High-Tech: Some Have To Take Stock Options In Lieu of Payment
The financial difficulties faced by an increasing number of local high-tech companies is affecting a range of service providers, from law firms to accountants and other consultants.
While the effects are difficult to measure, a sampling of professional service companies found an increasing number of high-tech clients are failing to pay their bills on time , not paying at all.
“One story I’ve heard had a company close down, moved everything out in the middle of the night and left the landlord holding the bag,” said Cliff Numark, CEO of the San Diego Regional Technology Alliance, a trade association for local high-tech manufacturers.
Bruce Ahern, a San Diego high-tech consultant, said a public company he did work for last year paid only part of the fee he was owed. Because of the financial problems and an inability to secure all the funding the company needed, Ahern said he accepted the rest of the fee in the company’s stock.
“Right now those shares have no value, but who knows down the road? If things work out, it could mean I would end up making more money on this deal. Then again, I could lose it all,” Ahern said.
The chance of cashing in on huge profits from early stage high-techs that eventually go public spurred a flood of investment into these firms in recent years. But the capital stopped flowing earlier this year as a massive sell-off of dot-coms and other high-tech stocks caused investors to take a tougher look at the companies’ bottom lines.
Diluted Ownership
“For some companies, they just can’t find the money. But more common is that they can find money, but the valuations aren’t what they used to get,” said Michael Kagnoff, a partner with the San Diego law office of Brobeck Phleger & Harrison.
The lower valuations mean companies have to dilute their ownerships, providing investors with larger stakes for the capital they provide, he said.
Kagnoff said he hasn’t seen a dramatic increase in the firm’s early stage clients failing to pay fees, but there have been a few situations where “it’s been a little bit touch-and-go both in the dot-com world and the non-dot-com or health care area.”
Like many other law firms, Brobeck occasionally takes small equity positions in some early stage start-ups rather than demand a monthly retainer for their services.
The process can occasionally yield wonderful results, as in the case of Dura Pharmaceuticals, one of the few local biotechs making a profit. But the law firm may also end up working with companies that don’t go public and eventually fail, Kagnoff said.
‘Part Of The Risk’
“It’s part of representing early-stage companies,” he said. “It’s part of the risk.”
Paul Kreutz, a partner with Gray Cary Ware & Freidenrich’s corporate group, said his firm sometimes defers fees and takes equity in smaller start-ups, but is very selective in doing so.
Despite the precautions, the firm has three or four clients in the last several months that have struggled to find the financing they need. The companies are in the telecommunications and Internet infrastructure areas.
The tougher financing market this year for all high-techs has caused service professionals to be more careful in which companies they work with, he said.
Some clients the firm took on about six months ago would not become clients today, “because we don’t think the funding is going to be available,” Kreutz said.
Jackie Townsend, president of the Townsend Agency, which has about 80 percent of its clients in the high-tech sector, said the gold-rush mentality that prevailed last year involving Internet-related companies caused many service providers to take equity positions rather than cash fees.
That decision may have proved costly with many companies unable to find a second or third round of financing and now in danger of closing or being forced to sell, she said.
Townsend said while her firm doesn’t use that method of payment, a few clients the agency worked with last year have encountered problems when they could not get additional capital financing.
Townsend said her firm has been turning away more business than it can handle and takes only those clients that have a revenue-based model.
“We don’t take on clients we don’t think will make it,” she said.
While some dot-coms or other high-techs may be facing financial straits, the overall market in San Diego “remains vibrant and strong, and so our particular practice remains vibrant and strong,” said Jim Ingraham, partner in the San Diego office of PricewaterhouseCoopers.
Ingraham said he wasn’t aware of any specific clients that have failed, leaving the accounting firm with unpaid bills.
While there are certainly some services that could have lost money when a high-tech goes under, the effects are likely negligible, said Peter Shaw, president of Shaw Management Advisors in San Diego.
“If they are a smaller (service) firm, then I suppose it would hurt, but for the larger companies, it wouldn’t have that big an effect,” Shaw said.
And for law firms, even if a high-tech does go out of business, legal services are usually still required, so they end up making money anyway, he said.
The main thing most high-tech start-ups running into financial problems want to avoid is filing for bankruptcy or closing down before selling its best assets, Shaw said.
For most high-techs, its most valuable assets are its employees, and when a firm goes bankrupt, those employees are usually gone, he said.
