Thanks to Gordon Smith for inviting me to guest blog—and kudos to Gordon for inviting Michael Burstein, who penned several insightful guest blogs here a few weeks ago—to generate some buzz about the intersection of IP and business law. In my posts over the next two weeks, I’ll follow on Michael’s outstanding foray into the overlap—and as I’ll describe, the “gap”—between IP and business law.
As Michael explained, IP and business law often intersects in three key areas: (1) Law & Entrepreneurship; (2) Markets for Technology; and (3) Innovation and Corporate Performance. Each of these areas has been growing at tremendous rates both in terms of academic study and real-world deals.
As an IP law professor and former founder of a .com-era software company, it’s greatly refreshing to see this newfound interest in IP & business law in the legal academy and practice. Yet, both domains still often suffer from what I term the IP transaction “gap”—namely, the lack of a deep understanding on the part of academics and lawyers of both the “IP of Business” and the “Business of IP.”
In simple terms, business lawyers often fail to appreciate the important details of IP and IP lawyers often fail to understand the business of their clients. As a client, my difficulties stemmed in finding business-savvy lawyers who had a sufficient grasp of IP—particularly the business aspects of IP—to ink the kinds of nuanced licensing, assignment, and acquisition agreements that would suitably account for the structure and risks unique to IP deals. The same sorts of “gaps” between IP and business law pervade law review articles that attempt to tackle this thorny intersection.
Of course, there are notable exceptions among scholars and practitioners alike. For instance—in addition to Michael Burstein—Ashish Arora, Stuart Graham, Richard Gruner, Bronwyn Hall, Jay Kesan, Josh Lerner, and David Teece represent an abbreviated list of some of the scholars with deep knowledge in both fields. Similarly, there are well-known (and lesser-known) attorneys with the same sort of cross-disciplinary aptitude. How do scholars—and practitioners and students—acquire this kind of knowledge? I have a few suggestions.
First, law schools should offer more cross-over courses in IP and business law. For example, at the University of San Diego School of Law, David McGowan and I have focused on expanding our cross-disciplinary IP offerings, which now include IP & Business, IP Strategies, Technology Transfer, and a Technology Entrepreneurship Law Clinic. Based on a survey of IP courses performed by William Mitchell Law School, fewer than 20 law schools offer any IP transactional courses other than IP licensing. Relatedly, law schools should provide certificates or concentrations in IP Transactional Law, as well as more opportunities for joint MBA/JD programs, with a special emphasis on technology-focused business and law.
Second, legal academics writing in IP & business should more frequently read and cite literature from outside the law review canon. In my view, often the best law review articles in IP draw upon scholarly works from business, economics, management, marketing, and related journals. One excellent way to quickly learn about the latest thinking in these fields is to attend conferences in these disciplines, such as the Academy of Management or American Economic Association annual meetings.
In this vein, academics and practitioners alike should cease the frequent practice of pigeon-holing certain issues as “legal” and others as “business,” relegating the latter to the expertise of non-lawyers. At my software company, we eventually fired every lawyer who made such hidebound distinctions. In their place, we hired transactional lawyers who understood our business well—not only our goals in a specific deal, but also overall—and who thus could provide integrated business and legal advice. In order to have this deep level of knowledge, transactional lawyers—especially those who practice in the tech space—need to immerse themselves in the business of their clients. In many situations, this might mean self-educating by reading a client’s business plan and fundraising slides, as well as general business magazines, books, blogs, and journals.
Last, and perhaps most importantly, we in legal academia—in addition to training students to “think like lawyers”—should give today’s transactional law students a head-start on “thinking like businesspeople.” By doing so we can help ensure clients receive the kinds of lawyering they increasingly demand (and need).
Thanks so much to Gordon Smith and the rest of The Glom for inviting me to guest blog for a couple of weeks. As Gordon mentioned in his very kind introduction, I’m a professor at the Cardozo School of Law in New York City, where I teach Patent Law, Corporations, and Property. My writing focuses on the intersections between and among these fields. My view is that the relationships between IP and business law are numerous, complex, and rich. But in our somewhat specialized sub-disciplines, IP and corporate law scholars don’t often talk to each other. (There are exceptions, of course, and I’m thrilled to be part of a group that is working to change this – more on that below.) In my posts over the next two weeks, I’d like to try to jumpstart some new conversations. I think we have a lot to learn from each other.
