Is the average taxpayer subsidizing those wonderfully, successful Silicon Valley companies much too much?


GPS Satellite

GPS Satellite

The typical Silicon Valley company has attached itself to the coattails of taxpayers or older established companies, all in the name of disruptive technologies.  Without these tax incentives, would these companies be so valuable, or, worst, ever get off the ground?

Let’s look at Uber and AirBnB.  Both companies rely heavily on geolocation.  Geolocation comes predominantly from the GPS signals from orbiting satellites and, secondarily, from the wireless radio towers. What are the costs related to GPS?  The DoD, originally tasked to place these satellites, spent over $12 billion.  There are 24 satellites orbiting the Earth at the distance of 11,000 miles. Mount Everest, as a comparison, only measures over 5 miles tall.  And these satellites lie on fixed orbital paths. With the $12 billion as the original investment, the U.S. government spends over US$500 million annually to maintain those birds. The annual GPS maintenance costs charged to Uber ($66 billion valuation 2016) or AirBnB ($30 billion valuation 2016) are zero.  Meanwhile, the average taxpayer foots that annual bill.

Let us be more accurate.  The GPS signal is just part of the process for geolocation.  To get better accuracy, one needs the telecom radio towers transmissions. The average radio tower costs anywhere from $250K to almost a $1 million (depending on capacity).  Sprint, a smaller carrier, operates over 70,000 towers without which smart cell phones would not function.  By taking the media cost for a tower times the total numbers, Sprint has invested over $3.5 billion.

What the costs to Uber and AirBnB?  Again, zero. The carriers allow these companies to access the geopositional data through APIs. The software companies overlay that data over their own digital maps and use the data derived from both GPS and towers to pinpoint positions.  What seems peculiar to the average analyst is how AirBnB and Uber can be valued as high or even higher than the companies that invested in satellites and towers, which require substantially more employees and engineers to manage than software apps.

Let us not stop here: Tesla.  Tesla/Solar City also derives additional tax subsidies to the tune of over $4.9 billion dollars.  The results are interesting: Tesla electric cars are priced beyond the average consumer,-  whose taxes fueled Musk’s companies. Meanwhile, Tusk’s personal wealth increased to over $10 billion through these companies.  How? every car he sells has tax incentives to the tune of $7.5 federal and state related credits (California).  His manufacturing facilities also obtained state and local subsidies.

We should also bring net neutrality in this conversation.  The fact of the matter net neutrality suggests that any Internet company pays the same to access the internet as any individual.  It means that any company can send billions of emails without incurring additional costs.  Another way of looking at it in terms of a company mailing envelopes through the post office.  Traditional companies spend so many cents for each envelope it mails; the more mail, the higher the bills.  Not so for technology companies sending out emails. Yet those emails must be transmitted through traditional fiber optic cables costing billions. Sea-Me-We III, a submarine cable originating in Asia and ending in Europe, cost over $1.5 billion to build. Across the Atlantic, the submarine cable costs over $600 million.  And maintenance is anywhere from $25k to $50k a day.  The average cost to an Internet company? Pennies, if at all.

We all hear about the great, disruptive technologies from these companies. And the wealth that these founders have accrued.  In fact, the Google co-founder, Sergey, has enough money to buy out half of his local town, Los Altos, California.  All these technology companies have surged the average cost for housing in California to over $500k.  And, still, the average taxpayer doesn’t benefit.

Another point of view is to see what happens when subsidies die. In the case of Hong Kong, the government ceased providing tax subsidies this year for electric cars. The result—no electric car sales. Another example is telecom infrastructure.  Google complained about the lack of fiber optic development in the U.S. by telecom carriers. Google thought it could do better than Verizon’s 170,000 employees (Google has over 40,000).  So it decided to deploy terrestrial fiber, appropriately named, Google Fiber, in a Kansas town. The result? Yes, the fiber was fast and speedy. But it stopped deploying beyond two to three towns in Kansas. (Imagine if Google were in charge in deploying fiber optic networks nationwide, if none existed, what would have happened.) When renamed Alphabet, Google has decided to sell off that fiber optic network. It, therefore, demonstrated that it was more profitable to run its business with net neutrality. Even recently, the Chinese government has refused to share the GPS signaling to the “Uber” industries in China.  (We can safely assume that the Chinese military has a budget that it wishes not to share with the private sector.) I guess that this scenario suggests that DiDi and other car tech companies would have to shoot its own satellites costing billions?

