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How times have changed for the lawyers who advise high-tech companies. Just a year ago, irrational exuberance ruled the day, the Nasdaq was soaring to record highs and initial public offerings doubled and tripled on their first day of trading so frequently it was almost boring. Venture capitalists, banking on quick payoffs, could not throw money at entrepreneurs fast enough. Practically any two-guys-in-a-garage.com could get funded. Lawyers with high-tech practices thrived, their plates piled high with dozens of venture capital financings, IPOs and mergers and acquisitions. Today, plates are still full, but the fare is different. The number of venture financings has gone down, but the ones that are getting done take longer and are more complex. Mergers are happening too, but for different reasons. The IPO is the only item that is no longer on the menu, at least for now. Whatever strategies high-tech companies are now pursuing, lawyers are finding themselves much more involved in their clients’ business. PROFIT MANTRA It used to be that a venture financing was a quick and painless procedure. Those days are gone. Venture capitalists now want business plans with realistic profit potential. They conduct due diligence. They take a tough stance on valuation and risk protection. So although fewer deals are happening, the time and effort lawyers must spend per deal has gone up. Mark L. Mandel, a partner at the New York office of Brobeck, Phleger & Harrison LLP, explained the shift in perspective: “The mantra of a year ago was revenue.” The emphasis was on capturing market share, or “ramping revenue,” through cash-intensive marketing campaigns. He added that especially in the business-to-consumer – or B2C – sector, all bets were on the brand name. “If you build it, they will come” was the thinking, and profitability was far off in the horizon, if contemplated at all, he said. “Today the mantra is profits,” Mandel said. Venture capitalists typically want the company to be profitable within three or four quarters. At the very outside, Mendel said, he has seen a few deals with emerging technology companies that had a profitability time line of seven quarters, or 21 months. Terms attached to venture funds are also much more harsh. Where they used to be satisfied with a liquidation preference of one or one and a half times investment, venture capitalists now are demanding up to six times their investment in the event the company is sold or goes public. And having learned, or remembered, that companies can actually stumble and fall, venture funders have also become less willing to share the risk of that fall. Where they decide that the forecast is bleak, venture investors are pressuring even solvent companies to shut down or merge with the aim of salvaging their investments. Another hard-nosed tactic venture capitalists have adopted is the “full ratchet” anti-dilution provision. This means that if the company seeks additional financing at a lower valuation — a so-called “down round” — earlier investors’ stock holdings are revalued at the lower price, increasing the investors’ ownership in the company. A full-ratchet provision can make it very hard for a company to get more financing, explained James E. Abbott, a partner at Carter, Ledyard & Milburn. It forces the company to go back to the original venture capitalists to ask them either to waive the full-ratchet provision or agree to a bottom limit. “Such deals are always more difficult,” he said, “because you have three parties at the table, all of whom have their own agenda.” The time frame for private financing has also lengthened. Back when market share was king, the mind-set was all about getting out there as fast as possible. Deals would go through in a month, Abbott said. One deal he remembers actually went through in just a week. Venture capitalists did not mind, he explained, because they could expect to recoup their investment when the company went public, which was happening very quickly, often within a year. But with IPO activity virtually nonexistent, that exit is no longer an option. Venture capitalists, in for a longer haul, are taking their time before taking the plunge. They are conducting due diligence, reviewing documents and negotiating terms with much more care and attention. GRIM ALTERNATIVES As tough as it has become for the companies getting private financing, the picture is even grimmer for those who cannot get any financing at all. Although venture capitalists still have plenty of funds, they are concentrating on funding companies already in their portfolio, said Thomas H. Kennedy, national coordinator of the technology practice at Skadden, Arps, Slate, Meagher & Flom LLP. And their industry focus has narrowed as well: They have pulled up their drift nets and switched to line fishing, as one lawyer put it. This has left many entrepreneurs, especially those in the disfavored sectors of “content providers,” B2C, and business-to-business, or B2B, out in the cold. Such companies have three alternatives, Kennedy said. They can merge, go out of business, or hibernate, toughing it out by cutting costs and keeping their core business going, he explained. In the flush times of 1999 and early 2000, mergers were a popular way to expand market share or move into other sectors — “growth M&A,” as Brobeck’s Mandel described it. Mergers were typified by “huge companies with enormous market caps buying other huge companies with enormous market caps,” he said. Today’s merger mentality is “mate or die.” Mergers now are defensive, Mandel said. Companies are seeing their segments getting hit, and realize there are only going to be a few survivors, he said. A merger can still be a good deal for some companies, even if it is the lesser of two evils. As an example, Carter Ledyard’s Abbott cited the recent merger of SeraNova, a Web consulting firm, with Silverline Technologies Ltd., a software services provider. Since going public last July, SeraNova’s business has done very well, Abbott said. But its stock had been dragged down with everyone else in the Web consulting business and the company was finding it hard to raise money. The merger with Silverline, Abbott explained, solves SeraNova’s cash flow problems, as well as concerns over some stock it had issued under less-than-ideal terms. Whatever strategy high-tech companies are pursuing to stay afloat, their lawyers are finding themselves more in the thick of things than they used to be. Before the Internet craze, companies expected much less of their deal lawyers, said Michael A. King, head of the emerging companies and venture capital practice at Weil, Gotshal & Manges LLP. “It was, ‘How are we going to structure this deal and when can we have the documents?’” he said. A DIFFERENT VIE Today’s entrepreneur has a different view of his lawyer. “We are like one of the principle advisors, always at their elbow,” King said. Not only will a lawyer advise his client on how much money to raise and which venture capitalists to approach, but he will broker the match and oversee the follow-up as well, he explained. “We’re involved in strategy from beginning to end,” King said. Enhanced role aside, lawyers claim that there is little concern in the profession that they will take the heat for failed dot-bombs. As one lawyer explained, when an entire sector crashes, it is harder to argue that it is the fault of any one player. Is there a light at the end of the tunnel? Everyone seems to agree that the Internet bubble has burst for good. “Use whatever word you want — it’s over,” one lawyer said. Indeed, IPOs are close to nonexistent this year. So far only seven IPOs have gone through, and none in high-tech, according to Daniel McCarthy, a market analyst with IPO.com. In comparison, by mid-February of last year, the number of IPOs had already topped 50. And the number of withdrawn IPOs in 2001 is more than quadruple the number that have gone through. But there is cause for hope. Brobeck’s Mandel said that his office has “several IPOs in the pipeline,” a sign that the market may be on the upswing. Even before the IPO window opens up again, Abbott predicted that the venture market will. Right now, the venture capitalists are a little shell-shocked, he said. But they have the money and are working hard to clean up their portfolios. “Once one or two of the more visible venture capitalists wade back in, the others will say it’s open season,” he said.

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