In this first post, I thought I would describe a few themes that bring IP and business law together, as a way of framing the more specific problems that I’ll discuss later in the week. So to get things started, consider the following:
- Law and entrepreneurship. Gordon and others (Brian Broughman, Sean O’Connor, Usha Rodrigues, to name but a few) have done tremendous work over the last several years to explain the particular roles that law plays in shaping the environment for new ventures (and to build an interdisciplinary Law and Entrepreneurship Association of scholars interested in these issues). In today’s economy, where many such ventures are based on intellectual assets, IP laws have a tremendous impact on the shape and success of those businesses. To take just a sampling of issues: Ted Sichelman and his collaborators find, in the Berkeley Patent Survey, that entrepreneurs seek often seek patents for reasons unrelated to the classic rationale of preventing misappropriation, such as to better attract venture finance; Colleen Chien reports that the costs of patent “trolling” are disproportionately borne by startups; and federal technology transfer policies determine how innovative ideas move from the laboratory to the marketplace.
- Markets for technology. The classic economic model of innovation is simple and usually involves a lone genius inventing in a garage. But bringing an innovative product to market requires much more. It requires linking the idea with capital and development resources for commercialization. Forging those links requires players to overcome a range of bargaining challenges. I’ve argued that IP may play a smaller role in overcoming those challenges than we think (so too has Peter Lee, who focuses on tacit knowledge), and continue to explore how transactions in information take place. But at the same time, we are seeing the rise of robust secondary markets for patents and copyrights, which raise a host of concerns with which corporate scholars are already familiar. If patents are to be treated as financial assets (as, for example, Michael Risch suggests), what disclosure regime should we apply? Would a patent market function like a capital market? Would that be socially desirable?
- Innovation and corporate performance. The popular business press is obsessed with innovation. And rightly so – innovation is a critical driver of corporate performance. But the organizational drivers of innovative behavior often depend on law. Dan Burk & Brett McDonnell, and several others, for example, draw on the theory of the firm to explain how the strength and breadth of IP affects firms’ make-or-buy decisions with respect to technology. Other innovation incentives – prizes, grants, R&D tax credits – have similar impacts on firm behavior, as Lisa Ouellette and Brett Frischmann have begun to describe. Later in the week, I’ll write about work that I’m doing with Fiona Murray – a management professor at MIT Sloan – about the governance of innovation prizes, a problem that we think has much in common with the governance of innovation process in other institutional settings such as corporations.
I’m really excited to engage with the community here on these and other topics. I look forward to hearing your thoughts, and to a fun couple of weeks!
I recently finished reading The Master Switch: The Rise and Fall of Information Empires by Tim Wu, a professor at Columbia Law School. The book was released in 2010, and I can't believe it has taken me this long to read it. (Concurring Opinions did a symposium on the book in 2011.) Once I started, I found excuses to peel away from other responsibilities so that I could read the book, and I finished it in three days. If you are interested in law and entrepreneurship, this book is essential reading.
Wu's proposed "Separations Principle" ("the creation of a salutary distance between each of the major functions or layers in the information economy") is nice example of a set of regulations designed to promote the "release of energy" that Darian Ibrahim and I discuss in Law and Entrepreneurial Opportunities. Wu argues that antitrust law alone cannot create an environment in which entrepreneurial action can flourish. He details the costs of monopoly with colorful stories, and shows how government sometimes enables entrepreneurship, but too often plays an abetting role in the supression of entrepreneurship. Of course, not everyone agrees with Wu on the effect of his policy prescription, but Wu has the frame exactly right.
By the way, on Saturday, Wu was the subject of a nice profile in the NYT, highlighting his role in the debates about net neutrality, a term he coined in 2003.
UPDATE: Speaking of net neutrality and entrepreneurship...
And this from today.
