VentureBeat

Out of all the tech sectors in the Bay Area, relatively more web companies that raised funding last quarter also saw their valuations rise, according to data analyzed by technology-focused law firm Fenwick & West. Cleantech companies that received backing came in second in terms of obtaining higher valuations, while life science and enterprise startups averaged smaller valuation increases. Overall, of 108 companies surveyed in the region, 68 percent of the companies that raised funds saw their valuations go up, with 19 percent staying flat and 13 percent falling.

Hopefully, this data is a sign of these web companies’ ability to make money as they mature — not just investors’ increasing desire to get a piece of them. Venture firms themselves have been busy raising more money lately, and other reports show more money going to later-stage companies, than earlier-stage ones.

Meanwhile, the initial public offering market is near-dead, as many IPO-worthy companies wait for better general market conditions (and maybe less regulation?) before trading in their private status. The total amount invested dropped nationally last quarter. So did returns on past investments, although those returns still beat the public stock markets.

[Image via etech-group.]

Private companies in Silicon Valley that raise venture capital are getting great deals.

When investors inject money into a company, they set a dollar value on it, to determine what portion of the company’s shares they get in return for their cash.

Bay Area companies funded during the quarter saw an average 74 percent increase in the value of their shares, when compared to their most recent funding around, according to a survey by law firm Fenwick & West of 126 technology and life science companies headquartered in the Silicon Valley region.

It was the second largest increase since the survey six years ago, exceeded only by a 75 percent increase in the first quarter of the year. The survey measured the change in share price during the round. Web 2.0 companies are especially hot. Of 12 financings where the stock price was more than three-fold higher, seven were Web 2.0 or related fields, said Barry Kramer, a partner at the firm.

So-called “up rounds,” or financing deals where the price per share is valued at a higher level when compared the prior round, exceeded down rounds for the 14th consecutive quarter. Up rounds exceeded down rounds 81 percent to 11 percents, a ratio that ties with the first quarter of 2007 for the highest ratio since the survey began.

[Disclosure: Fenwick & West is a sponsor of VentureBeat]

[Editor's note: Ted Wang is an attorney at Silicon Valley law firm Fenwick & West. Disclosure: VentureBeat is a client of Fenwick's, though does not have a relationship with Ted.]

The release of our firm’s Trends in Terms of Venture Financings shows that this remains a strong market for entrepreneurs to raise venture capital. The survey finds that valuations have continued to increase, while some tough terms negotiated by venture capitalists such as multiple liquidation preference and “ratchet” anti-dilution remain comparatively rare.

There is, however, a danger that the current climate is encouraging entrepreneurs to go too far. We are increasingly hearing requests for odd-ball terms such as very short vesting schedules (2 years?!) and founders’ protective provisions that recall the heady days of the Bubble.

In my opinion founders should resist the temptation to think outside the box with respect to the terms in their founders’ agreements and financing documents. Obviously, valuation and liquidation preference are key areas of negotiation, but for other areas I am a strong believer in plain “vanilla” terms.

If the market is good, why shouldn’t founders get the best terms that they can? My rationale is as follows:

• Standard venture financing terms represent a compromise between investors and entrepreneurs that is informed by years of experience.

• Developing and negotiating unusual terms is a waste of a company’s two most precious resources, time and money. Unique terms are highly unlikely to provide any return on investment and are certainly not correlated to the potential success of the enterprise.

• With respect to founders’ vesting, the people who build the company are the most likely to be the ones who lose out with “creative” vesting schedules. Most founders think about how to protect themselves from being ejected by VCs, however, the vast majority of the time, it’s the founders who get rid of one another when someone is behaving badly or not pulling his or her weight. With aggressive vesting, this can result in an ex-founder owning a huge chunk of stock, while the remaining founders work like dogs to make it valuable.

Someone out in the blogosphere has surely already begun typing, “Fenwick represents Kleiner, Sequoia and others and you’re just a shill for the VCs. Founders should get what they can, when they can!”

In response, I note first that the vast majority of my clients are on the company (as opposed to the VC) side. Second, and far more importantly, this is the same advice I give to my company clients. It may seem counterintuitve not to push for the “best” terms, but in my experience the marginal value of improved terms is not worth the investment in time and effort required to incur such gains.

This is an excellent time to form a start-up and raise venture capital. Use standard vesting, get a good valuation with a low liquidation preference and spend your time and effort building a great company.