Bootcamp: Be Careful with the ATM Card

The good times are back and the money is flowing. Angels are writing $3m checks, Hedge funds are writing $50m checks and VC is a low risk investment class again. Valuations are shooting up. For an entrepreneur, this should be a dream come true.

I would argue, that if not careful, entrepreneurs are setting themselves up for a fall later on as we saw in the last bubble.

There is a reason that many of our most successful tech companies were started in downturns. They had to maintain discipline and be capital efficient. When money and valuations are loose, so, often, are entrepreneurs discipline. Why should you care?

Let’s look at some recent IPO’s.
Vonage:
$ in — $396m
Post VC IPO Value — around $400m

Restore Medical:
$ in — $40m
Post VC IPO Value — $53m

Novacea
$ in — $122m
Post VC IPO Value — $93m

Pension Worldwide
$ in — $35m
Post VC IPO Value — $73m

IPO’s are supposed to be the big wins. If these are returning 1-3x, imagine the other deals.

VC’s usually invest in Preferred Stock. This means they get their money out ahead of common/founders in a sale (IPO’s are different). In fact, 74% of deals in Q1 had participating preferred which means the VC’s get their money and then participate according to ownership.

Exits have been weak for some time. Getting through a big pref stack (total $ invested) is not easy. Furthermore, if it looks like the VC’s are going to have trouble getting their money out, management’s life grows unpleasant and turnover often results.

It is difficult to show restraint when you have a war chest burning a hole in your pocket. Just be careful not to fill the punch bowl too high… On the other hand, make certain you have the long term capital you need. Remember that as tempting as pre-$ angel money is today, the road is long and hard. Projections rarely pan out. If you under-capitalize yourself by taking on a weak syndicates (e.g. not deep pockets), you risk getting crammed down or worse in downturns. Everything is rosy these days and most entrepreneurs feel bullet-proof. Just make certain that you are wearing Kevlar and not a play vest…