Five Years Too Late

November 6, 2008

Self-sufficient is the New Sexy

Filed under: downturn, venture capital — Tags: , — fiveyearstoolate @ 5:59 pm
Stuart Ellman

Stuart Ellman

I was at a board meeting the other day and a portfolio company CEO surprised me. I was concerned that it was taking a little longer to sign up a key partner and therefore we would run short on cash. The CEO told me that he will never run out of cash. Not only has he run the company incredibly frugally, but he is only going to spend money when he is able to get that cash from revenues. In the short term, he will take on some consulting assignments that are relevant to his core business. Wow. This is music to my ears. This is a CEO that lived through the 2001 crash and knows what it is like to raise money during times like these. To VCs, this is incredibly appealing… even sexy.

Another CEO was telling a different story and not hearing what he wanted back from his investors. He has done a terrific job growing his company, the leader in a new and sexy space. He doubled his revenues last year and will double them again this year. His problem is that his company burns (and will continue to burn) a lot of money. He went out to market and assumed the environment would be easy given how great he is performing. But, as a very knowledgeable source said, many VCs are just out to hurt their friends right now. People only want to put new money in a deal at washout and vulture-like prices. I keep getting calls from other VCs to join them in deals at $0 pre-money valuations. Wow, I haven’t heard calls like that since 2001. So, this unhappy CEO is getting back indications of interest, but only at punitively low prices. As a result, he is looking to his existing investors to do the round. The problem is, existing investors do not have enough money to fully fund the company. Don’t forget, VCs also have time limits, percentage limits, and dollar limits on existing investments. That is not a happy boardroom. It is about as appealing as sitting in a middle seat on an airplane next to a smelly guy.

Right now, growth is not sexy if it’s accompanied by a high burn rate. To navigate through this climate, every CEO needs to perform a simple analysis: First, how much money is in the bank (not including debt)? How much runway does this give you at your current operational posture? And what are you going to do about it?

  • First choice, get to cash flow positive on that money.
  • Second choice, get the cash to last for two years..
  • Third choice, see how much money you can gather from existing investors to get to cash flow positive.
  • Last choice, go to outside investors to get the additional money. Yes, there may be exceptions to the rule, but it is not a pretty market for companies with a high burn right now, period.

If there is one thing etched into my memory from the last funding drought, it is that CEO’s always wished they had cut more deeply earlier. A company with 70 employees will think it is cutting to the bone if it goes down to 50 employees. “I just cant go any lower without killing the business.” That is true until they then cut to 35, and then to 25 employees. At 25 employees, the CEO always wishes he had done the hard cut earlier and saved the money and uncertainty. Yes, it is not fair to have to cut a company that has performed well. But, when markets change, you have to do it. Great CEOs have failed because they have not reacted appropriately to changes in the funding environment.

So, hear it from me, or hear it from the markets soon enough. Become self sufficient on the cash you have. Even at the expense of growth. Frugal is sexy again.

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  1. When your existing investor’s standards contradict your goal, you may be able to use an audience to push your existing investors to re-invest.

    Let’s say the investor’s position is “we can’t invest because we have time limits, percentage limits, and dollar limits on existing investments.” And your position is “I want you to re-invest.”

    How do you get the investors to use a different standard? Use an audience. An audience is a third party “to whom your bargaining counterpart is answerable and who is sympathetic to your norms.”

    For example, I know of one situation where a well known angel investor has invested in a company whose VCs are being slow to re-invest. By negotiating in the angel’s presence or under the angel’s protection, the management team attempts to apply the angel’s standards (you should re-invest) to the situation.

    The VCs are answerable to the angel because they want to keep getting the angel’s dealflow. They also don’t want the angel to damage the VC’s reputation.

    More about using audiences:

    Comment by nivi — November 6, 2008 @ 7:33 pm

  2. […] a comment » Stuart Ellman of RRE Ventures just made a great post on his FiveYearsTooLate blog about the venture environment we’re currently facing, including […]

    Pingback by Bringing (self-sufficient) sexy back « Yet Another VC Blog — November 7, 2008 @ 1:13 pm

  3. What about the Cap M model?? Yadda, yadda, yadda.

    Comment by Philip Spencer — November 7, 2008 @ 11:11 pm

  4. […] How to use an audience to get your way when you’re negotiating. […]

    Pingback by Venture Hacks — VH Twitters: “Write a blog, not a business plan.” — November 8, 2008 @ 12:59 pm

  5. […] Self-sufficient is the New Sexy […]

    Pingback by Making the pie bigger « Yet Another VC Blog — December 30, 2008 @ 12:40 pm

  6. […] Self-sufficient is the New Sexy […]

    Pingback by Why most venture capitalists won’t invest in consulting companies « Yet Another VC Blog — January 15, 2009 @ 9:39 pm

  7. […] with the latest content. Now, on with the regular content…Thanks to Usman Sheikh for pointing to this article… the situation Stuart describes is both shocking and also described in an engaging way. […]

    Pingback by Startups: Become self-sufficient, even at the cost of growth : Green & White — October 21, 2009 @ 6:32 pm

  8. Amazing! Its truly amazing article, I have got much clear
    idea concerning from this piece of writing.

    Comment by canon tech support — January 24, 2020 @ 8:27 am

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