With investors and entrepreneurs ratcheting down their valuation expectations in the wake of the public equity market ‘repricing,’ an inconvenient truth is becoming a recurring theme in venture-backed startup boardrooms – that lofty valuation of the last round of venture financing is suddenly indefensible, irrespective of the company’s best efforts to perform to plan. That coveted outside lead investor willing to pay a big premium to back your high growth startup has suddenly developed ‘alligator arms’ which can’t quite seem to reach into those proverbial deep pockets. The CEO’s blood pressure is inversely proportional to their dwindling cash balances as investors preserve resources to weather the storm and board room discussions become more acrimonious than a presidential debate. The game plan is threefold (protip – you’re going to need all three ingredients):
1. Adjust the revenue and spending plans to defensible levels. Virtually every business plan that my partners and I have reviewed over the past two decades has been described as ‘conservative,’ and yet 90%+ of companies fail to hit plan. Forecasting is tough stuff – do your best to err on the low side to avoid needing to come back to the board for more cash when you are behind the plan. It’s a balancing act of showing enough growth to get funded and not so much that you have no chance of hitting the numbers.
2. Increase your bank credit lines. Banks are a good source of inexpensive accounts receivable financing which can be an important financing tool. Don’t over-estimate how much availability you’ll have when you need it as my experience is that only 5% of working capital lines are drawn at any given time due to covenant and borrowing base constraints. If you decide to take term debt from a bank, be aware that it comes with Material Adverse Change Default (“MAC”) provisions which make the loan callable when you are most in need of the cash. Those entrepreneurs and investors who have never been through a down-cycle are about to get an education on MAC clauses – don’t risk being one of them.
3. Evaluate venture debt as a part of the solution. Venture debt is enticing – it’s a large source of cash, and it avoids having to do a down-round which is painful for VC’s and management teams alike. Thoughtfully structured, it can be useful to help a team bridge a business plan to a valuation inflection point. Cash reserves and committed capital in venture debt funds are at record levels, and most lenders feel pressure to deploy capital. At the same time, demand for venture debt has spiked in the last two-quarters. It’s more important now than ever to consult with a long term committed venture debt partner that you trust to work with you in good times and during the inevitable hiccups.
Eastward Capital Partners