commonly 10%. So a $30 million fund is usually thinking that it can invest up to $3 million in any one company. Further, most VCs, given $X to invest in one portfolio company, will want to make sure some minimum fraction of X – let’s say 1/3 for an example – is available for the round after they first get in the deal.

    Ok, so let’s assume our VC’s Fund is $30 million. They want to put $2 million into you’re a round, and they have another $1 million lined up from another investor that will follow them into the A round. So they have $3 million for the A round.

    If you apply the 20/50 rule, you’ll find that to get the minimum 20% ownership for the A round investors, the maximum pre-money valuation is $12 million. If you want a significantly higher pre-money than that, you are probably better off looking for another lead investor with a deeper pocket; perhaps the smaller fund will follow in the higher priced deal.

Now, as I noted at the outset, the various rules and such noted above are, like most rules not found in physics or mathematics books, subject to exceptions. Maybe your deal should be one of those exceptions. But even if your deal should be an exception, the chances it will be an exception will be maximized if you know the whats and whys of the rules before you start trying to convince a VC to break them.

Back to the Future? Venture Investing in Flyover Country

The term “Venture Capital” covers a lot of ground, even when confined to the traditional institutional funds at the heart of the industry. Funds come in many flavors based on factors including stage of investment, industry focus, geography, and propensity to lead or follow in deals.

I’d like to suggest another basis for classifying venture investors, one that I think is absolutely critical when considering the unique opportunities – and challenges – of investing in places outside of the major established centers of venture capital investing. Places like where I grew up, and after twenty years in Silicon Valley and North Carolina, returned to some years back: Wisconsin.

My classification is based on two alternative paradigms for investing capital and managing investments: Nurturing and Managing.

The Manager Venture Investing Paradigm

The Manager paradigm dominates the venture business today (certainly in terms of capital deployed and public mindshare). It is characterized by large funds, many in the billions of dollars (see Softbank’s $100 Billion fund for the current outer limits of the industry) with multiple levels of investment professionals, many of which do not have early stage operating experience or even STEM educational credentials. The “value add” Manager investors provide is largely in terms of the later stages of expansion and exit planning and execution.

The Manager paradigm is ideally-suited to the contemporary Silicon Valley venture capital scene and in terms of number of deals and capital deployed the large majority of Manager paradigm investing occurs in Silicon Valley and a handful of other major venture capital hubs. Today’s large funds simply can’t efficiently make and manage smaller deals. Even those that operate affiliated “seed” funds typically make larger initial investments than their traditional seed fund peers, and limit those investments to deals that they perceive as having mega deal potential (and capital needs) going forward. As a result, the Manager paradigm funds are much less likely to invest in raw entrepreneurs who need a lot of hand-holding on basic operational blocking and tackling. Their deep pockets also make them more likely to focus on capital intensive growth/brand-driven exit metrics than profitability.

Now, the Manager paradigm may get all the headlines, and skew the statistics such that Silicon Valley round deal sizes and valuations or as much as an order of magnitude or even more than the comparable figures in flyover country markets, but it is not the only venture investing paradigm. In fact, it was preceded by a very different and still important, if no longer as publicly prominent, paradigm.

The Nurture Venture Investing Paradigm

The modern venture capital era began in the late 1940s and hit its stride in the 1970s.  Throughout that period, and into the 1980s, even the largest venture capital funds seldom exceeded $100 million and most were only a fraction of that. The prototypical Nurture VC was someone with industry operating experience as well as a STEM education. Further, these smaller funds had minimal junior staff compared to the layers of analysts, directors, junior partners, etc. that make up the bulk of the investment professionals at today’s larger venture funds.

The early decades of the venture business were characterized by something else, besides smaller funds: less experienced entrepreneurial teams. With the industry’s small size, and even with fairly rapid growth in the 1970s, it took awhile for the “serial” entrepreneur to emerge as a regular part of the deal flow. It was probably not until well into the 1990s that most venture-backed Silicon Valley startups included founders and senior managers well-versed in the art of building a high impact company from experience at prior venture backed emerging companies.

When you put all of these factors into a pot and stirred them up, you came up with the Nurture venture investing paradigm. An investment model based on VCs focusing on startups where they could add a lot of value to the deal in terms of the basic nuts and bolts of defining and building the business. Indeed it was a time where the venture investor was often involved – as for example Brook Byers and Genentech – in the actual conception of the business, recruitment of the founding team and formulation of the business plan. Sometimes well before it was even clear there would be any resulting investable deal.

