The 3 Things Venture Capitalists Say All Startups Must Do

The 3 Things Venture Capitalists Say All Startups Must Do

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Venture capitalist Bill Gurley thinks unicorns are in for a rough ride in the months ahead. He wants other startups to stop making the same fundraising mistakes.

 

The tide has gone out pretty quickly when it comes to venture capital rounds for promising tech companies.

And as so-called unicorns–private companies worth more than $1 billion–struggle with lower valuations, less potential investor cash, and more demanding investors in follow-on rounds, it should be a word of warning for startups of all kinds.

So says Bill Gurley, partner at VC firm Benchmark of Menlo Park, California, who on Thursday posted a lengthy blog post on the new world of venture capital investing for startups as he sees it.

He painted a picture that’s not very pretty. The environment has changed radically for highly valued unicorns that have depended for years on follow-on rounds of financing to grow and stay afloat. Gurley suggests financing will be harder to get for everyone, with ever more draconian terms and investor guarantees attached to the money, via what he calls toxic term sheets.

What’s more, a sudden price panic could set off an investor race for exits that could destroy some companies.

“As fear of downward price movement takes hold, some players in the ecosystem will attempt a brisk and desperate grab at immediate liquidity, placing their own interests at the front of the line,” Gurley says.

These are not entirely new concepts. In fact, John Backus, managing partner at New Atlantic Ventures, wrote about something pretty similar in late 2015.

The concerns of private companies valued in the multiple billions of dollars might seem light years away but should serve as cautionary tales, Gurley says.

Here are three things that Gurley and other VCs recommend any startup with big growth aspirations should do right now.

1. Focus on making money. In fact, do whatever it takes to make sure your company is cash-flow positive. “Achieving profitability is the most liberating action a startup can accomplish,” Gurley says. “Now you make your own decisions; it will also minimize future dilution.”

2. Keep it clean. If you plan to raise money from venture capital investors make sure you get a clean term sheet, not one that could trip you or your other investors up later. So-called dirty term sheets might include demands for ratchets –which essentially require the company to make up the difference between an earlier valuation and a later lower valuation — or liquidity rights. If getting a clean term sheet means taking money at a lower valuation, so be it.

Part of the problem now, says Ross Fubini, a Silicon Valley investor and former partner at Canaan Partners, is that many of the highly valued unicorns can’t exit.

“Companies that can’t exit need capital, and they have to make a decision between taking money with massive pain later, or pain now,” Fubini says.

3. Go public. Gurley says an intitial public offering is the best way for startup founders who get venture capital rounds  to protect themselves and their own workers. Until an IPO, Gurley says, common shares sit behind investors’ preferred shares. “If you really want to liberate your own common shares and those of your employees, then you want to convert the preferred to common and remove both the control and the liquidation preference over your shares,” Gurley writes.

In short, Gurley and other investors urge getting back to basics.

“The reason we are all in this mess is because of the excessive amounts of capital that have poured into the VC-backed startup market,” Gurley says. “The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.”

 

[Inc]

April 25, 2016 / by / in , , , , , , , , ,

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