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Eat When Served

May 2, 2011

Brad Svrluga

There has been no shortage of Bubble Talk of late. Investors and entrepreneurs alike are running around trying to figure out if the world has fundamentally changed, if the sky is about to fall, or somewhere in between.  Every venture industry blogger worth his salt chimed in over the past two weeks, so I’ll skip that party.

Given the state of the markets, though, I think it’s important that every company consider how you are reacting to this environment. There is a ton of capital out there, and for good companies, the process of raising money has never been easier. If you’re a company that’s due to raise money now, you lucked out. Congratulations.

But what if you don’t need to raise money now? Are you just unlucky to have missed the cycle? Not at all. I think we’re all lucky to be operating in this market. Every company needs to think hard about its balance sheet and be thoughtfully opportunistic, while resisting the temptation to get greedy.

As we talk about the impact of this market environment on decisions we make within our portfolio at High Peaks, I am guided by a simple but powerful three word mantra I heard from a fellow VC about ten years ago, not long after I first got into the business:

EAT WHEN SERVED.

In short, if the market wants to give you money on good terms, you should think hard about taking it, whether or not you need it.  If we somehow had perfect information about where we were in the greed part of the fear/greed cycle, it would be easy to optimize financing strategy around market swings. Given that we don’t, I’m here to tell you to go get the money now.

The point is, we don’t know when this party is going to end, we just know that it will end. I’ve seen capital markets seize up before a couple of times, and I’ve been caught flat-footed each time. I’m not in the mood to let that happen again.

So our companies are going to start eating. My partners and I are actively counseling all of our companies that have a good story to tell and anything less than 24 months of cash on their balance sheet to start talking to investors about raising more money.

But wouldn’t companies that can afford to be better off waiting another 9-12 months, making a bunch more progress, and then raising money at a much higher valuation? Some simple analysis makes my answer – NO! – quite clear.

Consider the possible outcomes of a company raising money in today’s environment; perhaps a year before its cash flow forecast suggests it needs to. Let’s evaluate likely outcomes as determined by (pardon the oversimplification) the two variables that drive financing success – (1) conditions in the macro-level financing environment and (2) the micro-level performance of the company. In the 2×2 below, the four outcomes compare raising that money now vs. waiting 12 months, when the company will have less money on its balance sheet but more data about its performance.

Comparitive Outcome of Raising Money Now vs. Waiting 12 Months

Company Performance in 12 Mos.

Weak

Strong

Financing Environment in 12 Months

Strong

Better

Somewhat Worse

Weak

Much Better

Neutral-to-Better

There is one possible outcome where the company is worse off for raising money today vs. waiting 12 months.  If the financing environment stays strong and the company performs well, the company probably would’ve been able to raise money on better terms in 2012 than it will in the next few months.  So you took more dilution by raising now. However, if either company performance or the financing environment get weaker, you are perhaps substantially better off for raising money today, and not worse than neutral.

Of course, every company situation is different, and the scientific approach would be to assign probabilities to each of the four variables in the 2×2, come up with expected outcomes in each cell and, whammo, you’d have a clear answer what to do. Problem is, while we may be able to make some quasi-intelligent predictions about company performance, we simply cannot know what will happen in the broader financing environment. Looking simply, then, at the four outcomes, in three of them we’re neutral to much better off for having raised the money now, and in one we’re likely somewhat worse off.

Based on that simple analysis, the prudent move is clearly to raise money now. And while we could perhaps do some analysis that would estimate the probability of each of the four outcomes, it’s not worth the effort. First off, you’d need some remarkable circumstances to leave that “Somewhat Worse” outcome box to be >50% likely (probably including near 100% certainty that company performance will be strong). Even more importantly, just remember that not raising capital now and guessing wrong on future performance could lead to fatal balance sheet challenges down the road.

So as we work with our portfolio, we’re getting to work trying to beef up our balance sheets wherever we can. We have little to lose, and a whole lot to gain. As we start those processes, we retain the option of feeling them out and stopping. We don’t need the money, after all, so if we don’t like the signals we’re getting from the market, we can always pass and come back when our story is even stronger.

There’s nothing like raising money when you don’t need it to swing the negotiating leverage in your favor. And even moreso, there’s nothing like a macro financing market that’s in the mood to serve up big helpings of capital. Put those two together and we should see some good outcomes.

If you’ve got a company with good momentum in an interesting sector, the capital markets are probably eager to feed you right now.

Please, take my advice, and eat when served.

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