Special Interview with Andrew Sherman, Attorney and Author

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Hi I'm Mike Pratt.

I'm the professor of Technology Entrepreneurship with

the Maryland Technology Enterprise Institute at the Clark School of

Engineering at the University of Maryland.

And today we have as our guest, Andrew Sherman, who is a lawyer with

the firm of Jones Day and also the author of our suggested reading,

Raising Capital, How To Get The Money You Need To Grow Your Business.

So Andrew thanks for joining us.

>> Oh its a pleasure to be here and always looking to build strong bonds

between the Clark's School of Engineering, The Smith School of Business and

as you mentioned, this is my 28th year of teaching,

so very committed to seeing the University of Maryland have a strong

place in the region in entrepreneurship, and specifically in tech entrepreneurship.

>> Great. >> Well thank you very much.

>> So before we get started on the book itself, I'd like to,

can you tell us a little bit about yourself and

about your firm that you know, >> Sure.

Well Jones Day itself is one of the largest lawfirms in the world,

I think we're fourth or fifth largest depending on who's counting and when.

We're a full service firm with offices all over the world.

Our two, probably, biggest practices are in commercial litigation.

We just wrapped up handling the bankruptcy of the City of Detroit.

We got the bankruptcy group from the judge a couple weeks ago, which was huge.

And our MNA and corporate transactional practice,

which I am a senior partner in that practice.

So, over the last almost 30 years of practicing law, I've worked with

early stage companies, mid size companies, very, very large companies.

Usually around their growth strategies, their capital formation strategies,

merger and acquisition transactions, that type of thing.

>> Got you.

So, with that type of background, what drove you to write a book like,

"Raising Capital"?

>> Well, I can give you the short, medium, or long version of that.

I'll go for short to medium.

1986, 87, I started writing a lot of articles for business magazines.

That led to my first book, and

since then I've written 24 books all around different business growth topics.

This book has done particularly well.

It's now in its third edition.

And really wanted to try and write a very pragmatic hands on, easy to understand,

not too technical from a legal perspective or a finance perspective.

But just kind of think of it like a football coaches

playbook on how to go out and raise capital.

What are the different pools and sources of capital.

What are the quantitative and non quantitative costs of capital.

In terms of control and other things that need to be given up.

And the books done fairly well.

I mean it's not going to be on Oprah's Book Club anytime soon.

[LAUGH] It's not gonna be probably on anybody's summer reading list,

but a lot of entrepreneurs and leaders of growing companies

that appreciate it as a good pragmatic resource.

>> Right.

Well I've actually, obviously read it and it's very good.

>> Thank you. >> And

I've been involved in the other side of venture capital.

I was in early-stage companies myself.

And raised quite a bit of money.

And I learned a lot.

I haven't gone through 17 years of raising capital.

It's still a very useful resource guide.

>> Thank you.

It's a combination of the two of them.

I think that there's nothing in this field like that which comes

from experience from doing it, if you can capture some of those ideas and basics.

I mean the book every year gets thicker and thicker and thicker and

there's a lot more to say, but I think that the course that you're teaching

should be very exciting, bringing together hopefully some highlights

from the textbook, but also all of your personal experiences.

>> Right, right.

And that is a good point.

We actually are focused on early stage companies in my class,

although this is a great resource for a company either from the very beginning,

so the company all the way through mezzanine finance and on.

So you mention it's a third edition.

>> Mm-hm.

>> And I think the original, the first edition was out in the '90s.

So my view of that, of the finance market specifically for

early stage companies., it's been a huge change.

And so, can you comment on that and

how that's impacted each addition along the way?

>> Yeah. I mean, get comfortable.

>> [LAUGH] >> Kick back,

cuz we got lots to talk about.

I would say, I'm trying to bucketize this to make it easy to digest and

to make it of greatest utility to your course and to the students.

In phase one, when a few of you might have just been a sparkle

in your parents' eyes, it was a very traditional marketplace.

You had old school thinking around venture capital.

It was you and the venture capitalist.

I remember some of the term sheets I drafted in the late 80s,

it was like, here's your term sheet Michael, and don't ask any questions and.

>> Right. >> Because we have all the power.

>> Mm-hm. >> Of course when we had our,

the tech boom, some of that power shifted

The banks were a good place to go if you had hard assets.

