Venture Capital: Road to the Neopets Stock Market

     From: Lawyerbot (Partner)

     Re: New Business

      Our clients have decided to not work with Virtupets in a joint venture. Instead, they will go ahead alone, as just Alien Aisha Vending. The next step we have to worry about is Intellectual Property. Essentially, every company wants to have its products and services clearly identified as being its own. Whether a company is a hotel or a luck-based company like Alien Aisha Vending, establishing and protecting a recognizable identity is often a key to attracting and building a customer base.

     A business cannot grow and retain its customers if they cannot distinguish themselves from their competitors. Alien Aisha Vending will want to preserve its exclusive use of the inventive approaches taken in creating its products (Nerkmids) as well as protect the product itself from duplication. Whether a company makes jewellery, books, clothing, or thousands of other products, it will want to ensure that its creative efforts are not simply replicated by a competitor.

     Intellectual Property refers to inventions, ideas, plans, methods, creations, secrets, and symbols that have economic value either in use or in sale. Legally, Intellectual Property is a range of creations that, because they have value, are given specific legal protections through property rights. From the point of view of a business, the key issue with Intellectual Property is having the ability to commercially exploit it, while preventing unauthorized people from obtaining the economic advantage of exploitation.

     For example, Alien Aisha Vending wouldn’t want Virtupets, Corp. and Dr. Sloth to "steal" the idea, and exploit it for themselves. Fortunately, legal protections exist and are essential to a successful market system. Without the ability to protect economically useful creations and identifiers, there would be little incentive to develop those things. The most aggressive and reactive competitors simply would duplicate and use or sell each new meaningful product development or identifier as it made its appearance in the marketplace.

     Without Intellectual Property protection, Virtupets, for example, would never have offered the opportunity to develop a business relationship with Alien Aisha Vending. Instead, Virtupets would have just waited for the release of Alien Aisha Vending's products into the marketplace and then simply copied them. Without these protections, customers will have difficulty identifying the provider of a product, or worse, distinguishing one product from another. Intellectual Property protections penalize parties who seek to mislead purchasers by falsely associating their products or services with those of a known provider of products or services.

     Please be prepared to discuss the potential Intellectual Property issues that Alien Aisha Vending might face. Since this is a specialized area of law, we are only looking to identify basic issues. We will debrief the client in a meeting next week.

     Winston let out a sigh of relief after reading the neomail. No longer will Dr. Sloth and Virtupets, Corp. pose problems for the new company’s founding, at least in the short-term. Now the finish line is clear ahead, and Winston prepared for the next meeting with his clients.

     Seven days later:

     "Alien Aisha Vending will have to decide if they want their Nerkmids to remain a trade secret, or seek a patent. The important legal element of a trade secret is that it is a secret. The best way to keep a secret is not to tell anyone. Unfortunately, in business, secrets often must be shared with at least some employees, as well as certain outsiders, such as a key part, equipment, or materials supplier; a customer; and maybe some service providers." Winston explained to Farvin and Sophix across the conference room table where another meeting took place.

     "On the other hand," Winston continued, "a patent is an exclusive property right granted to an inventor in exchange for sharing the details of an invention with the world. That is important to keep in mind—the contents of a patent application will be published. Seeking a patent, therefore, is largely incompatible with maintaining a trade secret. Although you might be uncertain on what to do, Alien Aisha Vending should still take certain steps to reduce the risk of your trade secrets being disclosed. Right now, the proprietary trade secret information gives you a competitive advantage."

     From the observation hub, Lawyerbot looked on with a smile (as much as a robot can show emotions). "Winston is doing a fine job representing my firm, and his performance with these clients’ needs exceeded my expectations. I will be sure to teach him a few more important parts involved in finalizing our client’s journey in forming their company."

     A few days later, Lawyerbot composed the following memo for Winston to read:

     As discussed previously, Farvin and Sophix have several financing options to explore as they launch Alien Aisha Vending. As an attorney advising early-stage businesses (or their investors), it is important to understand the bigger picture—for example, after the initial stage of funding, what happens next? How can early investors affect the direction and nature of subsequent rounds of funding? What milestones should founders be focused on achieving before seeking funding, and how does this evolve over the life cycle of a maturing business?

     First, we review the need for capital, the sources that might be available for capital formation, the traditional stages of financing, and the forms of compensation that a company might have to deliver in order to raise funds. We then look more closely at the venture capital industry. We examine how venture capital funds are structured and how the valuation and investment process work. Finally, we consider the steps that a company should take to position itself for a venture capital financing.

     For formation funding, start-ups usually look to friends and family. Start-ups often need additional funding to obtain supplies or equipment in order to further the development of the company's key product or products, create a prototype, rent office space, and/or hire employees. Friends and family investors may decide to infuse capital into a new venture on a "handshake deal" and often are willing to invest without detailed (or any) documentation.

     Next, an early round of funding. This could be the first of several rounds of formal financing, typically called a "Series A Round". Companies at this point will be more outwardly facing and necessarily focused on marketing and distribution channels. To the extent a company has been able to launch some version of its product or service, prospective investors will have the ability to gauge market interest in the product, among other things. By the time a start-up venture actively looks for Series A funding, the company needs a business plan and product that it can demo to potential investors. The company's business plan should be well planned and polished at this point.

     Lastly, in the expansion stage, investors generally expect to see a company with an operational or nearly operational business, meaning that production is in full swing and customers are actively purchasing or using the product or service as anticipated under the business plan. To the extent that this stage follows a Series A round, it will logically be referred to as a "Series B" financing.

