Cash, capital and conflicts: a VC startup survival guide
Published 25/02/2016 | 02:30
The Irish Venture Capital Association's recent Venture Pulse Survey for 2015 showed a substantial increase in the level of capital being raised by young Irish companies. While this is encouraging, it would be a mistake to expect it to automatically continue. Recent months have shown that the global venture capital community is not immune to negative macro-economic developments. There have been sharp falls in stock markets and commodity prices while there is continued uncertainty surrounding the future of Europe.
Many companies and investors we work with don't assume that further funding will be readily available once the cash raised in 2015 has been spent. While the circumstances for every firm are unique, five rules are generally applicable to most young companies who have raised - or hope to raise - venture capital in this climate.
1. Respect your cash
There is a conflict between your ability to grow rapidly and conserving your levels of cash. Your investors expect you to grow your business exponentially. This will likely require significant expenditure on product development, recruitment and marketing. But until your company becomes sufficiently cash flow positive, the faster you spend your cash, the sooner you will need to return to the venture community for more of their capital.
As that capital starts to become more scarce, consider whether you need to adjust your approach to fostering growth versus conserving cash.
2. Know your investor
Does your current investor have the necessary funds at its disposal to re-invest in your company? Most investment funds have a pre-defined life-cycle for (i) raising their funds (ii) investing those funds in companies like yours and (iii) disposing of those investments, hopefully for a profit. What stage is your investor at in this cycle?
If they are in the final stage, is it reasonable to assume that they will have the resources available to continue to invest in you? Even if they have the necessary funds, do they still share your vision for the business and have faith in the management team to execute your strategy?
If not, you need to start exploring alternative sources of funding quickly and, in the meantime, lengthen your 'runway' by slowing your cash burn.
3. Leverage your VC
If you chose wisely (or got lucky) when picking your existing investor, you selected them not just for their capital but for their experience in your sector and their industry contacts. Make the most of this now. Most investors prefer to see fellow investors involved in your company as it both validates their decision to back you and provides an additional potential source of capital and network of contacts. Ask your VC to help you identify other potential funders and, if appropriate, to make introductions.
4. Be prepared to adjust your expectations
Capital is no different to any other commodity when it comes to the laws of supply and demand. The less availability there is, the more it costs. If we are moving into a phase where venture capital becomes increasingly scarce, expect to have to 'pay' more for it by achieving a lower valuation for your company than you might formerly have hoped for. But beware of 'down rounds' - check the legal agreements you put in place with your existing investor to see if they will become entitled to some form of compensation if you raise money at a low valuation. If this is the case, start a discussion with them now about whether this is something they would be willing to waive, even partially. Their reaction will help inform your approach to your next fundraising.
5. Don't Delay
The fundraising process can be an unwelcome distraction from your core goal of building your business. Inevitably, it will prove to be a drain on management resources. It is tempting to ignore the reality that you are going to need to go through it again. But by leaving it until you are nearly out of cash, you are eroding your bargaining power with your investor who will know you are desperate for their funds. It is amazing the number of times we are told, as advisors on a VC deal, that the company needs to close the deal asap or otherwise it will be unable to make payroll at the end of the week or month.
There currently appears to be an abundance of Irish sources of venture funding for promising young companies. The Venture Pulse Survey reveals that this was matched last year by increasing interest from international funds.
However, global trends over the last three to six months indicate that the international venture capital market might be entering a period of relative weakness.
When coupled with the fact that many large Irish funds are at the end of their investing stage and are embarking on their own new fundraising rounds, it is not far fetched to expect that 2016 could prove to be a more challenging fundraising environment for young Irish companies.
If this turns out to be the case, by following the above rules you will ensure that you are in the best possible position to negotiate your next round of finance.
Stephen Keogh is a partner in William Fry's corporate department and is head of its London office