This article previously appeared in TechCrunch.
Cram failure is back – and I’m keeping a list.
At the turn of the century after the dotcom crash, startup valuations plummeted, burn rates were unsustainable, and startups were losing money at a rapid rate. Most of the existing investors (who are still in the business) hoarded their money and stopped watching until the debris was cleared.
Except, that is, for the bottom feeders of the venture capital business—investors who “distress” their companies. They offered desperate founders more money but insisted on new terms, rewriting all the old stock deals that previous investors and employees had. For existing investors, it was sometimes “pay to play” ie if they didn’t participate in the new financing they lost. Another time it was simply take-it-or-leave-it, here are the new terms. Some even insist that all early preferred stock should be converted to common stock. Going down is a big middle finger to common shareholders (employees, advisors, and former investors), because a reverse split occurs—meaning your common shares are now worth 1/10th, 1/100th, or even 1/1000th. Their previous price.
(A cram down is different from a down round. A down round is when a company raises money in a valuation that is lower than the company’s value in a previous financing round. But it does not come in the context of a large reverse split or change.)
They are back.
Crowdfunding has never gone away, the flood of capital in the past decade means most companies can raise another round. But now that the economic situation is changing, this is not true. Startups that don’t have a product/market fit and/or can’t generate enough revenue and/or don’t have patient capital are crunching for dollars – and bottom feeders are happy to help.
Why do VCs do this?
VCs throw around all sorts of reasons why – “It’s my fiduciary responsibility (which is BS because venture capital is a power law business, not a ‘saving every penny’ business”) or “it’s a good business” or “we’re opportunists”. They are right. Venture capital, like most private equity, is an unregulated financial asset class – anything goes. But the simpler and more painful truth is that it is abusive and usurious.
Many VCs have no moral center in what to invest in or what to do to maximize their returns. On the one hand, the same venture capital industry that gave us Apple, Intel, Tesla and SpaceX thinks that addicting teenagers is a viable business model (Jul) or destroying democracy (Facebook) is a great investment. And instead of society shunning them, we celebrate them and their return. The VC Narrative “All VC investments are equally good” Equally “All investments are equally good for society.
WSo would any founder agree with this?
No founder is prepared to see their company crumble from the ground up. There is a growing sense of dread as you frantically put in 100 hours of work knowing that unless you get more investment, years of work will be lost. You can’t sleep and are trying not to give in to complete despair. An investor comes along (usually one of your existing ones) and you propose to keep the company afloat and get you out of despair. When you hear the terms and realize it’s going to be a starter again, you’ll be gutted. He explained that this was the only possible outcome, the only way to keep the company afloat.
But then there’s one more thing – to make it easier for you and a few key employees to swallow the crap – you’ve promised to redefine (by issuing new stock in) the newly restored company. Okay, so all your previous investors, employees and advisors who trusted and bet on you get nothing, but you and a few key employees do. The seemingly unpleasant deal suddenly seemed reasonable. You begin to reason why this is good for everyone.
You failed the moral test and ruined your reputation forever.
Cram downloads are not possible without founder consent.
Stop Cram Downs
In the 20th century, terrorists took hostages from many countries, except the Soviet Union. why? Western countries would reluctantly negotiate with terrorists and offer concessions, money, prisoner swaps, and so on. The Soviet Union? Terrorists held Russian hostages once. The Soviets sent their condolences to the hostage families and never negotiated. The terrorists realized it was futile and focused on the Western hostages.
When founders stop negotiating, VCs stop playing this game.
You have a choice
In the panic of finding money founders forget that they have a choice. step up. Close the company and start another. Stop rationalizing how bad the choice is and convincing yourself you’re doing the right thing. You are not.
Chances are, most of your employees will have little or nothing left to show for their years of work after the new funding. While a few cram downloads have gone around, (though I can’t imagine) chances are you’ll never be a successful enterprise because you haven’t got enough customers at the moment. Your investors will sell your crowdfunding technology to divisions and/or use your company for other portfolio companies.
You think of a cream bottom fund offer as a lifeline, but they’ve given you a noose.
Time to think
When investors are pressuring you and you’re running out of money, it’s easy to get wound up thinking that this is the only and best way. If ever there was a time to pause and take a deep breath, now is it. Realize that you need time to put the current problem into context and imagine other options. Take a day off and think about what is currently unimaginable – what will life be like after the company is gone? What else have you always wanted to do? What else do you have in mind? Is it time to reconnect with your spouse/family/significant, declutter and get some of your life back?
Don’t get stuck in your own head thinking that you have to solve this problem on your own. Get advice from friends, mentors, and especially your early investors and mentors. There’s nothing worse than hearing about your decision to take a crap to previous investors and advisors that warrants permanently destroying relationships (and your reputation) when you ask them to sign off on a decision that’s already been made.
Being able to evaluate options in a crisis is a lifelong skill. Life is short. Knowing when to double down and when to walk away is a critical skill.
In the long run, your employees and the venture ecosystem would be better served if you applied your experience and knowledge to a new venture and took another shot at the goal.
Winners leave the field as they arrived.
Lessons learned
- Cram bottom is done by VC bottom feeders
- Taking “undue advantage” and contributing to the toxicity of the startup ecosystem
- Founders often believe that they should focus on rationality: “I’ll never have another good idea, I’ve put so much time and effort into this startup, I don’t have enough energy to do it again, etc.”
- Founders understand that it is good for their employees
- Take time to think about options
- Don’t get stuck in your head thinking that you have to solve this problem on your own
- You are burning out your early supporters.
- step up
- You can hold your head high and make another start.
- PS If you’re ready to go, chances are you’ll end up with a much better deal (if you want).
Filed Under: Venture Capital |
