Attorney Notes: Tough Terms Wane, Valuations Rise

Down rounds and toughly worded term sheets are becoming things of the past, compared with just a year and a half ago.

There are numerous reasons for this. A better M&A market has lifted venture spirits. So have upticks in startup IPOs and public market share prices.

Then, too, there is rampant excitement for social media companies, which is sparking ever-higher valuations for flagship firms, such as Facebook and Twitter.

Monitoring this changing sentiment is one of the jobs of Michael Patrick, a partner at Fenwick & West and co-author of the law firm’s quarterly venture financing terms survey.

In the latest survey covering the fourth quarter of 2010, Patrick found a substantial reduction in multiple and senior liquidation preferences.

He also identified a significant increase in up rounds with 67% of deals marked higher during the period, compared with just 25% in the first quarter of 2009. It was the sixth quarter in a row where up rounds outpaced down rounds.

Patrick calls the current trend “noteworthy.”

Here are edited excerpts from a recent conversation VCJ Senior Editor Mark Boslet had with Patrick in regards to terms and conditions and other legal matters.

Q: Up rounds have rebounded smartly in eight quarters. What do you expect to see from here?


I would be surprised if [the percentage of up rounds] went much higher. I think it is at a pretty high level right now. I wouldn’t expect it to necessarily go a lot higher.

Q: Fenwick & West puts together a financial barometer monitoring the increases and decreases in deal prices compared to earlier rounds. What trends are you see?

A: The most interesting part of the data shows that prices have been going up steadily for six quarters. In the fourth quarter, they went up more rapidly than in prior quarters. I think that is something noteworthy.

Q: What specifically did you find?


What we saw in the fourth quarter was the barometer showed an average 61% increase in valuations over prior rounds. That’s up from 28% in the third quarter and 30% in the second quarter. That’s substantial. The real test will be what we see in the first and second quarters of 2011.

Q: Another item you track with the barometer is the differences among industry sectors. Was there a stand out industry in the fourth quarter?


The barometer shows the software industry had a particularly strong quarter. It is important to know we include SaaS companies in software. [Editors note: 90% of software deals were up rounds.]

Q: What in general are you observing in term sheets today?


The terms we see are, by in large, consistent with improving valuations and the more up rounds. Namely we see fewer deals where there are multiple liquidation preferences [and] fewer deals where the new money coming in is senior to prior money.

Q: What have you observed specifically with respect to multiple liquidation preference?


The percentage of financings that had multiple liquidation preferences in the first quarter of 2009 was 28 percent. That has slowly worked its way down to a low of 13% in the fourth quarter of 2010. It’s a substantial reduction.

Q: What about senior liquidation preference?


A total of 45% of financings had the newest money requiring a senior liquidation preference in the first quarter of 2009 and that number has gone down. It was 28% in the fourth quarter of 2010. The numbers bounce around from quarter to quarter, but certainly there has been a trend in the downward direction.