BUSINESS BLOGS
BUSINESS BLOGS
category: business
05 Jul 2009

If you think the lack of IPOs scare venture capitals and threaten their existence, I can see another darker cloud lurk around the corner.

When the economy went off the rails, I said that VCs would soon realize that their limited partners would not be able to meet their future capital calls.  Afterwards, VCs would force companies to shut down so the VCs could repatriate whatever funds were left over. Read more here or here.

Turns out that was the case.

Today, with asset prices falling and the economy resetting, the reality is that the most recent financing round that most startup did was done at a valuation that, how can we say, was a bit too aggressive.

Back on September 30 2008, two weeks after Lehman filed for bankruptcy, Tech Crunch penned a list of companies it deemed were best positioned to weather the downturn.  This was dumbing things down, because the list was simply running down companies that had raised the most amount of capital.  In other words, the list was over-simplifying matters, because not knowing what the funding valuations were at, the companies’ funding were somewhat irrelevant: if their financial overlords no longer felt the companies could provide the home run-like return (on their most recent valuation), then the companies might be shut down.

Today, a full nine months after the economy went off the rails, there’s no real sign of of recovery.  Yes, the stock market is up 25% from the all-time lows, but for most startups, they are and shall remain under-water from a valuation perspective on their last funding round.  Exasperating matters: most projections prove bullish in hindsight, in the past year, those projections seem absurd.

This brings us to the nightmare scenario awaiting some VCs: historically it is the VCs who replace entrepreneur founders with their own executives.  But these days, if you have

- a founder who is not yet fully vested to begin with,

- a founder whose vested shares are under-water and will probably remain that way,

- a company that will require more funding, but whose valuation will be a down round,

- a company who will never really hit those projections they promised,

why on earth would the entrepreneur stay on in his position?

Why would he not resign, walk away and call a Mulligan and restart everything?  Sure, if the entrepreneur is a star, the VCs can grant additional shares, but the truth is, that won’t be material.

It might be tougher to raise capital in one sense, but in another, who cares.  As tough of a predicament as that might be, it sure beats running a zombie startup.