These events confirm one thing: net neutrality, tax subsidies, and incentives have all supported much of Silicon Valley’s economic success at the expense of taxpayers, not by some crazy, disruptive technologies where few benefit economically.  https://jrzarco2001.wordpress.com/2016/09/25/does-technology-wealth-trickle-down-to-others/

Posted in Capital and Management, Management and Capital, Strategy, Technology, Valuation | 3 Comments

What do Silicon Valley and the Italian dish, Pasta Carbonara, have in Common?


CarbonaraA seasoned SV entrepreneur and his younger colleague invited me to an Italian lunch in downtown San Miguel, California.  As a preliminary introduction, he mentioned he had met Steven Jobs on one opportunity. He then ordered a well-known dish, Pasta Carbonara.  The waiter brought his dish, and, strangely, 2 fried eggs (?) lied on top of the pasta. It occurred to me that, because many kitchens are staffed by Mexican-Americans in California, the cook looked up the recipe online and assumed incorrectly that the eggs were fried rather than mixed raw properly with freshly cooked pasta as an adhesive for the other ingredients.  This entrepreneur did not know the difference. That wrongly cooked dish sums up and is a metaphor on how startups operate in SV. https://jrzarco2001.wordpress.com/2017/07/02/the-barbarians-are-at-the-gates-in-silicon-valley/

As an example, at a Menlo Park event discussing board meetings for early stage technology companies, I bumped into a “founder” afterwards. He related to me that he ran his board meetings with yellow and red flash cards, similar to soccer warning cards, so that board members can elect to speak or vote on particular matters.  That way meetings would be held in a structured form. I pointed out that every board meeting I have held, as well as at publicly traded companies, applies the Robert’s Rules of Order formula, over 100 years old, to run board meetings.  He never heard of the Robert’s Rules of Order!  Why reinvent the wheel with some clumsy flash cards?  Board meetings are not soccer games.  And the “Rules of Order” covers every eventuality during a formal meeting.

Again and again, SV marches along its own rhythm with its own rules. Software engineers assume that everyone else in any other capacity is of marginal importance. They assume that the problem-solving tools for software engineering can apply to governance, medical technologies, etc. Wrong! Every managerial environment runs within its own structure (“structuralism”), mostly established by tradition or by local regulations. https://jrzarco2001.wordpress.com/2016/03/12/hiring-international-managers-what-to-avoid-what-to-look-for/  Ignorance is not an excuse.

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The Barbarians are at the Gates in Silicon Valley


greatwall

Various newscasts are assailing the fairy tale stories and Ivory Towers that originate from Silicon Valley.  As one of the largest gorillas in technology, Google has been slapped with a US$2.7 billion fine for anti-trust violations. The other technology gorilla, Facebook , faces similar penalties when Germany imposes fines in the millions whenever Facebook publishes anything that remotely resembles hate speech.  And I am sure that restriction will be broadened to malicious content. Even the VCs are being attacked. Various women entrepreneurs have come forward about sexual harassment while seeking funding throughout Silicon Valley.  VCs such as 500 startups have had their co-founders resign. With these claims, they will all face hundreds of thousands of dollars in legal fees and millions of dollars in settlements.  And Uber has as its crowning achievement of having disparate legal claims against it – from regulatory in its operations to sexual harassment.  The question will be whether Silicon Valley will adjust its hubris and reconsider its consistent mantra that disruptive technology has no boundaries.  Or will they fail to learn their lesson and continue their path to many legal minefields?