     The two basic inducements that a company can offer to potential investors are (i) agreeing to pay the money back along with a fee (interest), which means taking the investment as a loan, or "debt" or (ii) selling part of its ownership, or “equity," to the investor. Raising capital through debt is usually unattractive to the company, so most companies will offer shares of "common stock".

     The mechanics of an Initial Public Offering (IPO) are governed by the Neopets Securities Act of 2003. An IPO generally means the process of going public, and offering company stock for sale to both investors, and to general individuals. IPOs are usually underwritten (more on this later) by a major bank, and then offered for sale on the stock exchange. All IPOs generally follow a similar timeline.

     We will call the beginning, Day 0. The process of going public and selling stocks in Neopia is heavily regulated. That is because investors face information asymmetry. A key concern is that the public will overbid for new stocks, or will make investments not understanding the nature of what they are investing in. The Neopets Securities Commission has to balance the two tasks that it has: encouraging capital formation (free markets), and investor protection. Day 0 consists of organizational meetings between the company, bank, and key management personnel.

     The National Neopian Bank will serve as the underwriter for Alien Aisha Vending, Ltd, and will shepherd the company through the IPO process. The bank will buy the shares from the company at a discount, and then sell them to the public. The bank’s compensation will typically be a 7% discount, or "spread" that it receives from the company. It will buy the shares at that discount, and then sell them to the public at full price.

     However, that’s not all the bank will do. It also will reach out to potential purchasers, most of which are investors that have a prior relationship with the bank, to gauge interest. Since that is usually enough to give exposure to the company, the bank will also actively market the shares in a series of meetings across all the different Neopian lands. Known as road shows, these meetings are an opportunity for the underwriter to educate potential investors about the company and the company’s future plans.

     The IPO process wouldn’t be so difficult if it weren't for the amount of paperwork involved. The National Neopian Bank will also assist with the required filings, under the Neopets Securities Act of 2003. It will assist with preparing the registration statement. Once the registration is filed with the Neopets Securities Commission, the shares may be offered for sale. However, they cannot be sold until the Neopets Securities Commission declares them effective.

     Perhaps the most important role of the underwriter is setting the price for the IPO. To do this, the bank will consider the number of shares that will be offered, the prospects of Alien Aisha Vending, its earnings, management expertise, and the markets in which it competes. Another factor is demand for the shares, which can be gauged by interest from the road shows. After assessing these factors, the bank will work with Alien Aisha Vending to determine a final price.

     The Neopets Securities Commission divides the offering process into three time periods with distinct rules. On Day 60, the bank will make a confidential submission to The Neopets Securities Commission with the registration statement. On Day 100, a second confidential submission will be made, clarifying anything that needed additional detail.

     Before the public registration statement is filed, the underwriter and the company cannot say much about the company and reveal any information. During this time, no offers to buy or sell are allowed. Alien Aisha Vending will also not be allowed to advertise the offering. If any of these violations occur, then both the underwriter and company will be subject to liability, which means hefty fees.

     Once the registration form is public, then we move onto the next phase. The public filing occurs on Day 130. This is when the company and underwriter can travel through Neopia and go on the road show; explaining more about the company and trying to attract investors and the general public. Those that are interested can then make offers.

     The bank will build a “book” of interest in the offering. During this time, the Neopets Securities Commission will be reviewing the registration statement, and often requesting more information. This is an important time period for the bank as well. Because they will be liable for any misstatements, they will be carefully re-reading the registration statements to make sure that everything is accurate and clear. This process of looking for misstatements and omissions is known as "due diligence". A second public filing usually occurs around Day 160.

     Lastly, once the Neopets Securities Commission has approved the registration statement (Day 176) and given the green light for the offering to proceed, the final pricing occurs, and trading begins! Trading begins on Day 177 and the IPO will close on Day 180.

     Now, one might wonder why a company would want to go public. IPOs provide the opportunity to raise capital, to give those that own shares liquidity, and to provide funding for acquisitions. A typical company can raise at least 100 million NP. Some IPOs will be much larger, and we are anticipating that for Alien Aisha Vending, it has the potential to raise 1 billion NP.

     Once a company goes public, then early investors (such as founders and employees that were given shares as part of their employment agreement), have a market to sell their shares. Prior to going public, there was no market. The ability to transform stock into Neopoints is known as liquidity. Lastly, because publicly traded stocks on the Neopets Stock Market are liquid, they can be used like Neopoints. This will be especially important if in the future, Alien Aisha Vending would like to acquire another company.

     One year later…

     Winston walked around the brand-new headquarters of Alien Aisha Vending and marvelled at the sight of the crowd. The company just finished its IPO and it’s time to celebrate! Today, Alien Aisha Vending is one of Neopia’s most successful companies. Every day, thousands of Nerkmids are used. The allure of winning a Paint Brush continues to attract new users to try their luck, and keeps the interest of returning customers. Grundos Cafe is also a contractor now, providing the very specialty food concoctions Winston saw a year ago as part of the machine’s prize pool. Like any successful company, Alien Aisha Vending would like to keep growing and innovating. The founders, Sophix and Farvin, look forward to further innovations and welcome all suggestions.

     Presently:

     Today, any Neopian can stop by the Vending Machine in Neopia Central and try their luck! Stock can also be purchased with the assistance of Nigel the Chia – Alien Aisha Vending is listed as "AAVL" in the Neopets Stock Market.

     The End.