A New Entrant into the VC Ecosystem

Typically, when someone claims that they are pioneering a whole new business sector, they’re either exaggerating or lying outright. Not so with Paul Koenig and Mark Vogel, who seemingly are creating a new niche within the venture industry ecosystem — that of the shareholder representative.

It’s more interesting than it sounds. Here’s how what they’re doing works: When a startup is sold in a private M&A transaction, someone involved in the company — sometimes the CFO, often a venture capitalist board member — has to step up and represent all of the startup’s shareholders after the deal has closed. It’s not a symbolic gesture. Contrary to popular imagination, there are often years of work to be done following an acquisition, including monitoring an escrow account if there’s an earn-out provision, handling any claims that might arise, and dealing with purchase price adjustments.

It’s a thankless job, but because buyers naturally don’t want to grapple with every last shareholder of a startup, the onus always falls on one person’s shoulders. Or did until a year ago, when Vogel, a serial entrepreneur, and Koenig, a trained attorney, opened Shareholder Representative Services in San Francisco. Since then, more than 50 institutional investors, including Kleiner Perkins Caufield & Byers and Sequoia Capital, have paid the firm a flat fee to make their post M&A headaches disappear.

I talked with Vogel and Koenig today to learn more about their business.

So, why zero in on the piece of an M&A transaction that you have?

Koenig: I saw this repeatedly as an attorney working on these transactions. “The good news is that we’re ready to close and the bad news is that someone needs to volunteer.” No one wanted to turn down a $300 million deal, so someone always agreed to do it, but on more transactions than not, someone had to do it grudgingly, often the lead investment in the last round.

What are some of the more realistic complications that can arise after a deal is done?

Vogel: Let’s say that Microsoft acquires a company for $100 million. Typically, they won’t pay $100 million at closing. They’ll pay $80 million at closing and put $20 million in a bank account until they verify that everything they’ve been told is true, which can take years. In the meantime, if Microsoft feels like making a claim, they need someone to say, “we agree, you’re right” or “you’re wrong” and to take action.

Or say a seller thinks his company is worth $200 million, but the buyer agrees to pay just $50 million now and the rest based on achieving certain milestones. Shareholders need to monitor that situation closely to ensure that they get the true value from that future revenue stream.

But mundane paperwork, monitoring accounts and making sure there are no improper entries or bank mistakes, those are all things we also do to ensure that shareholders get every cent they are entitled to.

What’s some of the more inane stuff you’re dealing with?

Koenig: One hundred percent of the time, you have a handful of shareholders who can’t find stock their certificates, or who have many questions about when they’ll receive their money. It tends to be tedious, which is why most VCs don’t think it’s a good use of their time.

Vogel: Another thing is that under most of these agreements, things have to happen by particular dates or else claims are considered settled. If an indemnification claim is made and you don’t respond in 30 days, it’s deemed approved. You can lose an awful lot of money if you’re not on top of these things.

Let’s say I’m highly detail-oriented and exceedingly cash conscious. Is there another reason to hire you?

Koenig: Absolutely. We know a number of VCs who’ve been personally sued in their role as a shareholder representative. Even if they can defeat the claim, just defending themselves is a major reason they don’t like to take the job.

But our biggest competition is the board member who says, “I’ll do it rather than pay.”

What do you charge, by the way?

Vogel: We charge a flat fee for the entire life of the post-closing period, which is typically 12 to 36 months. But the amount we charge depends on the nature of the deal. We have to look at indemnification provisions, whether there are earn outs, whether there are working capital adjustments, as well as the nature of the seller and buyer.

Can you give me a price range?

Koenig: Sure, the minimum fee for any transaction is $25,000, because when we sign on, we don’t know what’s going to be coming. The buyer could be particularly litigious, or the seller could have made mistakes in the company’s representation. We can’t take $10,000 for what might turn into four years of patent litigation.

The high end would be $150,000, absent a multibillion dollar, insanely complicated, deal. But we haven’t seen that yet.

You can’t protect a client from being sued, though, right? If a buyer brings a case over patent infringement or something else, what happens?

Koenig: Typically the representative, when he gets the claim in, has to hire a third party — a litigator or an accountant, depending on what the issue is. But we have a number of contractors, including accountants and lawyers, who we work with as part of our fee. So we’re able to effectively avoid starting the clock on third party services the moment a claim comes in.

What goes on at your offices instead?
Vogel: Let’s say a claim comes in alleging some breach of something under the merger agreement. Our first step is to evaluate the claim. We then go to the requisite shareholders and discuss the risks and say whether we think it makes sense to agree or settle or dispute the claim. If the shareholders decide that a settlement is appropriate, we’ll take the lead and negotiate. If they determine that the claim isn’t valid, then we’ll take the lead in the process of negotiation, mediation, arbitration and litigation.

If as part of the process, we have to hire litigators or accountants, we’ll manage the process but the costs are born by the shareholders. That’s why shareholders typically set up an expense fund, a pool of money that shareholders voluntarily reserve so they have the resources in order to dispute claims.

What if you don’t have the requisite domain expertise to evaluate a claim?

Koenig: While VCs don’t want the [representative] job, they also don’t want to check out completely. What our engagement letter says is that we’ll manage the process but if any major issue comes up, we’ll let shareholders know and allow them to participate in the process. We’ll make suggestions but we’ll follow their guidance to the maximum extent that we can.

Vogel: Claims can be very specific, too. Today, I’m dealing with the issue of appropriate reserves for bad debt, and which accounts have the right agent. I can guarantee you that board and VCs were never involved in the company at that level of detail.

When are you paid?

Koenig: At the time of closing, which gives us the ability to properly staff up if necessary.

Do you anticipate having to do that? It’s such a tough M&A market right now.

Vogel: If anything, our volume has increased since the downturn. Awareness of us as an option is growing, and also, when you get into a down market environment, litigation risk goes up. If VCs didn’t want to be shareholder representatives before, they certainly don’t want to be them now.