In my previous blog, I related that Google, in spite of its General Counsel’s unmerited confidence in administrative success during the antitrust proceeding, would face a fine by the EU. https://jrzarco2001.wordpress.com/2015/08/29/google-anti-trust-european-community-law-international/ European antitrust law treats market dominance as being illegal per se.  Obviously, Google and its General Counsel failed to notice that. Instead, they assumed that what applies in the U.S.A. will work in Europe. Not a chance. The bottom line cost for its legal misstep: over $2.7 billion.  The EU rules and regulations, the only good, positive light for Google, have limits on much a company can be fined. Otherwise, its fines would have been substantially higher. Now its senior management team has to huddle during the July 4th weekend to determine the next steps to oblige the European government. And, it will not be surprising that similar antitrust legal assaults will originate from other countries, including the United States.

What about the other elephant, Facebook? In another blog, I also criticized how social media makes billions, displaces legacy newspapers, and never holds itself accountable for tortious abuses within its peer to peer platform. https://jrzarco2001.wordpress.com/2017/05/05/the-dilemma-facing-internet-content-platforms/  The German government has concluded the same: the Facebook platform must regulate its own content.  And it should be held accountable for negligence in doing so. One thing to note about the German regulations – finite time periods.  German culture is such that Facebook must abide within that timeline or face the consequences.  Don’t expect the German government to hand out a “Get out of Jail” card. Notwithstanding that, I can only see another Facebook shortfall.  Facebook claims that it will develop AI to filter unwanted content and hire additional reviewers, about an additional 3,500.  And find that malicious content within its 2 billion users.

Will that work? The Economist and the Chinese are doubtful.  The average Chinese content provider, operating with very strict governmental enforcement policies, hires over 100,000 reviewers while applying some AI to handle a population of 1 billion users to screen its content.  I, myself, have done considerable due diligence to be able to identify software capable of screening multimedia content without metadata. MITRE has also researched this area ad infinitum for the federal government and could only screen metadata and subtitles in the long run. What can Facebook accomplish in several months with 7,500 reviewers that both the Chinese and MITRE cannot? I am betting that dog won’t hunt. The truth has more direct, financial impact: hiring 100,000 reviewers will severely reduce Facebook’s profit margins.  So now Facebook’s dilemma is hiring the necessary resources or pay the fines, just as I surmised in my earlier blog.

Now comes the fun part, the Silicon Valley investors.  Several female entrepreneurs now have accused various investors of sexual harassment. In 2015, one case made the local tabloids where the woman lost at trial, Ellen Pao vs. Kleiner Perkins, against one of the larger firms in SV.  Now, with various accusations coming forward, we all wonder whether Pao’s legal loss was the fault of the quality of her lawyers, not from the actual events.  And we are all familiar with Uber’s situation. One female entrepreneur, Lisa Curtis, who underwent through some form of harassment, knows me personally. I recall that she was discouraged from discussing these acts without jeopardizing her fund-raising efforts. Therefore, SV male population has some growing up to do.

What seems to be the prevalent trend in SV is to ignore or flaunt rules and regulations domestically and internationally under the label of “disruptive technologies.”  Indeed, an early co-founder of Intel who developed the 8086 chip, a writer and journalist from Santa Clara, who flaunted the “creativity of Silicon Valley, and a technology PR senior manager invited me to lunch in Silicon Valley last year. The common theme during that lunch – scientists make great business managers (an attribution to Grove/Intel), and no other parts of the planet can create new technologies for the masses.

What we can conclude is this: in SV, one can startup a company unless you are a woman or over the age of thirty; SV is in the forefront of “every” disruptive technology and will control whatever market worldwide without regard to local regulations; SV can make public statements about its capabilities to screen content, however unrealistic or even false it might be.  Again, I always stated that the motivation here is not changing the world, but it is all about money and fat profit margins.  And it seems that the moneytrees, that is, the VC firms, in that NorCal region turn a blind eye to this behavior, unless the dirty laundry is exposed. I guess that, with their hands not so clean, when now accused of sexual harassment, they managed with loose reins their investments.  We will see how long will that continue.

 

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For 89 Bucks, anyone can be a Founder!


uber

When I relocated to Silicon Valley, I noted the usage of the ubiquitous sobriquet, “Founder”, next to the titles of CxOs for many startups.  Interestingly, anyone can register a C-corp for the total cost of $89 fee in the State of Delaware.  (By the way, it is cheaper in other states.)  With that action alone, one becomes a “founder”. But being a Silicon Valley founder can develop into a business leader?

