Articles

What is an Emerging Company?

The term “emerging company” is frequently used; however, there is still no widely accepted definition of the term and the characteristics of the firms that might fall within the scope of the definition.  This post will not resolve the issue but it will nonetheless provide some ideas of the types of companies that are the focus of The Emerging Companies Blog.

It is telling that the terms “emerging company” and “emerging growth company” are used interchangeably. While I selected the former for the title of this blog it should be understood that a growth-oriented strategy is a key element for the types of companies that I am interested in.  Also, while I will discuss the trials and challenges that small groups of entrepreneurs will go through during the very earliest stages of conceiving and starting their business (i.e., the “concept” stage), my real interest is in what happens after the “next great idea” has left the garage or the laptop in the attic and landed in its own discrete working space with human and financial resources obtained from outside the founder group. 

Applying these conditions, and a few others, I think that a working definition of an “emerging company” should begin by focusing on newly formed or reorganized companies that have successfully survived the early challenges that typically drive 80% – 90% of new firms out of business and established a resource base and organizational structure suitable for sustained growth.  One very important implicit assumption in the previous sentence is that the founders, other senior managers and outside investors have all targeted growth and expansion as a key goal in the overall strategy of the company.  In addition, emerging companies are built on the assumption that the desired growth will come from some new and unforeseen development that totally changes the dynamics of the market in which they are competing—technological breakthroughs, dramatic shifts in the costs associated with satisfying existing consumer needs, identification of new consumer needs and/or sociological or economic changes.  It is the job of the managers of the emerging company to embrace and exploit these developments by identifying business opportunities and creating new products or services to take advantage of them.

Whether or not a particular company is “emerging” is sometimes assessed by reference to how the company stands with respect to certain key business and financial characteristics.  These characteristics not only test the current and projected financial performance of the company—measured by revenues, sales, profit margin, cash flow, etc.—to determine whether the business has been, and will be, generating steadily increasing revenues at above-average rates, but also examine whether the company has the resources and strategies in place to grow rapidly.  Specifically, in order to qualify as “emerging” a company should demonstrate all or most of the following characteristics:

Management: Probably the most important success factor for any business is the presence of qualified, experienced and credible management and this is especially true in the case of emerging companies since they must face and overcome turbulent and challenging conditions as they move quickly through several growth stages. Ideally, the founder(s) and other senior managers should be experienced in the target industry and each of them must demonstrate a strong entrepreneurial spirit and dedicated focus on the business.  In any event, the company must have a management team in place rather than just one person acting as the CEO.

Distinctive Competence:  A company should have a distinctive competence in one or more areas that are essential to competitive success in its particular market.  Examples include proprietary design technology (e.g., patents and trade secrets), manufacturing know-how, a unique brand, or extraordinary services.

Market:  Emerging companies tend to be technology-oriented that have the potential to achieve annual revenues of at least $50 million on a profitable basis within three years after launch and ultimately attain a market valuation in excess of $1 billion within five years after launch.  While the current size of the market is relevant the more important consideration is whether the market is expected to grow and expand rapidly in the future and, in fact, many require that the company be competing in an industry that itself is considered to be “emerging”.  A related issue is whether the company has a sensible and believable strategy for distributing its products and services within the target market. 

Strategic Alliances: Emerging companies must have, or be in the process of developing, relationships or contracts with recognized companies in the industry in order to demonstrate the credibility of the company’s business model in the marketplace.  Strategic alliances can provide access to technology and other needed resources and allow the company to scale up its manufacturing and sales activities quickly without having to make substantial capital investments.

Products:  Emerging companies have innovative distinctive products, processes, or services that can dominate a niche market segment.  Ideally the company will be able to begin commercialization of its products immediately following completion of development without delays caused by the need to overcome regulatory hurdles; however, biotechnology and life sciences companies certainly fall within the definition of emerging companies even though they generally must wait several years before their products are approved for release to the public.  It is also a positive sign if customers must make recurring purchases of the company’s products and services.

Margins and Cash Flow: Actual or potential gross margins and/or cash flow should be large enough to permit financing of growth over an extended period of time, and produce a favorable return on invested capital.

Food for thought . . .

