Interview with Jim Jensen: Venture Insights from a JD/MBA
Jim Jensen joined Indicator as an Advisor four years ago and has been an invaluable resource in helping us with everything from fund formation, structuring and drafting deals for portfolio company financing rounds, and advising on M&A transactions for our portfolio companies. Jim is a Partner in the Palo Alto office of Wilson Sonsini Goodrich & Rosati, a preeminent firm specializing in business, securities and IP law. Throughout his nearly two decades of legal experience, Jim has represented countless startups, enterprises, angel investors, and venture capital firms.
We recently hosted a Q&A with Jim to hear his legal perspective.
You recently transitioned from Perkins Coie to Wilson Sonsini Goodrich & Rosati. What drew you to WSGR and what are you focusing on these days?
I view my return to WSGR as a return to my home where I started my legal career in 1999. WSGR is the premier technology firm, more involved in all aspects of tech law than any other firm, does more tech IPOs than any other firm and has a number of exciting, game-changing strategic initiatives in process in working with startup companies and venture funds.
Perkins Coie is also a high-quality law firm with high quality attorneys, and I enjoyed my time with the firm. However, Perkins is not a tech firm and is better known for representing Democratic political campaigns than tech companies and venture funds.
You’ve been in the venture business for almost 20 years now and you’ve worked on countless transactions. What’s one of the most dramatic changes you’ve witnessed?
The legal fee rates have more than doubled from when I started practicing. For financings, the fee caps for investor counsel have stayed flat or marginally increased. This has been possible because there has been a standardization of documents, primarily driven by the NVCA legal working committee and specifically by Sarah Reed, now of MPM Capital. To me, that has been a great step in the right direction and we need more of these types of innovations in legal documentation. Stay tuned because WSGR will have some exciting innovations to announce in this regard.
There is clear evidence that round sizes and valuations have gone up significantly, and there seems to be a blurred line between Series Seed and Series A these days. From the early days of your career through today, how have you seen the market change in these respects?
When I started practicing, there was not any Series Seed per se. Series A was a few million raised at a $5M to $10M valuation. This is generally called a Seed round now. Even in the past 5 years, an increasing amount of young companies have been calling their first round financing a “Series Seed” rather than a “Series A” financing. As you can see in the chart below, the median pre-money valuation and amount raised in a Series Seed financing in 1H 2018 look exceptionally similar to the same figures for Series A in 2013.
In the last few years, the hottest startups or those perceived to be hot (associated with certain accelerators), have been raising Seed rounds without market traction or real teams at pre-money valuations between $15M and $25M. I have lived through two or three valuation re-sets and there will be another one. After a re-set, I suspect we will return to traditional valuation norms and then there will be another bull period. Startup valuations and terms go through boom and bust cycles.
Regarding round sizes, a lot of the increase has been driven by companies trying to buy market share as fast as possible. This is largely a function of things being less defensible and a perceived arms race against competitors and a broader market. Furthermore, access to capital has exploded with low interest rates and institutions allocating to venture, and in turn, venture capitalists are looking to put this dry powder to work fast.
How have you seen the scale tilt in terms of deals being founder friendly vs. catering more to the investors? Who has more leverage now?
Founders clearly have the leverage right now. The hottest startups set their own terms, founders hold special classes of stock (sometimes with outsized voting rights), and often times founders have the opportunity to take money off the table before an exit, among other things. This will change during the next bust cycle.
Given the changes that you’ve observed, are there any important implications that influence how you view terms of early stage deals and how you advise early stage funds accordingly?
My view is that early stage funds should look in non-traditional places for deals to get better valuations and terms. This means more than attending demo days. Many early stage funds go to the same source for deals and then pay higher valuations and will have trouble finding exits to support the valuations. There are many great deals for the diligent fund with reasonable valuations and terms, and sourcing these opportunities doesn’t necessarily mean sacrificing upside.
How do you see the legal landscape evolving with the emergence of new frontier technologies like blockchain and new assets like cryptocurrencies? Has the advent of the ICO or “Token Sale” effected the way you structure or think about deals? How do you view that new market in general?
There will be successful business models based on blockchain, and blockchain will be incorporated into established companies and improve or potentially revolutionize their business models.
I want to distinguish between blockchain-based companies and buying tokens in lieu of equity securities. In my view, investors will be disappointed with the returns they receive from tokens over time even though blockchain-based companies may lead to fantastic returns.
ICOs have raised millions in non-dilutive capital after first raising through traditional venture means (equity or convertible notes). Investors are increasingly looking to protect themselves and benefit from these unforeseen scenarios, even when investing in companies with no ICO plans, either through a ROFR on future token raises that may or may not happen or by trying to get their pro rata share of proceeds or tokens as a distribution. But as I mentioned, the founders currently have the leverage, so it is not always possible to get these protections as an investor.
Crypto reminds me of dot-coms in 1999 and 2000. During those years, I represented many companies that changed their names to “company.com” because the name and orientation made the company more fundable. Two years later, those same companies were out of business or removed the dot-com from their names.
I am not suggesting that the Internet has not been or is not huge. It has been revolutionary. If you think about how the Internet changed the world we live in, it is undeniable. Blockchain could do the same.
That does not mean the current cast of crypto experts will be the ones that do so. Many are impulsive and unsophisticated and have only been involved in positive returns and outcomes. There will be a lot of roadkill in crypto much like dot-coms.
I believe that firms should focus on blockchain oriented companies that sell convertible debt and equity securities. These companies are no different from any other technology company in my view, and an investment decision should be based on the viability of their business models. I think the key to approaching all of these new opportunities is investing in businesses that fundamentally make sense. If that is the path chosen, returns will follow.
If you had to give one piece of advice to an early stage startup, in terms of key legal considerations, what would it be? How about an early stage venture fund?
There are elements of startup law that are critically important. Namely, making sure IP is assigned to the Company and making sure founder agreements are in place in case the founding team separates.
Incorporate the company correctly with knowledgeable startup counsel and then your next legal expenditure is probably IP protection until the startup raises capital.
The same rule with funds. Hire good counsel and don’t re-invent the wheel on terms. Keep in mind that there are group of firms that do venture fund formation law. However, the price at those firms varies dramatically, and if you are a small fund make sure you will receive the requisite attention at the firm you choose. If a firm’s core clients are Sequoia and Andreessen Horowitz, will they pay attention to your $30M fund or $100M fund? Probably not.