So, criticizing The Ethicist column in the New York Times is about as new as complaining about the weather. When the previous Ethicist, Randy Cohen, quit in 2011, I listed some of his columns that angered me the most. I don't believe the replacement, Chuck Klosterman, is an improvement, but the columns are definitely less definitive (it's easier to be less wrong when you are less clear). Last week's column, in which Klosterman said it was ethical for a college student to write one paper for two classes, most recently rankled the audience. The problem is that the NYT has a column called "The Ethicist," ethicists exist, but the NYT doesn't hire any of them for the column. It's as if there were a column called "The Economist" or "The Cardiologist," but the person writing answers to questions was neither of those things.
But enough about that. Assuming that the letters are written by actual folks, a letter appeared last month asking whether Zach Braff, who has more money than most people, was unethical by posting a film project on Kickstarter and asking for donations to fund it. Here is the Kickstarter page for "Wish I Was Here." The Ethicist's wishy-washy answer is that Braff doesn't lie in his "ask," so he's not unethical, but he might be unethical if he were merely using the Kickstarter page as free advertising, because the page may have led to big-studio follow-on financing in addition to the $3M in donations.
So, a few things the Ethicist doesn't seem to observe. One, even if Braff is using Kickstarter for something other than raising desperately-needed funds, he may have been using it for information-gathering, not advertising. The fact that so many folks donated money signals to him, the maker of the movie, and to studios, that there is an audience out there that loves Zach Braff and desperately wants a follow-up to Garden State (not my favorite movie, but apparently popular to many). Conducting an online poll is not nearly as accurate as a poll where web-clickers click with their credit cards. As Braff states, the rabid response to a similar Kickstarter project to make a Veronica Mars movie proved that there is a huge cult following who want to pay $9 to see a Veronica Mars movie. Yes, it's push-advertising, but it's really more valuable information-revealing.
Second, as Mel Brooks so fabulously writes in his play The Producers, "Never Put Your Own Money in the Show."
Cross-posted at SocEntLaw.
"Branding" is one area where proponents of the Model may argue that the Model is better than the PBC. As mentioned in my first substantive post, the PBC favors private ordering more than the Model, which makes the PBC more flexible, but also makes it more difficult to maintain a consistent brand. Branding could be useful to investors, consumers, and governments that wish to quickly identify socially responsible companies.
Some proponents of the Model may point to the required annual report (PBC only requires a biennial report) and the requirement of measuring general public benefit against a third party standard (optional under the PBC) as building the Model’s brand. In my opinion, however, neither the required annual report nor mandatory use of a third party standard is likely to facilitate creation of a useful brand under the current language of the Model.
First, the Model does not expressly provide an enforcement mechanism for assuring the public posting of an annual report and the use of a third party standard. Currently, a number of benefit corporations are in violation of the statute, but nothing seems to be done about the violations. Second, most of the few annual reports available are full of fluffy self-promotion and do not include much of value. Third, the available third party standards vary wildly, so simply requiring a third party standard is not likely to lead to a consistent and valuable brand. The updated version of the Model requires that the third party standard be “comprehensive,” “independent,” “credible,” and “transparent,” but those requirements will be difficult to enforce and, in any event, do not appear aimed at creating a consistent brand. A benefit corporation that does not see the value in using a third party standard may use the lowest standard available, provide little to no useful information to the market, and waste company resources in the process.
If the Model proponents wished to create a brand via statute they would do better requiring an annual charitable giving floor and a partial asset lock, as I suggest here. In my opinion, however, the heavy lifting in the branding department of social enterprise should be left to private organizations like B Lab. The social enterprise space is evolving quickly, and I think it unlikely the state governments would keep up with the changes and engage in the type of enforcement needed to maintain a valuable brand. Also, the term “social good” means very different things to different people, and therefore it is likely better to have private organizations develop various standards and allow the market to determine which standards, if any, are useful and valuable.