And many businesses in the first edition

that were raising capital still had hard assets.

They weren't the social media and soft asset companies of today.

>> Right. >> So you had the venture capitalists and

you had the banks.

And then there was this disorganized, loose notion of angels.

And many people who were angels,

particularly here in the DC market, didn't even give themselves that title yet.

I mean if you're a cashed out entrepreneur and

you did a few deals on the side, you'd get a few deals on the side.

You didn't need a title.

So that was kind of the state of play in the first edition.

In the second the edition, you see a little bit of pullback by the banks

because they were confused on, you know, how to lend to companies that were

information and data and processes-rich and hard asset-poor.

You saw the beginning of the decline and

chipping away of the venture capital market as it peaked and

then began to decline in terms of traditional venture capital firms.

And you saw for the first time thanks to John May and

others a true organization of the angel market.

The formation of the Angel Capital Association, more and

more angel groups being formed both locally and across the country.

And, so angels, all of the sudden, took a more prominent in the second edition.

Venture capitalists maybe ever so slightly less so, and banks, you know,

kind of still in flux.

You know, the advent of family and friends.

The advent, you know of private placements under reg D.

That all varies based on kind of the state of economy and

how people feel about their 401(k) in the future and that type of thing.

As you move towards the third edition, you have some interesting developments.

You have traditional venture capital stabilized.

Not really on the decline but not growing that much.

You have the growth of corporate venture capital, where large corporations wanting

to access innovation and other things begin to get more active.

You have a very well-organized, now, angel marketplace.

And, of course, you have the advent of this new concept known as crowdfunding.

And, the interplay of technology in the angel community and

private placements, the crowdfunding, the passage of the JOBS Act.

Which pieces of the JOBS Act have still not been written.

Maybe they will by the end of the semester but

they probably won't be by the beginning.

All of that has kind of come into play.

By the third edition of the book we have banking, not a lot of change.

I think some banks are trying to learn.

To lend to companies that are intangible rich and tangible asset poor.

You have a lot more activity at the family

business office level, where more and more cashed out entrepreneurs are saying,

okay, I could dump my money into a venture capital fund.

Or maybe we'll run our own venture capital fund.

Just a few hours in this same room where the camera was sitting was a father and

son team that were owners of a very successful business.

They didn't call themselves an FBO, but they were in the process of making

their first and second venture style investment in companies.

And so I think you're gonna continue to see that with the aging of

the baby boomers.

If the fourth edition comes out I'll probably drill down

more significantly on family business style investing.

>> Mm-hm. >> It's a hybrid of course between

traditional angel investing but seeing it at a family level when almost

a third generation, the son had a young son around 16 who

was touring around with a few crowdfunding things that he was looking at.

And so you, you almost had three generations of venture style investing.

So I think there have been a lot of interesting developments.

It will keep the course fresh, it will keep lots to talk about.

>> Keep you writing the book.

>> And it keeps me writing the fourth edition.

>> So just following up on the more recent changes that I have gone through myself.

Are you familiar with the term, the Series A Gap?

>> Of course. >> So you've heard of that?

>> Yeah. >> Right, and

so, you want to comment on that?

I've actually experienced this myself in my last company.

>> It's a huge problem.

So just to clarify for the purpose of the course, this gap,

if a in a typical progression of funding.

You have maybe an entrepreneur, and I'll just extend this out as far as you want,

but an entrepreneur that might have a little bit of money in savings and

is enough to get at least some pieces of the business going.

They might rope in a couple of friends and family.

Maybe a small angel, maybe not.

And their next round is typically in that two to five hundred thousand dollar range.

It turns out in this country other than perhaps a Reg D offering and

with venture capital shrinking in some ways.

Particularly what we all refer to as early stage venture capital

that we've created this huge funding gap in America for many companies.

The magical number of anywhere from two to five hundred thousand dollars,

which is considered as you say a pre-Series A preferred stock type

of ground has become among the most difficult to raise.

Now there are some options.

If crowd funding ever gets fully written, that might be one gap.

A 504 private placement style offering might be a nice solution.

But you have to know the people that are gonna write the units and

stay within the 504 guidelines.

There are the emergence of some new venture funds that

are looking at deals in the earlier stages, as you're familiar.

