Sacha Ross of Wilson Sonsini Goodrich & Rosati catches up with GrowthCap on current deal term trends and structuring considerations for growth equity investments.
RJ: Sacha, thanks so much for joining us. Maybe we could kick off with some background on yourself and the types of clients you work with.
Sacha: Sure thing. I grew up on the East Coast and went to college at Cornell. After graduating from Cornell I had an opportunity to earn an MBA at night while working at Deloitte & Touche. Following that, I wanted to pursue my true passion —to be a lawyer and help grow companies and solve problems. So, I went back to Cornell for law school. After law school, I went out to Silicon Valley in the late ‘90s—which was a very interesting time, as you might imagine—and started my career at Wilson Sonsini Goodrich & Rosati in Palo Alto and had the chance to work with some incredibly exciting and transformative companies. Wilson Sonsini was an exciting place to work; back then, as it is today, the firm was at the center of every big technology transaction. It was truly the center of the universe for technology.
RJ: I certainly saw that when I was working at Roberts & Stephens back in the early 2000’s; Wilson Sonsini was the law firm we most frequently encountered.
Sacha: Yes, working with tech companies has always been our model. We’ll work with enterprises ranging in size from two people with an idea to a massive multi-national corporation. Our focus is on those high-growth and technology companies, and on adding value—the appropriate amount of value—at every stage. As you can imagine, the solution for a late-stage, multi-national, hundred-billion-dollar enterprise may not be the same solution for a two-person start-up that’s focused on how to get off the ground. Ultimately, there’s an art to it, as opposed to a science, which I think plays into a lot of the issues that you often see in financings.
After practicing at Wilson Sonsini in the Valley, I left in 2005 for a start-up. I helped the start-upgrow, raise money, and build up a team, but pretty quickly realized that I actually loved the job I’d had, working with a wide range of companies like this as outside counsel. So, I returned to Wilson Sonsini in New York in 2008. I’ve been practicing out here since then, advising technology firms on how to grow, and once they’ve grown, on how to buy, sell, and exit.
RJ: So you work across the spectrum in terms of company size, I imagine your clients can require a wide range of expertise.
Sacha: Exactly. I’ve had a lot of experience with all stages of companies. Of course, as a company gets bigger and bigger, I’ll involve more and more of my partners as appropriate so that clients can benefit from world class expertise. For example, if there’s a privacy issue, I’ll bring in one of our privacy partners, and if there’s a complex licensing issue, I’ll bring in what we call one of our technology transactions partners so that the company is getting the benefit of a market leader in terms of expertise and experience in a lot of cutting-edge areas or the laws that technology companies have to deal with.
RJ: Given that you’ve worked in Silicon Valley then in New York, do you see much of a difference in terms of investment style and structure when dealing with investment firms from the different coasts?
Sacha: Great question. If you would have asked me in 2001, I would have given you one answer, but today I’m going to give you a very different answer. I think you have to look at it historically to really get to the right answer. Historically, the West Coast firms were all about creating wealth quickly and repeating the process, while at the same time trying in some degree to limit downside. Back in the day, many of the East Coast investors—and there are notable exceptions—had much more of a “I need to both create wealth and really protect my downside” approach. As technology has evolved and as New York has evolved into the No. 2 tech market, what I see, at least in terms of approach, from the traditional venture investors is very similar. Certainly if you look at all of the data, you will see differences in valuation, but if you look at term sheet differences at a macro level, there are not the major differences you saw pre-bubble. Today, I think New York and California VCs generally have a very similar approach, and a lot of that is driven by a change in mindset of the NY VCs led by some real innovators combined with the influx of the California VCs and the great brands that have opened up offices here in New York.
RJ: Switching over to a different type of investor altogether, family offices, many of whom are part of GrowthCap’s readership, how frequently do you encounter them in your deals? Do you typically find they are up to speed on investment terms in the private capital universe, or is there an education process you take them through?
Sacha: Especially over the past three years, we are seeing more and more family offices, and that’s been driven by a couple of factors. Number one, I think there is the impression from founders that they can go get better valuations or create better bidding tension by creating a round led by family offices. I say that’s an “impression” because I think that’s true of some family offices, but it’s not true of others. And in fact, it can be quite the opposite. The second piece is that rounds are getting bigger and bigger, so you’re seeing more and more people participating in them. You’re also seeing a convergence of the type of investments that family offices made in the 1980’s and ’90’s. They are much more driven by numbers and metrics, and today you’re seeing those family offices make investments in technology because a lot of these technology companies have true metrics that they can invest in.