One of my colleagues said that my latest article (written with one of my excellent students, Jordan Lee) sounds like an R-rated movie. The title is Discretion, and here is the abstract:
Discretion is an important feature of all contractual relationships. In this Article, we rely on incomplete contract theory to motivate our study of discretion, with particular attention to fiduciary relationships. We make two contributions to the substantial literature on fiduciary law. First, we describe the role of fiduciary law as “boundary enforcement,” and we urge courts to honor the appropriate exercise of discretion by fiduciaries, even when the beneficiary or the judge might perceive a preferable action after the fact. Second, we answer the question, how should a court define the boundaries of fiduciary discretion? We observe that courts often define these boundaries by reference to industry customs and social norms. We also defend this as the most sensible and coherent approach to boundary enforcement.
I wrote an article about a decade ago called "The Critical Resource Theory of Fiduciary Duty" that still gets downloaded and cited a fair amount, at least for a fiduciary duty article. It is about the structure of fiduciary relationships, and I wanted to do a follow on article about how courts know when someone has breached a fiduciary duty. I actually had a fairly long draft of an article that was just horrible, and I never published it, but I kept thinking about and teaching about this problem. Earlier this year, I had a brainstorm about the subject, and the result is this new article.
By the way, interest in fiduciary law seems to have exploded in the past decade. Some of that interest stems from Tamar Frankel's book and the accompanying conference at Boston University. Some of the interest stems from the fact that fiduciary law is interesting in many countries outside the United States, where much of the best writing on this subject is found (see Paul Miller, for example). I look forward to a new surge in interest this summer, as Andrew Gold and Paul Miller have organized an excellent conference on The Philosophical Foundations of Fiduciary Law, to be held in Chicago. I am writing a paper entitled "True Loyalty" for that conference and very much looking forward to reading the other contributions.
'Opportunity' is a central concept in entrepreneurship research, and this Article explores the relationship between law and entrepreneurial opportunities. We adopt the widely held view that entrepreneurial opportunities are ideas created by entrepreneurs, rather than resources waiting to be discovered. Of course, as with all products of the imagination, entrepreneurial opportunities draw on existing resources for inspiration, and we contend that some legal systems are better than other legal systems at encouraging entrepreneurs to think about existing resources in new ways. We also contend that when entrepreneurial opportunities are exploited, the inventory of resources expands, thus laying the foundation for the creation of more entrepreneurial opportunities. This 'opportunity cycle' leads to plentiful and continuous opportunity creation.
Legal rules play an important role in each stage in the opportunity cycle, and two sets of stories told about law are foundational to innovation research. The first is that property rights (i.e., rights to exclude) are essential in the development of innovative resources because property rights assure market participants that they can retain many of the benefits of their success. The second is that various sets of legal rules – including laws limiting barriers to entry, bankruptcy laws, and corporate laws relating to limited liability and asset partitioning – reduce the costs of entrepreneurial action and failure, thus emboldening entrepreneurs to exploit opportunities. Our thesis is that all of these stories are part of a grander tale about the opportunity cycle, and the central theme of that tale is that the promotion of entrepreneurial action is a fundamental value of the U.S. legal system, the expression of which through positive law inspires entrepreneurs to create more opportunities.
If you are at Law & Society this Friday and Saturday, come to the mini-conference on Entrepreneuship & Law that Brian Broughman (Indiana - Maurer School of Law) and our own Gordon Smith (BYU) have organized. Here is the line up:
Friday, June 3, 2011
8:15 am to 10:00 am Regulating Entrepreneurs 2122 (Chair: Brian Broughman)
- Mira Ganor (Texas), The Power to Issue Stock
- Erik Gerding (New Mexico), Shadow Banking, Financial Innovation, and Regulatory Arbitrage
- Michelle Harner (Maryland), Mitigating Financial Risk for Entrepreneurs
- Poonam Puri (Toronto), The Regulatory Burden of Corporate Law