But we need more of them.

And the other thing that's really interesting,

you know going back to your question about first edition versus third edition.

>> Right. >> You probably remember this.

At the peak of the dot-com mania if you weren't using

to build your website at $5.8 million you just weren't cool.

And I share that with my students over at the Smith school, and

they look at me like I'm on drugs, like who would pay $5.8 million to build

a website when you can do it now for free if you'll pay for a year of hosting, and

so the cost of business and launch has reduced.

And what's happened is that, that magical gap, of say, two to 500 is

not only a gap pre-series A, but because the costs have shrunk.

It's about what a lot of companies need to get up and running.

>> Right.

>> And, yet it's one of the hardest to raise in the country.

So, I think it's something that if we're gonna continue to have strong

entrepreneurship and innovation in both technology and non-technology ventures.

We've got to figure out a way to close that gap.

And I don't know that we've kind of nailed that one yet.

>> Do you think that venture capital firms have,

I'd like to say outsourced the early investing to the angel groups?

>> I think they have.

If you look at some of the local, you look at your NEA's of the world.

I mean these are, don't get me wrong, remarkably successful venture funds.

But there's a blurry line now between what's a private equity fund and

what's a venture fund.

The venture fund goes out and raises $1.5 billion and

they're gonna do say, ten or 12 deals.

Now, you're looking at companies that need on average, $100 million.

>> Mm-hm.

>> I know I'd like to have $100 million, but

I don't know too many companies that need $100 million to get started.

>> Right. >> So

as the venture funds get bigger, they might be saying, look,

from a transactional perspective, we don't wanna play in that.

>> You know 200,000 all the way up to even a million or a couple million.

I mean, come to us when you need three to five million,

come to us when it's going to be a Series 8 deal.

If that inflation or girth continues to grow,

you're going to have almost a zero to five million dollar Series A Gap.

>> Right. >> Not just a two to five hundred

thousand dollar gap.

>> And the other issue is that the funds are getting so big,

that they need a bigger number to actually move the needle.

>> Right. They're not set up to have hundreds of

investments.

>> Right. >> They're set up, you know,

in a typical raise to do ten, twelve, fifteen deals.

The one thing I would keep an eye on in that regard is corporate venture capital.

>> Mm-hm. >> I mean some of the corporate venture

capitalists are they're investing for

strategic reasons, not always quantitative reasons.

And so to them,

the amount of money may not be as important to the access to technology.

So if you were an early stage battery company.

And you're gonna make my iPhone last five times longer before it needs charging.

Don't worry.

I'll make plenty of money.

If you only need $300,000 to make that prototype battery.

Apple or Nokia or Motorola or

Samsung might all be willing to invest that small amount of money.

Because look, they're not in it for

the return on investment of the battery company.

They were in it for some strategic reason, right.

>> So, this book is primarily targeted to the US market.

[CROSSTALK] >> Primarily, yes.

>> But there's some international discussion in here.

>> Yes. >> And

the course that we're doing on Coursera is about, three quarters

of the people who look at this video will actually be outside the US.

So, but I think the basic concepts and

principles are applicable internationally.

The basic concepts and principles are applicable absolutely on a global basis.

Some of the legal references in the book are US specific, but some countries have

mimicked US laws in terms of securities and other things that might be similar.

Obviously, check with local counsel before doing a securities offering.

I will say one thing on that on that.

Just this morning I tore out of, one out of The New York Times and one out of

The Wall Street Journal, an article about entrepreneurship in Spain and

another one about entrepreneurship in Hong Kong.

We in this country for many years had

a significant global lead in entrepreneurship.

I mean we weren't maybe good at a lot of things, but

we were sure good at entrepreneurship.

That is changing, and it's changing rapidly.

I mean without stating the obvious of entrepreneurship in places like China and

around the world, Europe in particular is going through

a pretty significant economic recovery in the last few years.

And in places like Ireland and Spain and even Greece and Italy and

the UK, entrepreneurship gets a lot of the credit for that.

In places like Asia and the Middle East,

entrepreneurship has helped lead almost political and social transformation.

Entrepreneurship has helped break up the monopolies or

the oligopolies of Latin American wealth, opening up pathways to wealth.

Entrepreneurship has always been strong in Canada, Australia.