RJ: That’s a great insight, there are more technology companies today that you can vet using a fundamental business mindset. And from your take, do you think in light of the multi-billion dollar valuations that we’re seeing applied to “Unicorns” that we’re in a bubble and the hype going to the Ubers of the world is spreading around to other early stage companies?
Sacha: There are certainly world class investors who think so. I am not sure “bubble” is the right word – to me that means when it pops, there’s nothing there. While valuations may be high, at their core these are still fundamentally real businesses that underlie these valuations. They may not exactly tie in a revenue or EBITDA multiple way, but ultimately, they are real companies. However, that’s not to say that I don’t think there are Unicorns out there that can and will fail. This is a rapidly changing space, and companies need to execute. If they don’t execute, whether their valuation starts with a “B” or an “M,” they will fail or they won’t have as high of a valuation.
RJ: And on the note of potential investments not turning out as anticipated, what are some of the structural elements that you find folks spending time on when it comes to term sheet negotiations, whether that’s downside protection or other areas? What do you typically find are the hot button issues?
Sacha: The biggest hot button issue in any deal, especially in the venture space where you may have growth capital and venture both competing for that investment, is always valuation. From valuation flows a relatively straightforward allocation of risk and return between the parties. Essentially, what we would commonly see is a 1X preference, probably non-participating for the most part, and to a lesser degree participating up to some type of cap. As a firm, we actually release data in our quarterly Entrepreneurs Report that some of your readers may find interesting. In terms of other key terms, we don’t see redemption that often; it’s seen as somewhat of a naked right and not really worth a lot of negotiation. Cumulative dividends aren’t typically found, although there are certainly examples. You can always see where there’s a valuation gap between investors and a founder when you see a lot of very unusual waterfalls and liquidation preferences, liquidation preference multiples, etc., which wouldn’t necessarily seem unusual to a family office. The key is real agreement on valuation. Rounds should be focused on a straightforward cap table so that investors, founders, and employee incentives are all clearly aligned at driving toward a large exit, be it an IPO or a sale of the business.
One important distinction on the terms that I would add is that family offices are more likely to run into control issues than traditional venture capitalists. There’s a myriad of control issues, but two are key in any venture deal. First, does the investor have a block on a future financing? Second, does the investor have a block on the sale of the business? Generally, in technology and venture deals, people will get comfortable with that notion because venture capitalists have the reputation in the marketplace as facilitating deals and sales and not as serving as a gating item to such transactions. Frankly, many family offices have that reputation as well, but an unknown family office or an unknown wealthy individual maybe swimming upstream on terms like that.
RJ: So the trend now is removing those types of rights for investors?
Sacha: Not for venture. Not for venture or people where you know how they will behave, but potentially for investors where you do not necessarily know how they will behave in a situation involving a high-growth tech company. There are plenty of family offices that have a great reputation for investing in tech, and it’s not going to be an issue for them. For those where it’s their first, sure, it may be.
RJ: Is there anything else I might be leaving out or do you think we’ve covered it?
Sacha: I think we’ve covered it. I t’s an interesting time and there are a lot of really smart people—and frankly, very sophisticated people—at family offices who, when faced with the venture set of documents, may say, “Well, these don’t really work.” And part of venture investing is valuing the art over the science, and seeing the art repeated over and over is a useful exercise for many.
RJ: My take away from this conversation was it’s not always a one size fits all. Frequently, at least in the negotiations I’ve been a part of, someone will inevitably make the comment, “Oh, well that’s not market,” which may or may not be the case, but each deal is different so context has to come into play and the experience of the investor and anticipating how they would act.
Sacha: That’s absolutely right. In a lot of ways, what’s market makes a great deal of sense, but if anyone were to take a fine-tipped pencil to all of the standard terms that you might see in a tech investment, some would make sense and some wouldn’t, so it’s not a truly scientific approach. It’s much more of an art of “if I have the important things that I care about, can I make the rest of this investment work?” It’s that art combined with the “how can I quickly generate and create wealth while limiting risk to a reasonable degree” approach that contributes to getting these deals right.
RJ: Again, I really appreciate the time. I think a lot of folks will find this additional detail regarding the structuring side of the deal business very informative.
Sacha: Great. Thanks, RJ.