- Discussants: Kristin Johnson (Seton Hall) & Sarah Lawsky (UC Irvine)
12:30 pm to 2:15 pm Governance Structure of Entrepreneurial Firms 2322 (Chair: Brian Broughman)
- Brian Broughman (with (Jesse Fried & Darian Ibrahim), Delaware Law as Lingua Franca: Evidence from VC-Backed Startups
- George Geis (Virginia), Organizational Contracting and Third Party Rights
- Alicia Robb (Kauffman Foundation), Entrepreneurial Finance and Performance: A Transaction Cost Economics Approach
- Discussant: Bobby Bartlett (UC Berkeley)
Saturday, June 4, 2011
8:15 am to 10:00 am Law, Entrepreneurship, and Innovation 3116 (Chair: Gordon Smith)
- Mike Burstein (Harvard), Exchanging Information without Intellectual Property
- Sean O’Connor (Univ. of Washington), Transforming Professional Services to Build Regional Innovation Ecosystems
- Peter Lee (UC Davis), The Accession Insight and Patent Infringement Remedies
- Karl Okamoto (Drexel), Law and Entrepreneurship: An Assessment Approach
4:30 pm to 6:15 pm Global Entrepreneurship 3519 (Chair: Gordon Smith)
- Afra Afsharipour (University of California, Davis), US Private Equity Investments in India
- Sofia Johan (York Univ.)(with April Knil and Nathan Mauck), Determinants of Sovereign Wealth Fund Investment in Private Equity
- Gordon Smith, Stability and Adaptability
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Gearing up for the Facebook movie in October, I am reading The Facebook Effect: The Inside Story of the Company That Is Connecting the World by David Kirkpatrick. As I have mentioned before, I love business histories, and this one is very good, even if Kirkpatrick falls victim to the bane of many business historians: infatuation with the subject company.
Only one-third of the way through the book, I am surprised by the number of legal actions generated by Zuckerberg and his merry men. (So far in the story, all of the employees of the company are men.) We have heard a lot about the Winklevoss/Narendra claims, and the book mentions several other people who lay in Facebook's wake.
But it doesn't mention Paul Ceglia, the man who now claims to own 84% of Facebook based on a contract that Mark Zuckerberg signed in 2003. You can see a copy of the contract Ceglia filed with the court here. Take a look at Paragraph 3, which states, "The agreed upon completion for the expanded project with working title 'The Face Book' shall be January 1, 2004 and an additional 1% interest in the business will be due the buyer for each day the website is delayed from that date." Ceglia claims that Zuckerberg was late with his work, but eventually delivered after Celia had reached an 84% ownership share.
Facebook's response to this claim has been less than confident. Originally Facebook's lawyer told a federal district court judge, "Whether [Mark Zuckerberg] signed this piece of paper, we're unsure at this moment." The next day, Zuckerberg was trying to clarify that statement: "If we said that we were unsure, that was likely taken out of context, because I think we were quite sure that we did not sign a contract that says they have any right to ownership over Facebook." The following day, Facebook gave it one more try, this time through a company spokeman:
Mark has made it clear that Ceglia's claims are absurd and we strongly suspect the contract is forged. However, we have not seen the original (no one has, including the court). Thus, we're focusing on the things that are not open to interpretation and are indisputable--Mark could not have given interest in a company that didn't exist or and idea he had not thought of yet and, even if he could, the statute of limitations has expired.
"Strongly suspect the contract is forged"?
On the other side, Ceglia claims that he simply forgot about the contract, but he discovered it recently when looking through his files as he prepared to defend himself against charges of fraud in connection with his wood pellet business. Plenty of reporters are looking into Ceglia checkered business career, but I suspect his 15 minutes of fame have almost expired, even if the contract is authentic. Even if Zuckerberg had a project called "The Face Book" that somehow involved Ceglia, it seems unlikely to me that the same project ultimately became "TheFacebook" (and later just "Facebook").
The other twist in this story is that another person is claiming to own Facebook through Paul Ceglia: "Andrew Logan, StreetDelivery’s founder and CEO ... claimed Ceglia was under contract to StreetDelivery in 2003 when he set up StreetFax and hired Zuckerberg. If Ceglia’s contract with Zuckerberg gives Ceglia an ownership interest in Facebook, that interest may belong to Logan, he said.... 'We’re going to lay claim that I own it,' said Logan. 'He was under contract to me."
Don't get your hopes up, Andrew.
