If you invest in startups, you will get some zombies in your portfolio. I have a few. They stink. If you are a fund manager they stink because you can’t wind up your fund and pass the tax loss to your LPs. If you are an angel investor, you’d like to take the tax loss but can’t because the company just limps along.
Sometimes startups are so cutting edge and so far ahead of the pack that the educational hurdle is too high for them. Customers don’t “get it”. They do a sales presentation and the customer is full of questions and interest but isn’t really hot to integrate the startup into their workflow or supply chain.
I invested in Tallgrass Beef way back in 2005. It was tuition as the company never made it and one of the reasons why was the educational hurdle. There were plenty of other reasons why as well.
I know companies that have so many convertible notes on their capitalization table that there isn’t much equity in it for the employees, and the investors don’t have much hope of getting any money back. By the way, because you have to pay interest every year on that note, each year that goes by drives the must-have-to-earn-return acquisition price up a little bit. Plus, you screwed yourself with VCs that don’t want to decipher a capitalization table like that.
Right now it is a horrible fundraising environment. I don’t think we have hit the “the economy is so bad that finding and funding early-stage startups will create big winners” part of the economic cycle yet. We are still in a downtrend and I don’t think we get there for at least two years. One of the reasons we didn’t raise another fund at WLV was the overvaluation of every single company we looked at. It would have been a disservice to LPs.
However, a friend sent me some data from CB Insights that shows valuations are down 20-30%. By the way, I don’t think that is enough “correction”. I am so old I remember doing Series A rounds at $10MM or less. I was chatting with a startup that did their Series A at $80MM…..all I can say is they better perform and live up to it.
If your company still has a burn rate and isn’t cash flow positive, you are going to find the current fundraising environment challenging to say the least. It’s hard to tell the story of “we have been at this a long time but gotten nowhere except we think that good times are around the corner” to investors who are more than willing to sit on their hands.
You won’t be seen as a “great CEO” just because you weathered the storm and have eeked out a survival strategy.
I have seen companies cut staff and cut expenses while claiming to be cash flow positive. They don’t have big growth in their top-line revenue though. I call this the “Monty Python Black Knight Strategy” of growth. It’s not a strategy for growth. You aren’t building a venture company you are building a small business or a consulting company. The Black Knight Strategy is a strategy to get yourself to Zombiehood.
For those not old enough to have enjoyed the exploits of Monty Python, here is the clip. This is back in the days when we had good humor everywhere. Watch some old Richard Pryor clips too.
If you find yourself as CEO of a startup that has been in business for 5-10 years, and you are still trying to raise money on convertible debt notes so “the market can catch up” or “we can figure it out” there are two actions you need to take.
Resign as CEO. It’s pretty clear you can’t lead a company to the promised land. You have raised money a couple of times and you had a chance. If there is truly a great idea there, someone else needs to take a shot at it. I had a company like this in my angel portfolio and the second CEO earned us a nice 7x return.
Bring in a COO that has done it before and give that person full control while you become the “idea person”. The COO decides if your ideas fit into the overall strategy and implement them. The COO brings in their hires, and you take a very large step back.
Sell the business at a price. It might not be acceptable to you and you might not make money but if investors get break-even money back or better, it’s a win.
Sell off pieces of the business. Maybe you have developed one thing of value that some company might buy and run with. That gets investors a bit of money and allows you to wind down the business.
Exit the business and wind it down. Go out of business. Thank your investors for their support and let them know that you wished it would have gone differently but sometimes these things don’t work out. Good investors will understand that and they will appreciate getting the tax write-off. Failure is a part of the process.
We are entering the “harvest your losers tax selling season” of the year-long stock market cycle. If you are a startup CEO, you need to take a look in the mirror and really objectively analyze where your company is at, and if you are the right person to take it to the promised land. You also need to think about if it can even get to the promised land. If not, see above.
I’d say we are in the beginning of a major downturn. I heard of a survey where some 1/3 of small businesses didn’t make rent payments last month. That does not portend well for commercial real estate, which is usually second to fall after residential. Next will be layoffs, then closures and then the real pain will set in.