I could never understand Silicon Valley’s obsession with the term, “founders,” almost as if that individual would be able to walk on water.  Start a company with 89 bucks, and that “founder” should be the sole manager of his/her vision to a very fruitful exit. Let that “founder” have absolute control over his/her company with the appropriate corporate, legal framework, where the founder’s shares represent multiple votes.  Those young founders should be given clear, loose reins like any infant coddled by a mother. One problem: these are not “children” and those toys are being bought with money from institutional investors, many of which are retirement funds. Being a founder does not equate to being a business leader. Many Silicon Valley founders, we are finding out, are petulant and selfish, others difficult, and some are merely aimless.

Of course, we should look at Uber, with one WSJ article comparing its management to the series, Game of Thrones – https://www.wsj.com/articles/uber-14-bosses-one-corporate-game-of-thrones-1497468304?mg=prod/accounts-wsj.  Frankly, I consider it apropos metaphor. Can we safely say that Travis Kalanick would be the “Ramsay Bolton” character, the ruthless leader who would execute whatever action to retain or seize his authority over his kingdom?   Bolton emphasized absolute control by removing any opponent who would block or interfere his leadership – including killing his father and half-brother.  He instilled fear. In his battles, he would release arrows to jeopardize the safety of his own soldiers, just to win. Yet, we know how the series terminated that character.  Fear and ruthlessness, as a mode of leadership, can only get you so far.

Therefore, “founder” does not equate to true leadership. Still, various leading SV commentators extol entrepreneurship and title, founder, as the only way to be successful in the business of technology. Having control is better than sharing leadership with employees. They conclude that ruthless founders should foster fast growing companies to return sizeable returns for its investors. One company, Theranos, raised an incredible $740 million, and its founder, Elizabeth Holmes, was profiled in many major business publications.  Uber capital raising efforts even surpassed that of Theranos by raising over a billion dollars. These commentators forget that control does not result in good and effective corporate management.

Leaders show compassion and empathy.  And that is what “Jon Snow” Game of Thrones character is about.  In the Game of Throne Series, Snow trains his own team better swordsmanship for them to survive.  In his battle against Bolton, he believed that Bolton’s selfish leadership would impact the motivation of his armed forces.  Snow believes that battles are won by encouragement and selfishness.  He is, unquestionably, a leader whom many would follow in any battle.

If Kalanick is the “Bolton” character, then Jamie Dimon, CEO of JP Morgan Chase, is the Stark family member, “Jon Snow.”   Why?  Dimon demonstrated his concerns about the lowest levels of his workforce by raising the minimum wage for the bank’s lowest ranking employees so that the lowest ranks have a decent standard of living.  http://fortune.com/2016/07/12/jamie-dimon-jpmorgan-employees-raise/. JPMorgan Chase employs over 234,000 employees and ranks as one of the best, profitable banks in the World.  Great business leaders generate the best long-term results for their organizations.

Contrast this Silicon Valley attitude when the Silicon Valley company, “Yelp”, discovered that a minimum waged employee complained in a blog about her low, minimum wage salary in one of the most expensive cities, San Francisco, where she barely made a living. Yelp’s response was to terminate her.  So much for compassion in Silicon Valley.  Or, in the case of Uber, one woman complained of sexual harassment, she was totally ignored and, consequently, she resigned.  Or people should remember the recorded video of Kalanick’s response to the Uber driver, an employee, who complained about his financial losses.  Or we can look at Theranos treatment of one employee, the grandson of one of the board members, spending over $200k to defend himself from Theranos’ ruthless attorneys, when he attempted to whistle blow the company’s ineffective technology.  His observations were later vindicated by the FDA.

Much of Silicon Valley’s behavior is attributed to the venture capitalists in the region. They invest in “founders” who will achieve growth at whatever it takes to get there. Whatever shortcuts needed. Even with mendacity. Paul Thiel, a well-known Silicon Valley investor, applies the “blitz-scale” approach to growth. Super speed to become number 1 priority in the industry in short-time frames. Maybe these guys should learn something from the Game of Thrones to see what appropriate management strategy achieves in the long run.