The industry’s structure during the ascendancy of the Nurture paradigm had other implications, among the most prominent of which was the emphasis on profitability as an exit metric. This was not because Nurture investors were any smarter than today’s Manager investors, who by comparison are far less concerned with early profitability. Profitability was part of the Nurture paradigm simply because the typical Nurture fund – even when factoring in syndication of investments – simply did not have sufficient capital to support a portfolio company burning tens or hundreds of millions (or as per Uber recently billions) of dollars of capital a quarter.

The Nurture paradigm led to venture capital’s first golden age in the 1980s. It also sowed the seeds of the Manager paradigm which arrived on the scene in the later half of that decade. The Manager paradigm was launched, ironically enough, when some of the great Nurture firms started raising the first wave of mega funds with hundreds of millions of dollars and, before long, even billions of dollars to deploy.

Implications for Flyover Country Venture Investing

If there is still a meaningful role for Nurture funds in Silicon Valley, there is very little room – today – for Manager-modeled funds outside of Silicon Valley and a handful of other of the larger venture investing centers. And that is something that too many folks in flyover country just don’t understand. And something that is making it even more challenging than it needs to be to foster the emergence of a meaningful high impact entrepreneurship and investing sector in still nascent and emerging flyover markets.

I saw the problem in North Carolina circa 1990, and I see the problem in Wisconsin, today. Regional folks who want to foster a vibrant high impact entrepreneurship and investing community look to Silicon Valley and, seeing how the Manager venture investing model dominates the headlines, conclude that we should be doing the same thing here. That we should invest as if our entrepreneurs had the same kind of “been there, done that” startup experience and networks that their Silicon Valley counterparts enjoy.

Well, they don’t. The opportunities and challenges of venture investing in Wisconsin in 2017 are indeed comparable to the opportunities and challenges of venture investing in Silicon Valley. But Silicon Valley circa 1975, not 2017.

What places like Wisconsin need, in terms of venture investors, is Nurture VCs, not Manager VCs. We need small funds, run by hands-on partners who bring their own “been there, done that” high impact startup operating and investing experience to the game. People who are willing to get down in the trenches with entrepreneurs to help shape raw talent and ideas into fundable deals; and who are willing and able to start doing that even before making an investment. Venture investors who can proactively help their portfolio entrepreneurs achieve profitable operations supporting attractive exit opportunities with lifetime risk capital needs that don’t exceed even the average A round in today’s Silicon Valley.

Unfortunately, instead of Nurture funds led by experienced startup entrepreneurs and hands-on investing professionals helping raw entrepreneurs with good ideas build modest companies that offer solid investment returns with limited capital, what I’ve seen here in Wisconsin is mostly investors with little or no venture backed startup operational or seed/early stage risk capital investing experience casting about for the kind of startup teams and capital-ready deals that fit the Manager venture investing paradigm.  Teams and deals that we just don’t yet have enough of in Wisconsin to support a sustainable high impact venture-driven startup community.

Don’t get me wrong. I think – know – that Wisconsin and places like it have the raw entrepreneurial talent and capital to become small but important and sustainable centers of high impact entrepreneurship and investing. But getting there is not going to happen unless and until the folks who want that to happen understand that right now we need Nurture venture investors, the kind that built Silicon Valley, not Manager venture investors in the mold of those who get the headlines in Silicon Valley today.

Consumer Product or Medical Device? (Or Maybe Toy?)

By Paul A. Jones and Joel E. Henry, Ph.D. (Managing Partner, Michael Best’s Missoula Office)

So when is a consumer product – say a little matchbook-sized box you wear on your wrist that keeps track of your pulse over the course of the day –a medical device?

“What difference does it make?” you might ask. Well, if you are developing that little box for market, quite possibly tens of millions of dollars of added development and testing expenses, a couple of years more development and testing time, and millions of dollars of legal fees, regulatory expenses, insurance premiums, and misc. other costs both before market introduction and after. Not to mention likely a different distribution model, a higher price point, and lower volumes.