Where does your company or client stand in relation to the various characteristics of an emerging company listed above?  What characteristics might be the most important?  At what point should the founders begin to structure their business model and strategies to guide the company into the profile of an emerging company?

Hit the Ground Running

Assume you have been engaged to provide business counseling to a new client or to serve as the new general counsel of a company.  One of the first things that you’ll want to do is obtain as much information as you can about the business and operations of the company so that you’ll be able to start making a contribution as quickly as possible.  While you’ll eventually want to sit down and speak with all of the key executives, managers and employees, as well as the company’s major outside business partners—a topic we will cover in detail in future posts—the best way to get started is to obtain and review certain basic documents before you actually begin your new assignment.  The information in these documents can be used for initial issue-spotting and can also serve as the foundation for asking the right questions in subsequent interviews and understanding how contracts that you’ll be asked to review fit into the overall business plan of the company.

The range of documents that you should review will vary depending on whether the company is a reporting company and thus required to make certain information publicly available in periodic filings with the Securities and Exchange Commission (“SEC”).  Assuming that is the case, you should ask for, or download on your own from the SEC website or a commercial service, the following documents:

  • The reports on Forms 10-K, 10-Q and 8-K filed by the company over the last three years (or such shorter period that the company was required to file such reports);
  • The company’s S-1 registration statement if the company completed its initial public offering within the last three years;
  • The proxy statements filed by the company, and disseminated to shareholders, over the last three years (or such shorter period that the company was required to makes such filings); and
  • The contracts and other documents that have been filed as exhibits to the company’s SEC filings over the last five years (or such shorter period that the company was required to make such filings).

While you should read everything closely there are certain disclosures that should be carefully reviewed—the description of the company’s business and the risk factors associated with the business, the notes to the company’s financial statements and the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”); the disclosures made in the Form 8-K reports; and projections of future performance and anything else that might be deemed a “forward-looking statement”.

If the company is not subject to the reporting requirements you should ask for copies of comparable documents such as the business plan or offering circular distributed to potential investors and other formal communications to investors and shareholders over the last two or three years that include material information regarding the company.  Material contracts for a privately-held company will need to be obtained directly from the CEO and other senior managers of each of the departments.  When requesting such information take note of how long it takes to receive the contracts and where they are maintained within the company since you may want to suggest changes in the records retention procedures down the road.  When asking for contracts you should apply and explain the same standard of materiality that would be used if the company was required to file the documents with the SEC and that means you should obtain, at a minimum, copies of the charter documents of the company (i.e., articles and bylaws with all amendments); all employment-related agreements, including stock option plans and agreements and change-of-control agreements with senior executives; major real and personal property leases; major contracts with outside business partners (e.g., contracts relating to R&D, manufacturing and sales/distribution); and pension and benefits plans.  Stock records, or at least a list of the shareholders and option holders (including the number of shares owned or subject to option), should also be obtained.

Contracts, documents and policies from several other areas should also be obtained regardless of the reporting status of the company.  First of all, you should request and obtain copies of “boilerplate” contracts and terms and conditions that are continuously used in business relationships with employees, vendors and customers.  For example, make sure you look at the company’s employee confidentiality and assignment of inventions agreement and the company’s personnel handbook and policies.  Also review the company’s standard terms and conditions of sale and purchase on its invoices and purchase orders.  Second, make sure you review the minutes of the board of directors and the charters of each of the committees established by the board, particularly the audit and corporate governance committees. You should also seek and obtain background information on each of the directors and senior managers including resumes and, the case of management, a timeline of their progress and advancement within the company. Third, ask for copies of communications with the company’s outside auditors regarding legal matters over the last few years. Finally, make sure you review the company’s recent press releases and copies of promotional materials that the company regularly disseminates to the public regarding its products and services.

As noted above, the best idea is to review all of these documents before your assignment begins and you should allow sufficient time to complete the full review and, if possible, prepare your own index of the documents and summary of important recent developments relating to the business, organization and legal situation of the company.  For example, you should try and develop a list that includes, in chronological order, major contracts, product introductions and personnel changes.  All of this takes a lot of time and concentration and some of what you learn will not be immediately useful to you in the first stages of your assignment; however, by doing your homework early you’ll eventually be way ahead of the game and in a position to demonstrate knowledge and value to your external or internal client.  If you’re outside advisor be careful about attempting to charge your client for any of the time spent “getting up to speed.”  It won’t be appreciated and you’re probably better off treating the time as a marketing effort.