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The Dilemma Facing Internet Content Platforms


FB

In a recent NY Times April 2017 article on Facebook’s content dilemma, https://www.nytimes.com/2017/04/25/magazine/can-facebook-fix-its-own-worst-bug.html?_r=0, the author didn’t really hone in on what has led to this strange situation.  From day 1, newly established Internet companies always relied on one major component of their business models: let the users contribute the content at no incremental cost. As an example, Hotmail became a billion-dollar business that spent “0” dollars on marketing.  That is why Time Draper, of Draper Fisher & Jurvertson, always invested in these technology companies. Besides a few programmers and hardware engineers, this business model relied on the users to originate the content and the website was just the forum for that activity. Meanwhile, the founders reaped the financial benefits from a skeletal framework and the millions of eyeballs that monitored that content.

Many other Internet companies have pursued similar strategies. For example, ecommerce such as Amazon allows consumers, not by an employed expert in the industry such as Consumer Reports, to provide a five-star rating.  This rating system created a new approach for establishing ecommerce credibility by having the average consumer show his or her satisfaction or disappointment in a product.  Was there any cost to the Internet website for this system? No.  None awarded any personal contributor any compensation. In other websites, like Quora, the users, not experienced journalists or writers, originate their critical content. Contributors with putative experience or expertise add comments on a wide variety of subject matters.

Facebook became the social media icon by establishing sites that allowed users to contribute and collaborate.  Of course, the label being pasted on these sites as “peer” based.  As I see it, the reason behind this model: great profit margins. Virtually all Internet companies run a very profitable business staff with only programmers who support the software and infrastructure.  That is why their revenues per employee stand out among every other industry.

None bothered to monitor or even edit the content. Indeed many rely on the so-called Federal immunity laws for Internet hosts to avoid prosecutions from libel or any potential liability hosted in the networks. These companies let the users demonstrate traction. And they never bother to employ an “expert” in the field.  Even Theranos, the controversial healthtech company that raised over $740 million, believed that there was no need to employ a medical expert such as a doctor to evaluate the efficacy of their medical technology at their peril. It applied its own sense of review. That was their “business model.”

And with such great profit margins, these tech companies replicated their models internationally as if such 0’s and 1’s software can be reproduced anywhere and everywhere.  But can that future still valid for Internet media?

Contrast this profitable, peer contribution model against established companies. Retail stores such as Macys rely on thousands of salespeople. And apply standard consumer product ratings obtained from Consumer Reports or similar industry resources. Newspapers employ educated journalists, whose work is clearly vetted by senior editors.  For the NY Times, he/she must have certain credentials, one of which is holding a degree in journalism.  That written piece would be approved by senior editors.  Then these drafted articles are then scanned by attorneys prior to publication to avoid any libelous lawsuits.  All these quality controls don’t exist in the new Internet model.

Does Facebook or Reddit ever go that far? By looking at the cited NY Times photograph of Facebook’s content operations, that efficient model is eroding day-by-day, but not far enough. Facebook employs thousands of reviewers.  But are they journalists and fixing the content problems?  One Economist commentator is skeptical.  With 2 billion users, even several thousand reviewers, many of whom are not journalists, cannot screen the onslaught of content that fuels FB profitability.  That hiring only represents < than .000015% of FB users. Hiring a capable population of reviewers would definitely erode FB’s profit margins.

And what about their new approaches to screen content that supposedly incorporates A.I.?  Will it actually work?  I doubt it.  These companies employ college grads mostly with engineering degrees. Not qualified to the same journalism work expected at the NY Times.  And can the software screen for libel?  Can it differentiate a hallmark photo taken in the Vietnam war possibly the catalyst that brought down the war and former President Nixon and not treated that same picture as pornography? Can an image that might be passable in the U.S. not pass the prurient interest of an Asian culture?   I daresay I cannot foresee in my lifetime the development of a software algorithm that can successfully achieve that.

And notice the dilemma FB faces. The more personnel it employs, the margins will shrink. And this Internet freedom to publish anything is actually dangerous since there is no accountability. Anyone, who has access to a computer, can publish false content from any geographical location.  Whether it is true, or poorly written, etc., it doesn’t matter.  Then there is the geography dilemma – the Internet is borderless; languages and dialects and politics are not.