Alas, having perused FDA Guidance on distinguishing consumer products from medical devices (including some recent draft Guidance), and talking about the matter with some of my colleagues who spend substantial time practicing in the medical device regulation space, my take is that there is a lot of gray area around this question. Which is to say, there are a lot of current and soon-to-appear products out there for which good arguments could be made that they are consumer products – and good arguments could be made that they are medical devices. And that in some cases, the answer might even hinge on whether the manufacturer labels the product a toy. And that’s a problem.

While it takes pages and pages of regulation and guidance to get there, basically the distinction between a consumer product and a medical device – according to the FDA, which is to say the people that matter here – is pretty simple: the application of the distinction, less so.

First, the distinction. If the purpose of a product is to process inputs which are collected by the product from a person (a substance, for example sweat or blood, or data, for example a pulse) and use that to diagnose or suggest treatment for a medical condition, you have a medical device. Thus, for example, a personal ECG consumers can purchase without a prescription for the purpose of determining if they should see a doctor about an arrhythmia is a medical device, and is regulated as such. And that is true regardless of the intended use (well, I think so: more later).

Now, on the above logic, you would think that a product you wear on your wrist that keeps track of your pulse would be a medical device. I mean, the only real reason to have such a device – beyond a gee whiz sort of curiosity – is to monitor your physical activity for purposes of improving (or at least monitoring) your health. Clearly a medical device, right?

Well, no. The FDA has said, in its guidance on medical devices, that it will not deem a product a medical device if it’s only intended use is to encourage or maintain a general state of health or healthy activity, and the use of the product does not entail any significant risk to the user or third parties. Thus, your smartphone app for keeping track of your pulse isn’t in fact a medical device according to the FDA. This class of products would include (among many others) things that monitor calories burned or suggest healthy menus to control weight.

On the other hand, if your exercise monitor claims it can help you manage your Type II Diabetes, you’ve got something that is a medical device and that the FDA will consider to be a medical device. (You can see, I think, how this could get confusing.)

It gets more confusing. Our exercise monitor that is marketed as a tool for helping manage Type II Diabetes is in fact a medical device according to the FDA, and thus subject to regulation as such by the FDA. But the FDA, as a matter of policy, has indicated that it will not enforce those regulations with respect to such a medical device. That’s not a regulation but a policy. Which means it can be changed pretty much any time for pretty much any reason, without going through any rule making process or seeking industry or consumer input.

The thinking, here, is not to enforce the medical device regulations in the case of medical devices that present a low risk and are aimed at helping the consumer better manage a particular medical condition where the use of the device conforms to a generally accepted medical consensus. In this case, getting more exercise is a generally accepted mechanism for managing Type II diabetes. Another example of this kind of medical device would be a device that “coaches breathing techniques and relaxation skills, which, as part of a healthy lifestyle, may help living well with migraine headaches.” But, then again, FDA guidance says that it would regulate a medical device that listened to someone’s breathing to diagnose bronchitis (and yes, there is technology that does just that).

You can see, I think, how all of this can get pretty confusing. And we have not even talked about what “low risk” means (basically, if a product is invasive – that is it involves puncturing the skin or otherwise inserting something in the body as opposed to on it, or if it involves applying something (a laser, for example) to the body that could harm the user or a third party if not used correctly, you have a product that is not low risk).

If you think you can figure all this out on your own, here is a final twist; admittedly a pretty strange twist, but I think a valid one for purposes of illustrating how much uncertainty there is as the FDA struggles to adapt to a rapidly changing technological environment.

If you’ve ever had kids, you know that you can buy toy stethoscopes. These products, at least some of which are as functional as low end “real” stethoscopes, are not regulated as medical devices. They are marketed and intended to be used as toys, and include labels that they are not to be used for medical purposes.

On the other hand, traditional stethoscopes intended for medical use are medical devices (albeit regulated with a light touch). And “smart” stethoscopes – devices that enhance, manipulate, or interpret information generated by the stethoscope – are in fact regulated as medical devices (which, given the initial example of the personal ECG product, isn’t surprising).

So, what about a “toy” smart stethoscope? Before you say that labeling it a toy doesn’t work because it is clearly capable of performing a medical function, remember that so can a dumb toy stethoscope.

The answer? I am not sure. But there is, in fact, a “business card toy ECG” on the market. At least there is as this blog goes to press. You figure it out. And if you are smart, talk to your lawyer about your thinking before you run too far with it.