If you are planning to attend the Law & Society Association's Annual Meeting at the end of this month, you may be interested in our conference-within-a-conference on Law & Entrepreneurship. Here are the paper sessions:
Scheduled Time: Thu, May 27 - 10:15am - 12:00pm
Title: Law and Entrepreneurship: Corporate Finance 1211
Chair: Gordon Smith (Brigham Young University)
Law Firms and IPO Pricing
*Rob Beard (University of Illinois)
Choice of Organizational Form: Preliminary Data
*Brian Broughman (Indiana University)
Open Source and Financial Regulation: Technology to Improve Securities Disclosure and Financial Regulators
*Erik Gerding (University of New Mexico)
*Larry E Ribstein (University of Illinois)
Scheduled Time: Thu, May 27 - 2:30pm - 4:15pm
Title: Law and Entrepreneurship: Intellectual Property 1411
Chair/Discussant: Darian M Ibrahim (University of Wisconsin, Madison)
*Shubha Ghosh (University of Wisconsin)
Governing Networked Production: Private Ordering in the Biopharmaceutical and Semiconductor Industries
*Matthew C Jennejohn (Delaware Court of Chancery)
Relationships, Technology Transfer, and the Limits of (Intellectual) Property
*Peter Lee (University of California, Davis)
An Empirical Study of Litigious Non-Practicing Entities
*Michael Risch (West Virginia University)
Scheduled Time: Fri, May 28 - 12:30pm - 2:15pm
Title: Law and Entrepreneurship: Venture Capital and Private Equity 2311
Chair: Brian Broughman (Indiana University)
What Killed the Venture Backed IPO?
*Robert Bartlett (University of California, Berkeley)
The Evolution and Renegotiation of Venture Capital Contracts
*Ola Bengtsson (University of Illinois)
Institutional Investment in Listed Private Equity
*Douglas Cumming (York University), Grant Fleming (Wilshire Associates), Sofia Johan (Tilburg University)
The New Exit in Venture Capital
*Darian M Ibrahim (University of Wisconsin, Madison)
Discussant: Gordon Smith (Brigham Young University) email@example.com
Scheduled Time: Fri, May 28 - 8:15am - 10:00am
Title: Law and Entrepreneurship: Social Values 2111
Chair: Karl S Okamoto (Drexel Univesity)
Entrepreneurship and Employee Ownership
*Matthew T. Bodie (Saint Louis University)
The Potential of Laws and Procedures Governing Business Entities in Facilitating Women's Entrepreneurial Development in the Horticulture Sector of Zimbabwe
*Rosalie K Katsande (University of Zimbabwe)
The Venn Diagram of Business Lawyering Judgments: Toward a Theory of Practical Metadisciplinarity (download)
*Jeffrey M. Lipshaw (Suffolk University)
Making Money While Making a Difference: Can Law Help Social Entrepreneurship Transform the World?
*Antony Page (Indiana University, Indianapolis), Robert Katz (Indiana University, Indianapolis)
The Release of Energy
*Gordon Smith (Brigham Young University)
UPDATE: My friend and co-author Danny Sokol also comments on this development, though with much more panache:
In my own research in this area for an article in which I am writing with Gordon Smith (BYU Law), we note that lots of the existing literature in entrepreneurship is fundamentally about legal issues. Nevertheless, academics in other fields that have been active in entrepreneurship research (sociology/org theory, accounting, finance and economics) for the most part have yet to make these connections explicit in their work.
As I explained to a colleague on Friday who wondered why the "law" part is so important if it has not been explicit in much of the non-legal research to date, my answer to him is that the "law" is like the Book of Esther. Unlike other books of the Bible, God (in all possible variations of the name) does not appear even once in the Book of Esther. However, as we learned in Hebrew School, this does not mean that God is not ever-present in the story.
Biblical allusions aside, law and entrepreneurship is a hot field and one that I think will continue to grow in part because the study of entrepreneurship has taken off in many universities. With BIGLAW jobs perhaps no longer guaranteed for students, law and entrepreneurship allows students to access an area of law where jobs might be possible for those who are willing to take on some risk. Additionally, increasingly the structure of BIGLAW might make a number of current BIGLAW associates and partners more willing to take the plunge into a fascinating area of law that is a driver of US innovation and growth.
I posted this in October, but I am moving it up as a reminder ...