Internet Rating System Cost Structure INDUSTRY Operator Staffing Recurring Costs
Amazon 5 Star Choices US$0.0 Consumer Reports Salaried Experts Salaries, HR
Reddit Volunteer Contributors US$0.0 WSJ Professional Writers Salaries
Linkedin Contributors/Non-Confirmed content US$0.0 Michael Page Experienced Headhunters Salaries, Commissions

What about false content – fake newspaper stories?  Content juxtaposed against controversial imagery. And who are the final reviewers – masters of journalism?  Or recent college grads with backgrounds in technology?   And are there attorneys reviewing the content for libelous information? Of course not.   And the decision-making and youth based predilections are based upon of the average age of the hired staff The Internet content providers get a free “get of jail card” on any false and misleading content. Then they apply the so-called disruptor labels, or that they are legally free from ANY accountability to the veracity of whatever they published electronically.

One Internet provider once related to me that under the Internet regulations, no Internet provider is legally liable on how its content is used.  Nonetheless, that same Internet provider can make a fortune from false content.  And every Internet reader truly believes that the content originating from a brand name such as Facebook.

The irony for the hallmark content providers is that the technology industry, in its “technological” glory, wanted to control any content from any source worldwide. None ever worked in a newsroom or published a book – where legal restrictions applied.  Now Facebook has encountered a double edge sword in its conquest of social media with millions of downloads per hour with over 2 billion people. Yes, it has become a media behemoth.  Now FB finds it cannot control the very network content distributed worldwide. Zuckenberg claims that it will be able to vet the content with programming. Let me think: it must match the content with veracity and fact checking.  It must not be libelous.  It seems to suggest that Facebook is replicating with A.I. both the NY Times newsroom and the legal department. And even a greater hurdle will be the multiplicity of languages out there. But I have difficulty already in having a comprehensible translation of Hungarian into English. Imagine millions of content contributions every day.

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Why is Fred Wilson (USV) excoriating convertible notes and SAFEs that finance early stage companies?


Cuban CurrencyIn a recent blog, Fred Wilson concluded that early stage investors and founders would be better off being financed directly with equity in its early stages rather than through convertible notes or, the recent Silicon Valley hybrid, the SAFE. http://avc.com/2017/03/convertible-and-safe-notes/?utm_source=dlvr.it&utm_medium=twitter  Both instruments delay the transfer and value of equity until a later date.  True enough, debates about later stage dilutions and valuations arise. Rather someone has forgotten how notes, convertible notes, and equity play a role in risks, return, liquidation rights, and dilution.

First year business school finance paradigm states that the cost of capital is far less for debt as opposed to equity for shareholders.  Much of this makes sense: founders prefer to get capital without dilution.  Another incentive comes from investors, who are only looking for a decent return, know that debt is on the top of the food chain of liquidation rights.  (What this means is that if the company were in bankruptcy, the debt holders get preferential treatment over shareholders.  And more compelling is that all debt holders – from banks to other noteholders – can get a piece of the pie to be repaid.  And, if there is anything leftover, the shareholders receive the crumbs.)

Now, in terms of bank debt, I have witnessed that the financing institutions delve into substantial negotiations to establish the pecking liquidation order of the debt being issued. There can be as 4-5 tranches of debt instruments, each with different liquidation preferences.  Hence banking institutions are particularly sensitive to where they stand in the event of a company’s liquidation.

Then came the convertible note: it is a hybrid debt instrument that can be converted to equity. That gave the financier the option to protect himself during the early stages of the company and, if the company prospects look excellent, the note can be converted into equity at some predetermined value. But what is the value being criticized by Mr. Wilson. There can be so many hallmark events that can impact any equity’s valuation.  And sometimes the conversion is precipitated by the needs of the company based on the dilution aversion and financial status.