Supreme Court Changes Where Patent Lawsuits Can Be Filed

On May 22, 2017, the United States Supreme Court overturned nearly 30 years of venue practice under Federal Circuit precedent. Prior to the Supreme Court’s decision, patent litigants could be dragged into court essentially anywhere an alleged infringing act occurred. In TC Heartland LLC v. Kraft Foods Group Brands LLC, No. 16-341, slip op. (U.S. May 22, 2017), the Supreme Court reversed the Federal Circuit and held that “a domestic corporation ‘resides’ only in its State of incorporation for purposes of the patent venue statute.” Id. at 2. Thus, a domestic corporation can only be sued for patent infringement in the state where it is incorporated, or where there has been an act of patent infringement and where the corporation has a regular and established place of business.

The patent venue statute provides that “[a]ny civil action for patent infringement may be brought in the judicial district where the defendant resides, or where the defendant has committed acts of infringement and has a regular and established place of business.” 28 U.S.C. § 1400(b). The general venue statute, however, provides that “[f]or all venue purposes,” certain entities, “whether or not incorporated, shall be deemed to reside, if a defendant, in any judicial district in which such defendant is subject to the court’s personal jurisdiction with respect to the civil action in question.” 28 U.S.C. § 1391(c)(2). The Federal Circuit in TC Heartland held that this language defines the meaning of the term “resides” in § 1400(b), relying on its prior decision in VE Holding Corp. v. Johnson Gas Appliance Co., 917 F.2d 1574 (Fed. Cir. 1990), which had interpreted the version of the general venue statute enacted in 1988 to reach a similar conclusion. In re TC Heartland LLC, 821 F.3d 1338, 1342-43 (Fed. Cir. 2016).

The Supreme Court disagreed with the Federal Circuit. It found no material difference in the language of § 1391(c)(2) and the language of the general venue statute in effect when the Supreme Court issued its decision in Fourco Glass Co. v. Transmirra Products Corp., 353 U.S. 222 (1957), where it held that the patent venue statute was “not to be supplemented by” the then-codified version § 1391(c). TC Heartland, slip op. at 5, 9. In fact, the Supreme Court in TC Heartland found the argument for incorporation of the current general venue statute’s definition of “resides” to be even weaker, noting that the statute now includes “a saving clause expressly stating that it does not apply when ‘otherwise provided by law.’” Id. at 9 (citing 28 U.S.C. § 1391(a)(1)). The Supreme Court also found that there was “no indication that Congress in 2011 ratified the Federal Circuit’s decision in VE Holding” when it enacted the current version of the general venue statute. Id. “If anything,” the Supreme Court observed, “the 2011 amendments undermine that decision’s rationale,” which relied heavily on Congress’ decision in 1988 to replace the language “for venue purposes” present in the statute at the time of the Supreme Court’s decision in Fourco with “[f]or purposes of venue under this chapter.” Id. at 9-10 (emphasis in original).

Though the Supreme Court limited its holding to domestic corporations, the decision is a dramatic change to the patent litigation landscape. The Court’s decision abruptly ends the practice of a domestic corporation being brought into a court which has little connection to the corporation. Frequently, these cases were brought in the Eastern District of Texas, as it was perceived to be “plaintiff friendly” to patent owners. Now, domestic corporations can only be sued for patent infringement in their state of incorporation or where they have a “regular and established place of business” and have committed acts of patent infringement. Oddly, this means that a patentee seeking to enforce its patent can be forced to sue in the defendant’s state, rather than its own home district court. While the Supreme Court’s decision significantly limits the practice of “forum shopping” in patent cases, it is possible that Congress will enact new venue legislation. In the meantime, however, plaintiffs must comport with the venue restrictions as interpreted by the Supreme Court, and defendants in pending cases will want to investigate moving the cases back to their home court.

This blog post was written by Kenneth M. Albridge, III and John C. Scheller of Michael Best.

A Term Sheet is Not a Deal

First the good news. If you get a signed term sheet with a reputable angel or venture investor, there is a very good chance you will get a deal done. Unless, of course, you don’t.

Probably the most common element of every term sheet is the provision that states unequivocally that by signing the term sheet neither party is obligating itself to enter into an investment transaction, whether on the terms reflected in the term sheet or otherwise. Still, if the parties do reach agreement on a term sheet, there usually is a deal made, and usually on terms mostly consistent with the term sheet. That said, herewith a look at the most common reasons a “done term sheet” does not lead to a “done deal.”