Darian Ibrahim, Brian Broughman, and I are organizing a "conference within a conference" for the next Law & Society Association Annual Meeting in Chicago, Illinois on May 27-30, 2010. The LSA's call for papers is here. Our goal is to assemble several paper panels of scholars who are doing work relating to law and entrepreneurship (broadly defined). We welcome not only legal scholars, but also scholars in other disciplines.
While much of the work at LSA is empirical -- and we encourage the submission of such proposals -- we also encourage other proposals.
This year the LSA is soliciting proposals for projects in the early stage of development that could be presented at work-in-progress sessions. We would be interested in developing a proposal for such a session focused on law and entrepreneurship, so please feel free to submit such projects to us.
You may submit a proposal to any of us via email, but as a default matter, please send your proposal to Gordon Smith by November 30, 2009.
My research has focused on how sophisticated entrepreneurial parties – including angel investors, venture capitalists, venture lenders, and entrepreneurs – structure their relations, and how the corporate, securities, and commercial laws respond to their unique needs. In my venture debt paper, I discuss how lender liability and equitable subordination rules shape venture lender practices. In this post, I’ll focus on the securities laws.
First, there’s the exit structure of venture capital (with credit to Gordon for an excellent paper of the same name). In the past, hot IPOs allowed VCs to return big gains to their fund investors. In this recent public policy proposal (click on the Apr. 29, ’09 doc), the National Venture Capital Association laments that there were only six IPOs total in the U.S. in 2008. The securities laws aren’t helping the situation. As Larry Ribstein and others have observed, the costs of going public thanks to Sarbanes-Oxley have dampened the IPO market, and there’s a legal minefield we teach in the securities course known as the gun-jumping rules that makes the IPO process far more cumbersome and error-prone than the process for seasoned public offerings. Sure, a start-up needs to provide more disclosure than Microsoft, but it’s not like no one has vetted these companies. They have been subject to rigorous and repeat scrutiny from (venture) capital markets from their inception. Why are the gun-jumping rules so complex?
Second, long before exit, private placement rules and broker-dealer laws might be impeding optimal levels of funding from angel investors, the precursor to venture capital. In my last paper, Financing the Next Silicon Valley, I explored both the ban on general solicitations in private placements and the reach of the broker-dealer laws to see whether angels had reason to fear the application of these laws to their activities. I concluded that there is a plausible case that the letter of these laws, if not the spirit, are indeed violated by routine angel group practices. First, when entrepreneurs approach angels (and VCs) without a “preexisting relationship,” as they do whenever they send a business plan cold, there appears to be a general solicitation. This leads to a host of potentially bad outcomes including recission rights, dissuading follow-on VC financing, and delaying an IPO. Second, when individual angels take the lead on a start-up’s due diligence for their group and receive extra stock in the start-up as compensation, they arguably fit within the definition of a broker-dealer. I can’t imagine that the broker-dealer laws were meant to apply to this situation, and granted the SEC hasn't enforced either of the laws I mention (to my knowledge), but the cloud of uncertainty they hang over angel group practice certainly isn’t enticing more angel investments, at least according to my sources.
Bottom line: with our traditional economic engines like Wall Street finance and the auto industry in crisis, we need start-ups more than ever, and there won't be start-ups without angels and VCs. Market forces have already hit these investors hard; the securities laws shouldn’t exacerbate the problem. The SEC and Congress should re-examine these laws and ease up a bit to help keep our entrepreneurial culture going strong.
Thanks to Gordon for his nice words about my new paper on venture debt, and for his great help whipping it into present form (a new version just went up on SSRN). When I started the paper, I remember a friend warning me that “debt is not sexy.” Worse, the financial crisis has given debt a bad rap. Yes, consumers may take on too much debt, but don’t believe all the naysayers. Debt is awesome. It is extremely important in financial markets. Even in the start-up world my paper explores, where equity from angel investors and venture capitalists dominates, the use of debt makes for a fascinating story. Start-up companies have no track records, no positive cash flows, no tangible collateral, and no personal guarantees from entrepreneurs, yet are able to attract billions of dollars in loans each year. How is that possible? Read the paper to find out. Long live debt!