Every now and then, I meet a hardworking founder with some great tech. But I know I’ll never invest in their business.
Despite founders’ best intentions, some companies develop serious problems. Those problems can make a startup untouchable for investors.
We put those companies in the “too hard bucket.”* And we move on to the next deal.
Let’s run down a few of those nightmare scenarios so you can avoid them!
Debt
I recently saw a cool early stage company addressing a big market. I was interested — until I found out they were almost $1 million in debt.
Early stage companies must avoid debt like the plague. It will weigh your company down like nothing else.
Investors will not touch an early stage company with debt. We want our capital to fund new growth — not pay for past mistakes!
For companies like this, the best option may be bankruptcy. Into the “too hard bucket” it goes.
Cap Table Problems
Cap table problems won’t bankrupt you, but they will stop you from ever raising a dime of venture capital.
Some startups give a huge slice of equity to a dev shop or venture studio. If someone other than founders and investors own 40% of the company, it cannot be financed.
The founders own way too little to be incentivized. And if they’re not incentivized, how will we make a return?
Maybe the cap table could be fixed with the right agreements. But most investors will put that in the “too hard” bucket and move on to the next deal.
Down Rounds
At the peak of the market, countless companies raised at huge valuations with little or no revenue.
Now, it’s time to pay the piper.
If a company raised at $100 million, it will need around $10 million a year in revenue to keep that valuation today. Otherwise, it’s looking at a down round.
Many venture firms don’t want to deal with down rounds.
Let’s say the new price is $50 million. The founders and all the prior investors will hate the new investor for “taking away” half their paper wealth.
Who wants to walk into that situation?
So, many firms put down rounds in the “too hard bucket”. Now, the formerly hot company can’t even raise a down round.
They can’t raise at all.
Always keep your valuation reasonable. And make sure the money lasts long enough to hit your milestones.
Wrap-Up
Founders have to understand the investor’s perspective. At any given time, there are 20 deals in the investor’s inbox.
If your company has serious problems, an investor isn’t interested in how they can be fixed.
He just puts your company in the “too hard bucket”. On to the other 19 deals…
So stay out of debt, keep a clean cap table and raise at reasonable prices. That gives you the best chance of success!
What kind of companies are in your “too hard bucket”? Leave a comment and let us know!
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More on tech:
From $10 Billion to Zero — Late Stage Ice Age
*thanks to Chamath Palihapitiya for coining this term
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