Pearl Cohen: Postponing legal aspects costly in the long term for tech entrepreneurs

"Many entrepreneurs neglect the legal aspects involving their startup, triggering in many cases tax, IP and corporate problems," explained the tech experts of Israeli law firm Pearl Cohen. "Others postpone for too long the time in which they form their companies, intensifying these tax and IP issues. We see entrepreneurs who avoid signing founder agreements with their partners, without understanding how critical these agreements are and how carefully they should be drafted. Other mistakes involve choosing wrong investors, without sufficient due diligence or understanding of the impact these investors would have on their lives after they invest. We also see entrepreneurs structuring investment deals inefficiently, avoiding the use of easier and more modern methods for early-stage funding."

Pearl Cohen is one of the top Israeli law firms participating in CTech’s Most Important Gateways to Israeli Tech series. The heads of the firm's tech department answered a series of questions asked by CTech about their involvement in the Israeli ecosystem and why tech entrepreneurs should never neglect legal matters.

Oded Kadosh (from right), Atir Jaffe, Inbal Perlstein, and Guy Lachmann.

Name of firm: Pearl Cohen

Tech sectors of expertise: Commercial, Venture Capital and high-tech law (startups, growth companies, VCs, Angels’ Investors, IP, M&A, VC, healthcare, cyber, AI and ML, SW and DevOps. Prop-tech, HR-tech, Big Data, Semiconductors, Ag-tech and food-tech, Mobility, Fintech and blockchain, Gaming

Number of lawyers in the tech and VC departments: Over 40

Heads of department: Atir Jaffe, Guy Lachmann, Yael Baratz

Notable clients (startups, growth companies, VCs, angels): Among our notable clients we can mention: Playtika, WSC Sports, ,Medi-Tate, Lusha, AP Partners, SOMPO, NTT, Grupo Bimbo, Telefonica, JVP, Deel, Connatix, BrainQ, IN Venture, Singular, ZenGo, Fusion, C2i Genomics, Duality, Pixellot, Sharegain.

Notable deals in 2020-2022:

As part of our extended relationship with our clients, we can mention several deals during these past years:

• Cyarx Ltd. (Siemplify) M&A – sold to Google
• Datum Biotech and Datum Dental M&A – sold to MIS for more than $100M.
• Semperis C Finance Round – of more than $200 Million (investment and secondary)
• Medi-Tate M&A- US$ 210 Million for ~83% of the share capital (Company’s Valuation ~$300M)
• Lusha Systems Ltd.- Financing round with overall value of up to US$205,000,000 (primary and secondary investment) (Company’s Valuation ~$1.5B)
• Connatix Holdings Inc. in its acquisition by Court Square.
• WSC Sports Technologies Ltd. in its $100M raise Series D round
• Sharegain Ltd. in its $64M Series B round.
• Sandymount Corp. in its acquisition by Alpha Laval Holdings
• C2i Genomics Inc. in its $100M convertible financing round.
• Acquisition of: Convexum by NSO, WIND by Yandex, Waycare by Recor, Deepcube by Nano Dimension

Following the SPAC and IPO boom in 2021 - What trends are you expecting for the upcoming short and medium-term?

Atir Jaffe, Partner in the Hi-Tech Practice Group at Pearl Cohen's Tel Aviv office: Although those high valuations may bring a certain cache, and we will probably continue to see higher valuations for emerging category leaders, most likely only a few of these high valuation’s companies will grow in accordance with their valuation. We believe that we will see more investments, but not in the same volume, and that SAFE’s will become the preferred method for raising capital.

Will we continue to see funding rounds at the fantastic valuations we saw last year? Why?

Guy Lachmann, Partner in the Hi-Tech Group at Pearl Cohen’s Tel Aviv office: We actually anticipate a decline in tech company valuations and in investment round sizes. From what we feel, the market has reached its top around the beginning of 2022 and has been slowing down since. In a way, this slow-down should be seen as a positive phenomenon, since the fantastic (and in some cases inflated) valuations we saw in 2021, could not continue for long. Investors today are far more reluctant to invest in 2021 terms and companies find it harder to secure funding than before. Nevertheless, VCs and other investors have managed to secure a very large amount of money over the last 2 years and will have to deploy these funds, albeit taking a much more careful approach. We anticipate the sector to be affected the most would be late-stage companies, where securing massive amounts of money to continue supporting growth would become a very challenging mission. Lesser impact is expected on early stage, also given the gush of new angel investors and high-net-worth individuals who entered the investment circle.

What is the most important process Israeli high-tech has experienced over the past two years and where does it leave the industry?

Lachmann: The market has experienced various processes in the course of the last two years, some of which will have a very long-term impact on how business is done in the Israeli tech industry. Firstly, the move to hybrid and in some cases full remote work in tech companies have changed the common HR concepts, the aspects tech employees look for in their job positions and work environment and the way teams are structured and managed. These are bound to stay and will also have an impact on ancillary industries supporting the core hi-tech sector. Secondly, employee recruitment and retention has become a major challenge, also considering the booming investment market and huge fundraisings by tech companies. Employee loyalty is at its lowest level in years, software engineers and other hi-tech professionals continue to move from one position to another and fewer look for establishing long-term career positions. Thirdly, Covid has made Israel much more global, and tech oriented than before. It could help the local industry position itself at a much stronger place globally, paving the way to many other countries in which technology is less well-rooted than Israel.

