30 West 3rd

Very Early Stage Technology Investing

Keep your company from growing hair…

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Over the last few weeks I’ve watched one of our prospective investments regress into an uninvestable situation.  It has happened more than once in the two years we’ve operated.  I’ve noticed a few common behaviors that seem to emerge in the funding process that make the deal grow hair.  Deals with lots of hair just don’t get done.

The most serious mistake is spending as if the new capital is already in place.  Raising money, from first conversation to closing, is at best a 90-day process, usually much longer.  Occasionally a company begins to spend ahead of the investment.

This is often done by deferring salaries or taking in capital willy-nilly without investor input or approval.  Sometimes there is even an expectation that an institutional investor will pay back this short-term debt out of proceeds.  It would be rare for this to happen, and it will not happen at all if the investor group is not brought into the conversation.

Taking on short-term debt, running up payables, deferring salaries, and creating other unwanted balance sheet items are negatives for the new investor.  First, they demonstrate that the current leadership is not focused on a critical element of running a start-up:  managing working capital.

The entrepreneur can assume that any debt taken on prior to institutional investment will at best be converted into the terms of the investment.  Any debt taken in after the conversation starts with investors should be discussed with those investors to ensure they agree with the spending.

The easiest way to avoid all of these problems is to spend frugally, treat even your friends and family investors as if they were experienced angels, and start raising money at least 180 days before you need it.  And during the investment process make sure you have a contingency plan for existing without cash, or a shutdown plan.  In today’s environment investors are very selective and may go fairly deep into a diligence process before deciding to pass.

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Written by Mike Venerable

July 4, 2009 at 4:52 pm

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