Bataan Death March

The venture business runs between the goalposts of greed and fear. This is no more apparent than during a funding event. Entrepreneurs are often puzzled by why another company’s funding erupts into a feeding frenzy, while their fundraising drags on like "the Bataan Death March." While no one can ever capture all of the intangibles, here is my stab at a couple of drivers:

Scarcity is king: like with any other asset, people tend to want something more when it is popular and they may be prevented from getting it. During a financing, this happens when there are active parties doing due diligence and generating term sheets. Scarcity is enhanced by several factors:

• small raise amount…less available, less for new investors
• strong insider interest…if Mikey likes it, the cereal must be good.
• leave room for one at the table…if only one new investor can get in, they can’t collude since they are now all competitors for the one slot. This eliminates their ability to coordinate their attack and drive price down.

Financings, like fish, smell after a while: you can sometimes generate strong interest and buzz initially during a financing. However, if investors fail to advance the ball or, worse, begin to turn down the deal, it begins to go stale. Word gets out when lots of groups have looked at a deal and turned it down for the same reasons. Eventually, it is like the guy that all the girls at school turned down for the prom. To prevent this, use a rolling prospect list. Don’t go to all 25 potential investors day one. Go to the top 5 and see how they respond. Begin to tee up the next 5, but only engage a handful at a time. You won’t be able to service everyone at once. As they start to drop out or slow down on you, you can add additional names.

Where’s the beef?: without a forcing mechanism, investors will hover like vultures waiting for something to happen. Often, companies will try to create a pseudo forcing event by telling investors that they have a term sheet in hand. I recommend only doing this if you have a term sheet, while not optimal, you would be willing to close on (because you may have to). New investors will do one of three things. One, do nothing, waiting to see if you are bluffing. If you are bluffing, you are now officially screwed. They will assume you are so desperate that you are resorting to lying and will assume the price will be coming down. Two, back channel to figure out who the term sheet is from. They will decide if it is worthy of their throwing in a competing offer. If it is from Sequoia, then people start to foam at the mouth. If it is Dumb Strategic A or No Name VC, then they don’t really care. Three, shut down their process since they have too far to go on their due diligence and won’t make it in time.

Three’s a crowd: following up on the last point above, make certain when you start the herding process by announcing a term sheet, that your potential other suitors are far enough along in their process. You want to try and keep the various parties at roughly the same place in their due diligence processes so they all feel motivated to dive into term sheet at the same time. You need at least three players throwing out term sheets to run a solid process. When you start with only two, one of them is likely to drop out for some reason. This leaves you negotiating without a back-up and it will show through eventually.

Raise when you want, not when you need: any investor can look at your balance sheet and cash flow statements to figure out how much runway you have. The worst cluster *(&^#’s I have experienced are when the company is burning significant amounts of cash, insiders are tapped out and there are only a few months of cash left. Investors know that when you hit the wall, they can get you for pennies. Ironically, once you hit the wall, very often, they will not jump in since you are truly damaged goods at that point. If they do jump in, you will be squeezed mercilessly. So, keep the burn under control and stretch out the runway. Make certain your insiders have dry powder.

Listen for Key Themes: when you hear back from the first batch of investors, determine key themes and impediments. Make certain you have answers in place to address these. Do not go the defensive route and say "these stupid investors just don’t get it. Why is it called venture capital if they want all of the risk out of the deal." Whatever, the reason, the consumer is always right and if enough consumers come to the same negative conclusion, you are tarnished regardless of reality. Don’t let lightning strike twice. If your pitch is disorganized or conveying the wrong points, fix it. If they want to see more customer traction, it might make sense to hold off the financing process a touch and get a few more customers in place. If they don’t like your burn, reduce it and get your financials under control more.

Intangibles that drive a strong process:

• Market position/rank: everyone loves a champ. If you are #1 or #2, people are interested. If you are further down the food chain, someone has to find something special in you to love.
• Proximity to exit: if investors can taste and see the exit, they are more likely to jump in and to price based off of that assumed exit value.
• Attractive analogs: investors will put you into a given category. They will look at other companies in that category and see if they like it or not. Telecom equipment is not a good category but a sexy 2.0 (for now) is more interesting.
• Strong economics: good margins and sales momentum.

In short, you have the ability to control your destiny. Be prepared for the investors not to come in and make certain you have your plan B in place. Knowing this, you will appear and negotiate with more confidence and avoid being lumped in with the kid without a prom date. Manage your burn, your dry powder and your milestones to make certain you don’t end up over your skis too far. And, try to drive scarcity into the process. Small investor allocations, strong business momentum and multiple stalking horses (or self-sufficiency) all lead to peaked investor interest. Avoid bluffing and fake forcing mechanisms as they always seem to backfire and make you look like a naive amateur. Don’t believe your own hype (manage your alternatives religiously) because financings can go cold quickly overnight. If investors smell blood, you will find yourself in a painful Bataan Death March.