What are the business/cultural/economic differences between Israeli and foreign VC investors?

Inbal Perlstein-Mandelbaum, Partner in the Corporate and Licensing Groups at Pearl Cohen’s Tel Aviv office: Israeli based VC’s typically invest in earlier stages, due to their investments size and their familiarity with the market. Their key advantage is their ability to meet most companies early on and assist with connections in the local market (such as connecting people/building teams). However, they tend to be aggressive in negotiations and highly involved with the day-to-day operations (either through BOD representation/Veto rights).

In contrast, foreign VC’s usually invest at growth stages, writing larger checks. Foreign VC’s (due, in part, to their size) are not as involved in daily operations and in some cases may not even request BOD representation. They are, however, very instrumental in connecting their companies with industry leaders, key personnel and clients abroad".

Why aren’t there enough Israeli institutional investors in tech? How should they be encouraged?

Jaffe: Israeli institutional investors are limited in the amount they charge as management fees, we believe that if the limit will be removed or at least reduced, it will be possible to invest more in this area.

Are there any sub-sectors that seem riskier to you (saturation in cybersecurity, metaverse not mature enough, ICOs, etc)?

Lachmann: Metaverse is the new buzz word covering blockchain and other related areas, it is indeed risky given its ever changing legal conditions and continued lack of clarity relating to regulation. Israeli companies operating in these areas will continue to have a rough ride trying to operate and manage their business from Israel given unfavorable and unfriendly regulation and banking system. We do not necessarily regard cyber security as a risky sector, and the ability to raise money to startups operating in this field remains high. Digital health, although being super popular, sometimes involves revolutionary technology and concepts, some investors find harder to digest. These companies may require increased efforts to raise money.

What is the most important thing an entrepreneur should focus on when selecting a law firm?

Jaffe: The entrepreneur needs to choose a lawyer whom he can establish a personal relationship with, like other teams’ members at the beginning of the journey. In addition, the lawyer he chooses has the required skill that can help such entrepreneur to connect with other investors and potential funds and who has professional abilities to handle the company (including in the company's intellectual property) from the day of its establishment, through its development and growth via fund raising rounds and commercial agreements and, if applicable its “Exit” (via M&A, IPO, SPAC etc.).

What are some basic mistakes made by entrepreneurs?

Lachmann: Many entrepreneurs neglect the legal aspects involving their startup, triggering in many cases tax, IP and corporate problems. Others postpone for too long the time in which they form their companies, intensifying these tax and IP issues. We see entrepreneurs who avoid signing founder agreements with their partners, without understanding how critical these agreements are and how carefully they should be drafted. Other mistakes involve choosing wrong investors, without sufficient due diligence or understanding of the impact these investors would have on their lives after they invest. We also see entrepreneurs structuring investment deals inefficiently, avoiding the use of easier and more modern methods for early-stage funding.

What are the most important parameters for a law firm when deciding to represent an entrepreneur in a deal (product, paying customers, entrepreneur’s previous experience), and what would be a reason to turn down an entrepreneur (if any at all)?

Lachmann: Tech lawyers must value the ability of an entrepreneur to raise funds, as a critical component when deciding whether or not to represent him or her. In many cases, lawyers spend less time understanding the business of their clients, its risks, and challenges prior to being engaged by them. In many cases, lawyers representing tech companies must be well versed in VC industry trends, in the way VCs think and operate and on their investment preferences, in order to better assess the risks involving their representation of each startup. In many cases, the decision on whether to represent one startup or another is based on utter gut feeling (which is hopefully based on vast experience). Startups seek legal representation at a very early stage of the process, and when engaging law firms very seldom move from one to another. Therefore, parameters like paying customers, market size etc. are less relevant, while strong and experienced founders play a major role.

What are the most crucial stages of a deal?

Oded Kadosh, Partner and Chair of the Corporate & Licensing Group at Pearl Cohen: Every deal has its crucial stages, however these change from one deal to the other depending on various parameters, from the type of transaction, though the terms and relevant parties. In mergers and acquisitions, for example, it would be crucial to understand the expected waterfall right at the outset. Delays in defining the way it should be calculated and handled throughout the deal and post close could trigger significant difficulties at a later stage. Venture capital financing transactions, on the other hand, many times amend the corporate governance of a raising company, therefore addressing such parameters is crucial to be done as early as possible in the deal. Most deals, however, have a crunch time during the days before closing and sometimes the period between sign and close. During these periods issues might pop up either due to market trends, other deals or internal changes at a party level, all the way to late due diligence findings and new regulatory impacts. Possessing the right attitude and relevant experience is key to cross said crucial stages.