A year ago, an investor colleague made a convertible note investment for a Colorado company for about $50k.  I asked him why he did it and he stated the company promised an interest rate of 8%, an interest rate much higher than sitting idle in a savings account.  I commented that he could have achieved such returns with a far less risky investment in junk bonds – companies with track records. But investments in that area tend to be more complex and advanced for some investors. Rather, the Colorado company was an early stage startup with apparent, positive prospects in RFID technologies.  However, after a year, the company never reached the cash flow it projected and exhausted its capital through its operations. It decided to convert those notes into equity. From a quick glance at their financials, the company didn’t have the cash to pay back the noteholders after their notes reached maturity. In other words, it had no other option other than to convert the notes or renew them.

From its short history, this Colorado company needed the least expensive capital to sustain its operations. It marketed promissory notes, which could be converted into equity. When early stage companies cannot get bank loans, it peddles “paper”, namely, debt instruments. Even publicly traded companies seek debt financing through the markets as an alternative to issuing more stock – which would depress their value – or bank debt. (Today’s financial markets contain the level of sophistication to trade billions of dollars of notes, even junk bonds, to satisfy any investor’s appetite for risks and returns. I myself developed the creation of bank debt securitization with TD that churned about US$2 billion a month. So any type of debt market can be created overnight.)

What convertible notes offer is an upside to just receiving fixed/variable interest rates for capital. And like anything else that deals with equity, it has its risks – dilution, swings in valuations, and changes in liquidation rights. So, regardless of what Mr. Wilson feels, I don’t foresee substantial changes in how startups get financed.

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Why is IP valuable?


I recall inquiring a new client that essentially seem to be a software consulting firm whether it had IP (“intellectual property”) and whether it retained such IP when providing software consulting services to their clients.  Its CEO replied in the affirmative.  However, when I began to do my due diligence, I noted that the IP was non-existent.  Maybe there was a misunderstanding. Yet, not having IP severely impacts the valuation of this type of company, I concluded.

As I have related to someone else, if it is not “written somewhere”, it does not exist.  That is tvaluationrue for IP.  IP must be registered or secured somehow by notices or security. There are 2 major categories of IP  — that IP which is registered and notified as being protected through registration, and that IP that has notification but held as trade secret.

For the first category, we all know about patents. There are fairly well understood rules regarding patents that include vetting and registration.  In other words, if not properly registered, the IP is not protected. There is some form of notification, “patent pending”, to offer some notice of the process.  I certainly did not see any such notification from this client.

Then there are the registrations for trademarks and copyrights. The former has an approval process as well during registration, and, when in process, there is a form of notification on any mark. Copyrights can be filed and require notification by the ubiquitous “©” symbol.  Again, did I see any such marks or copyrights for this client, the answer is still negative.

Finally there is trade secret that has no registration.  Instead, any third party must be notified on every document or page, that the information or formula is protected.  Every page must warn through the appropriate label the viewer of its protected claims. Otherwise there is no protection.  Again, nothing that the client demonstrated to me showed that protection.

With regard to this client, I knew that it developed software for the telecom industry.  I also noted that it had no registered trademarks, no patents pending, or even trade secrets.  Now, in this software industry, it is hard to argue “trade secret” to coding, since software codes are designed to bring certain results and, through minor modifications, codes can be rewritten and still bring about the same results.  Code alone is not protection. Since the results are not protected, that leaves little or no room to protect code.

Now, as GC, I have invariably received notices from outside counsels from potential investors to produce “any and all IP” held by the company.  Unless I have documentary proof of the IP, I would have considerable difficulty of delivering such IP requested through due diligence by outside counsel.  And, when I fail to produce such documentation, I immediately know that it would have an impact on the valuation of the company.

All of this analysis makes common sense. Now, going back to this client. Should the client re-evaluate its claims regarding IP?  The answer is affirmative. Can it then begin to buttress its IP portfolio?  And the answer is still affirmative. Look at Apple: it continuously files for patents, marks every year. It is not only a reflection of its innovation but also its acknowledgement that the innovation needs to be protected somehow.  IP creates not only branding; it increases barriers to entry for competitors.  Hence IP adds to the valuation of the firm. So every company’s CEO must be made aware that there is no avoidance in the very request about its IP portfolio and it must be produced upon request.  That is what that every client should know.

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