  1. The investor can’t build a syndicate sufficient to close the deal out. As they teach you in entrepreneurship boot camp, getting a deal done is first about finding a lead investor. Someone credible who can put a stake in the ground and then help the entrepreneur close a syndicate around that stake. If your lead investor is a top tier fund, or even a second tier fund committed to invest 75% or more of the minimum closing amount, chances are somewhere between no-brainer (top tier fund) and highly likely (second tier fund) that you will get the deal done. On the other hand, if your lead investor is an anonymous angel committed to take only 35% of the minimum-closing amount, don’t hold your breath. The take home point here: your chances of turning a term sheet into a deal are pretty closely tied to the market credibility and relative capital commitment of the investor that signed the term sheet.
  2. Deal due diligence uncovers a major issue that either can’t be suitably resolved, or reflects badly on the entrepreneur’s competence. All-too-common issues that come up in due diligence include IP ownership issues (e.g. important IP was developed without appropriate work-for-hire or assignment documentation) and capitalization table issues (e.g. equity distribution is not well-documented; potential claims for significant equity outside of the cap table turn up; previous investors were unaccredited, or paid too high a price). The take home point here is get your due diligence ducks lined up (and shot, if they need shooting) before you sign the term sheet. Investors – good ones, at least – don’t like surprises, particularly when they suggest a careless, clueless or deceptive entrepreneur.
  3. In the rush to get the term sheet done, one of the parties punted on an important issue, figuring that she could take care of it in the fine print of the closing documents. For example, I once saw an investor leave the question of subjecting some of the founder’s stock to vesting for the closing documents. The very fact that the investor thought avoiding the issue at the term sheet stage was a good idea shows what a bad idea it was. A simple lesson: if an issue is material to either party, deal with it in the term sheet. It may kill the deal, but it will save a lot of time, distraction, energy and expense.
  4. The entrepreneur and the investor discover, under the pressure of getting the deal done, that they do not work very well together; or one or both of them loses confidence in the integrity of the other. Closing an early stage deal can put a lot of pressure on an entrepreneur (less so an experienced investor, who does a lot more deals). Pressure can bring out the best in a good entrepreneur. And the worst in a bad entrepreneur. Just as bad investors turn off good entrepreneurs, so bad entrepreneurs turn off good investors. Not that you can’t be an aggressive, take no prisoners entrepreneur and succeed, if that’s your style. But whatever your style, wear it well.
  5. Internal events at the investor’s shop derail the process. Say, for example, the partner leading your deal moves to another firm, or gets hit by a bus. Stuff happens, and when it does, deals often die. Being good is not enough in the high impact entrepreneurship world. You’ve got to be lucky too. Or at least not unlucky.
  6. A major external event shocks the market generally or the particular segment of the market the deal is in. Remember 9/11? I do. And so do several entrepreneurs I know who were trying to close deals at the time. More failed than succeeded. I’ve also seen deals blow up based on a shock to a particular market segment, as for example diagnostic deals in the aftermath of a major patent ruling that basically gutted the IP protection upon which the bulk of diagnostics companies were built. The take home lesson here: after you get the term sheet signed, close your deal with all deliberate speed. And stay lucky.

When an entrepreneur tells me they have a lead investor on board, my first reaction is to ask some questions. Who is it? Have they signed a term sheet? How much are they committing? How confident are you that all of your due diligence ducks are lined up? If the answers to these questions are satisfying, I’ll mentally note that the deal in question will most likely happen. Unless it doesn’t.

Jones: Alas, here is still not there

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Jones: Alas, here is still not there” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“‘Over the course of the past two years, the median pre-money valuation for seed-stage financings was $6 million and the median deal size was approximately $2 million.’

So reports Mark Suster, partner at Upfront Ventures, in a fourth quarter 2016 venture capital market report by Cooley, LLP, one of Silicon Valley’s leading law firms. (They also reported serving as counsel for 187 venture capital financing involving $2.7 billion in the fourth quarter: yes, Virginia, the rich really are different.)

Clearly, the seed deal market in Wisconsin – where my sense is that the median pre-money seed round valuation is something more like $1 million, and the median seed deal size more like $300k – is a bit of an outlier. As are most flyover country markets. That said, here are some things these numbers got me thinking about.”

Click here to read more.