Ockham Technologies, Equity, Boards, and related issues John Burr Ockham Technologies, Equity, Boards, and related issues

Ockham Technology – what happened? Board of Directors Raised first round from VCs (Noro-Moseley & Monarch), with each getting one seat on the board Added a 5th, very experienced industry person Development/outsourcing – Outsourced to ThoughtMill Also hired Gus as internal development team leader Founder tensions Tensions continued to grow, and worsened after Ockham hired a COO Mike left Company sold in 2002 to competitor

Splitting Founder’s Equity Lesson #1 Splitting Founder’s Equity

Considerations in Allocating Initial Ownership Potential Problem – Ockham founders split only based on amount of initial equity Other criteria to use: What cash, ideas, & property contributed? If property, what is value? What contributions are founders expected to make in the future? What opportunity costs will each founder incur? Career risk taken by each founder Financial demands faced by each founder May have to reserve ownership for future founders. Potential problem - split equity very early Splitting the ownership of the firm is one of the most difficult aspects of structuring the new business. It can be a very sensitive issue - but delaying it may prove disastrous. For example, what if a person contributed actively at the pre-incorporation stage, but is not longer an active part of the founding group. That person may reappear at the time of venture financing, where the firm’s value has escalated, and assert an ownership right. It is best to settle their claims at the incorporation stage, where valuation is low, rather than having to deal with them at the time when the company has increased in value. Founders should take into account any contribution to the business that they believe should be recognized, including those listed on this page. Finally, it is advised that each member of the founding team be represented by different attorneys. In practice, this is usually not done, but it may present a conflict of interest if not done.

Dynamic equity-splitting Person Initial share of equity Share if FULL-TIME involvement on 4/19/2000 Share if only PARTIAL involvement on 4/19/2000 Share if NO involvement on 4/19/2000 Ken 20% 10% - as per 2.1(b) 0% - as per 2.1(a) Jim 50% 50% - as per 2.1(a) Mike 30% 30% - as per 2.1(a) Generally, dynamic is better than static

Lesson #2 Building a Board

Boards and new ventures Texas angel – $10 mm, 50% stake (“Dumb” money) VC - $2 mm, 33% stake (“Smart” money) Does VC create $48 mm in value? ($8mm / 16.7%) Advice & Resources to build pie Control & Ownership

The Benefits of Having an Independent Board Brings perspective and experience, and a set of complementary skills for the CEO Recognize the need for long-term planning and assist in long-range strategies Can provide a framework for control and discipline and give CEO someone to answer to Can be challenging and objective critics, serving as an internal check for CEO Can be mentor or coach Can lend credibility Source: Bagley, CE & Dauch, CE. The Entrepreneur’s Guide to Business Law, West Publishing.

The Size of the Board 5-9 people Small enough to be accountable and to act as a deliberate body, but large enough to carry out the necessary responsibilities. Outsiders should outnumber the insiders Usually, no more than 2 insiders on the board. Source: Bagley, CE & Dauch, CE. The Entrepreneur’s Guide to Business Law, West Publishing.

Type of Representation Needed on Board Need functional skills needed to keep the business running smoothly and to bring business to next level of growth Need right mix of personalities Should inventory the resource needs of the company before you begin recruiting the board: What is the competitive advantage of the company? What will be the demands on the company and the likely changes in the next few years? How much technical expertise is needed to understand the company’s practices? What role does marketing play? R&D? Customer service? What is the company’s access to financing? Source: Bagley, CE & Dauch, CE. The Entrepreneur’s Guide to Business Law, West Publishing.

Type of Representation Needed – The needed skills Assess management team’s strengths and weaknesses with regard to industry experience, financial expertise, marketing experience, start-up experience, and technical know-how, maybe international experience. Age, gender and cultural background Be wary of filling board with: People whose interests may not be aligned with the company’s, or to whom the company already has access. Attorney Subordinates to CEO Consultants Source: Bagley, CE & Dauch, CE. The Entrepreneur’s Guide to Business Law, West Publishing.

Outsourcing & New Ventures Lesson #3 Outsourcing & New Ventures

Reasons new ventures outsource At early stages, founders are stretched too far Founding team may lack relevant capabilities Working on tight deadlines Adds flexibility when when a company is still experimenting with its business model Negative: May lack a level of control for critical function

Social capital & Entrepreneurship Lesson # 4 Social capital & Entrepreneurship

Entrepreneurship exists precisely because people do not have equal information or beliefs - Kirzner (1973) If a resource owner held the same beliefs and information as an entrepreneur, she would adjust the price to the point where the entrepreneurial profit would be eliminated.

seeking capital or other resources Problem Domain: seeking capital or other resources Dilemma 2: Entrepreneur can engage in opportunistic behavior Dilemma 1: Entrepreneurs are reluctant to fully disclose idea A MARKET FOR LEMONS

What did Ockham do to signal qualilty?

Sample of over 64,000 Swedish males followed between 1994-2001. Folta, T.B.; Delmar, F.; Wennberg, K. 2010. Hybrid Entrepreneurship. Management Science.

Folta, T. B. ; Delmar, F. ; Wennberg, K. 2010. Hybrid Entrepreneurship Folta, T.B.; Delmar, F.; Wennberg, K. 2010. Hybrid Entrepreneurship. Management Science.

SOLUTIONS TO THE LEMON’S PROBLEM Incentives Staging of capital Allocation of contractual rights – VCs use convertible securities and covenants to delay the entrepreneur’s compensation until the outcome of the venture is revealed Staged investments provide VC the right to abandon if negative information about the entrepreneur or venture is revealed Entrepreneurs face forfeiture provisions that require them to lose shares if they have below-target performance, and punitive dilution rates, which protect the investor’s investment if the venture underperforms. It would be foolish to accept these terms if they were not truly confident in their own abilities and deeply committed. Social Capital Due Diligence

SOLUTIONS TO A SECOND PROBLEM – EX POST MONITORING Board of Directors Keys to subsequent capital Social Capital

Social ties “interject expectations of trust and reciprocity into the economic exchange that, in turn, activate a cooperative logic of exchange. This logic promotes the transfer of private information and resources … and motivates [both parties] to search for integrative rather than zero-sum outcomes.” Uzzi and Gillespie (1999: 33)

Reputation Information Networks What is Social Capital? Personal Ties Referrals