Seattle’s Startup Lawyer: An Interview with Craig Sherman of Wilson, Sonsini, Goodrich, and & Rosati

Below is a conversation with long-time Seattle startup concielgere', Craig Sherman, who is a partner at Wilson, Sonsini, Goodrich, and & Rosati. I have known Craig for years and he's been in the catbird seat on Seattle startup deal flow for many years.  Since there is so much interest in the overall trends in financing startups because of the global economic turmoil, I thought that the readers would greatly
appreciate Craig's insights. 

Question: What does the overall deal flow look like right now for you and your firm (“deal flow” in terms of the number of financings and M&A transactions)?   

Craig: Deal flow hasn't quite plunged off a cliff, but it's rolling down a very steep slope head over heels.  The number of angel and VC financing deals has fallen dramatically, and those deals that are getting done, for companies that have the misfortune to be running out of cash in the fourth quarter of 2008, are getting done on onerous terms.  Multiple liquidation preferences on bridge loans and preferred stock financings have returned (ie the new investors receive 2-5x their money back before prior investors, let alone founders, receive anything).  Valuations have plummeted.  Like in 2000-2002, we're seeing follow-on rounds completed at $500,000 to $5,000,000 premoney valuations.  Some small and midsized M&A deals are moving forward, but slowly, with more due diligence, and a fair amount of uncertainty over valuations.  There are still a number of positive liquidity events with large cash-rich companies buying attractive very early-stage startups with strong teams and strong IP.  The strongest startups are hunkering down and hoping for better times soon.

Question:       You’ve been involved in the startup community for many years, how do you think this era of startups will fare versus the Web 1.0 startups?  

Craig:  Web 1.0 startups raised massive amounts of money at insane valuations, and spent even faster than they could raise money.  The vast majority of more recent startups, particularly outside Silicon Valley (but even there), learned the lessons of the last crash, and have raised and spent money far more conservatively.  There's no question that the herd is being thinned right now, and a number of startups will disappear in the next six to 12 months.  But this time around, deal valuations have less far to fall and startups have not been spending with reckless abandon, so far less trimming is necessary (or possible).

Question:       What is the tone in Board meetings that you sit-in on?  For example, are Boards dictating reduction in staff, profitability, etc?  

Craig:  EVERY board meeting begins with a discussion of the Sequoia RIP/death spiral powerpoint.  And every board meeting concludes with a discussion of how to cut back to push out the cash-out date, ideally for at least 18 months, if not indefinitely.  It's a very rare startup that is not looking at at least a small reduction in force.  But most of these cutbacks are relatively small, and in many cases only an acceleration of normal (and typically unnoticed) trimming of the lower performers.

Question:       What has surprised you about this downturn in terms of impacting the startups that you are working with?  

Craig:  The biggest surprise is the rapidity with which the public markets have unwound, and the accompanying spread of absolute fear and uncertainty.  The economy as a whole has been suffering for over a year, but it's only with the severe declines of the public markets in October that the actual impact (in terms of declines of real revenue and cost-cuts required in response) has been felt in most technology startups.  But though most VCs and startup CEOs are extremely concerned and taking responsive measures, most technology investors and executives have been through this exercise before, and there is less absolute panic in the tech community now than there was at the beginning of this millennium.

Question:       What advice would you give startups right now? 

Craig:  Retreat to the bomb shelter each night and survive.  But the air is not radioactive — survival is possible if you can maintain the strength to fight off the wolves.