>> Israel is a big one.

>> Exactly.

[CROSSTALK] And so I think that you're 100% right.

I think the principles of the book apply, but

even this third edition was written a bit, this'll sound terrible,

but I'm gonna say it anyway, a bit with like a US attitude that we

have the monopoly on knowledge about entrepreneurship.

And the truth is while I still think that we are a global thought leader on

entrepreneurship and that many countries look at our best practices,

in our lifetimes, that is shifting.

And I know when I was a younger man and you were, it was a given that hey,

we may not be good at stuff but when it comes to innovation entrepreneurship,

intrapreneurship, we really have a monopoly.

But I think you're seeing that change has become much more globalized, and

you're seeing some countries now, this particular program in Spain was

offering a series of tax incentives to be an entrepreneur in Spain that was

far more progressive than our system, or certainly more progressive than our system

over the last six years just in terms of entrepreneur-friendly legislation.

And other countries are getting this message.

I was actually tearing these articles out because I was already constructing

next semester's midterm, and I was going to use them as reference points.

But other countries are getting the message that if they

make their ecosystem entrepreneurship friendly and

if they remove barriers to raising capital, that good things will happen.

One last comment on that I think you'll find interesting,

years ago I was with the Department of Commerce and

we were speaking at an angel capital investment

conference in northern Europe, and we were in Norway,

and one of the attendees of the conference came up to us and

he said, you know, right now I'm a pretty wealthy guy and

I'm paying 78% essentially in taxes.

Why would I wanna be an angel investor and make even more money so I can pay more?

Another 78% plus my money is sitting abroad right now,

I'd have to bring it back into the country to make some of these investments.

So you can see that even tax policy plays a pretty significant

role on people's willingness to make investments.

And if they're not gonna be treated at least somewhat favorably,

that creates a logjam effect on the flow of capital.

>> Right.

So before we close, again this is a course focused very much on the early stage.

Any final comments on advice you'd give to an early

stage entrepreneur just getting started?

>> Sure, two things.

Make sure you walk a mile in the source of capital's shoes.

Many early stage entrepreneurs are so focused on their business plan and their

business model and their target customer that they forget that when someone writes

you a check, they're not thinking about you, they're thinking about them.

They're thinking about where does this opportunity fit into my portfolio.

Am I the sibling managing the family wealth, and my brothers and

sisters just yelled at me for making too many investments?

Did I just get yelled at for making not enough investments?

Walk a mile in their shoes, understand their perspective.

You might go to a venture fund that falls madly in love with you, but

they've already just exhausted most of the capital that they had

raised on that round, they are holding their little dry powder for

who's already in their portfolio, and they're off raising another round, but

that could be a year from now before they raise it.

I mean, not enough times does the entrepreneur turn the tables,

sit in the investor's shoes, and understand that perspective.

The last thing I'll say is, and I think you would agree with this,

we have never in the history of mankind, had so

much cash on the sidelines, so much cash accumulating.

The numbers are well into the trillions.

I've studied finance enough to know that cash cannot sit idle indefinitely.

We didn't create currency for it to sit idle, right?

We created coins and dollars so that I could buy things from you and

you could buy things from that person and that person.

It's designed to be in play.

At some point the levy will break.

Any entrepreneur that tells you there's just no money out there,

it's the opposite.

There's gobs of money out there.

You have to have a strategy for tapping it.

But I have never seen, in my 53 years on the planet and

30 years of doing this, so much cash accumulated, and so

it's a very exciting time to be an entrepreneur.

It's a very exciting time to be out raising capital.

2015 could be the perfect storm, in a good way,

of accessing capital for projects, so right now I am,

as Greenspan would say, cautiously optimistic, globally.

And I think that Capital is out there.

You've got to figure out ways to access it.

>> Right.

And on that very positive note, I'll thank you again for agreeing to come help us.

It's been very interesting for me to meet you in person.

[CROSSTALK] >> Very much so, thank you.

>> And for our viewers, those of you who are on this course,

whether you're a brand new entrepreneur or you're an experienced

entrepreneur who's raising their second or third or fourth round, mezzanine round,

this is an unbelievable resource that I would highly recommend that you use.

Thanks again.

>> Thank you.

Good luck, everybody.

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