Keeping Up on International Legal Developments

Keeping up with changes in the law, and projecting trends and developments that may impact a particular industry or business in the future, is a daunting task when only one country is involved; however, lawyers and managers can quickly become overwhelmed when business activities are taking place in multiple jurisdictions around the world.  Fortunately, there are a number of resources are available for researching international law including traditional law libraries, online collections of international law materials, and information disseminated by governmental agencies and international organizations.  The trick is to come up with a clear and simple system for keeping abreast of legal developments in the topical and jurisdictional areas that are of the greatest relevance to the lawyer and his or her clients.  The following list includes some ideas that I have collected from experienced international lawyers:

1.         Identify and monitor a group of web sites that specialize in information regarding international laws and regulations.  For example, the World Legal Information Institute has links to country-specific LII sites.   Some organizations provide free e-publications.  Examples include “International Law in Brief” from the American Society of International Law (click on "publications" then click on "ILIB") and the “Global Law News” from the Library of Congress.  If you are a Westlaw subscriber, use the “West Clip” service to receive alerts for new developments.  Go to the "Alert Center" menu and you’ll find a list of the various alerts and tracking services. 

2.         Identify one or more of the many large multinational law firms (e.g., Baker & McKenzie, Bird & Bird and Clifford Chance) that send out free newsletters with updates on local laws and sign up to receive those newsletters on their respective web sites.

3.         Subscribe to the free, legal online database “internationallawoffice.com”, which “pushes” e-mails to subscribers with updates written by leading law firms in various jurisdictions on the legal topics and countries chosen by the subscriber.  Mondaq is another good source for this type of service.

4.         Identify one or more local law firms that may have free client newsletters and see whether it is possible to sign up to receive those newsletters.  If a subscription service is not available, establish a regular schedule for visiting the web sites of those firms to see whether there are any updates.  In some countries similar information is available through the local office of the Big-4 accounting firms.

5.         Join appropriate international, national, state and local bar associations.  The International Section of the American Bar Association, for example, has numerous country-specific committees and most of them distribute information of current legal developments on a regular basis. If you can find a listserv or discussion group on the local law, subscribe. The listservs can be very helpful because they usually address practical questions; however, the utility depends on the country and the subscribers.

6.         Join local in-house lawyer organizations like the local affiliates of the American Corporate Counsel organization or the specific national in-house lawyers association.

7.         Establish and maintain personal relationships with several local lawyers so that you have someone to go to obtain “on the ground” insights into new developments and clarifications on issues that cannot readily be understood through the other sources.

8.         Identify and monitor the official web site of the national government in each country of interest to find copies of new laws as they are adopted and published.  It may also be possible to monitor case law in the country through a central web site operated by the highest court in the country.  Note, however, that there may be delays in the publication of information and that commercial services may be the preferred alternative if cost is not a significant issue. 

9.         Identify and monitor other web sites for local governmental entities that oversee activities of particular importance to your company or client including legislative developments.  For example, the central bank web site is usually a good resource for current developments on a wide range of issues include inbound investment, foreign exchange rules and the like.  Local intellectual property offices are also a good source on information on intellectual property laws and licensing issues.

10.       Identify local newspapers that might be available online and monitor them regularly.  Reviewing the local news provides valuable context to understand legal and regulatory developments.

11.       Join appropriate US-based trade industry organizations, such as the US China Business Counsel.

12.       Join local American Chamber of Commerce organizations, especially those that have a legal services sub committee.

13.       Learn the basic principles of civil law when appropriate for the countries that you are monitoring. In East Asia, for example, civil law jurisdictions include China, Japan, Korea, Russia, Vietnam, Cambodia, Thailand, Indonesia, Laos, Macau SAR and East Timor.

14.       Subscribe to journals on the areas of law in which you are interested. Also, identify conferences that address areas of interest and either attend those conferences or arrange to receive the written materials from those conferences.

15.       If you’re really ambitious, learn the local language–law is seldom translated, and even less seldom translated accurately.  Cases are almost never translated.  Also, language skills make it easier to communicate with local counsel since it may be difficult for them to explain legal concepts in English.