Kicking The Can

When it comes to investment structures, I hope that my 30+ years as an entrepreneur and VC has led to some wisdom about what works and what doesn’t because it certainly has led me to have strong opinions on the topic.  People like to say that VCs are in the pattern recognition business.  If that’s true, then today I’m seeing a troubling pattern developing around company valuations aided and abetted by the overuse of debt.

Convertible debt, SAFEs and venture debt all have their place, but increasingly, these structures are being used specifically to avoid setting a price for equity. And if there is no price, there is no all-important “meeting of the minds” between seller and buyer when the money changes hands. Yes, these vehicles make “today” easier, cheaper or more expedient – at the expense of “tomorrow.”

In other words, they kick the can down the road…

To be fair, over the years I’ve kicked more than a six-pack worth of convertibles down Lake Shore Drive, if you catch my drift. Do I feel good about it? No, but, part of the reason its good to have an experienced operator as a VC is to avoid foreseeable mistakes. At this stage of my life, experience has taught me to align interests early.  I know that when investors and entrepreneurs are aligned, both maximize returns.


Valuations are high relative to business fundamentals. What does this mean? Lots of things, but mostly it means that performance expectations are high too. The big mistake I see many entrepreneurs make is to try to optimize the current transaction at the expense of the future. Look, everyone wants to maximize deal terms, but, fundraising is not a one-time event.  You will be back at it for your next round sooner than you think.  The best entrepreneurs are the ones that treat fundraising like a game of chess, where each move sets up the subsequent moves for success.  You should always be thinking one or two moves (funding events) ahead! 

There are two things that will make your next move easier.  First, do NOT overpromise now… When you go back to your existing investors and ask them to participate in the next round, the biggest indicator of their response is how the company has performed compared to the expectations that you set in the last round.  Imagine two scenarios:

1)    You raised your last round on projections to get to $20 million in ARR but are coming in at $16 million.

2)    You raised your last round on projections to get to $10 million in ARR but are coming in at $14 million.

Even though the first scenario has more revenue, I promise you it would be easier to raise money on the second scenario as you are exceeding investor expectations.  The lesson here is sales 101 – promise just enough to get the deal done and no more. Or, said another way “under promise and over deliver.”

The second thing that will make your next round easier is if you have a reasonable “hurdle” to clear. The “hurdle” being the post-money valuation of your last round.  Everyone likes to invest in companies that are growing fast with valuations that are escalating, very few like to participate in down rounds.  So, even if you get what appears to be an attractive valuation for your first round, think about the capital that you have, the progress it will buy you and your confidence that you can raise the next round to have a pre-money valuation that is higher than this round’s post-money valuation.  If you are not dead confident of this, then this valuation may be too high and may hurt you in the long run.  And remember, we are all optimists – we have to be, to be entrepreneurs or VC’s. That means that the strong odds are that results will not be quite as good as or it will take longer than you think. Leave yourself some buffer!

Think it through.  Play it out in your head.  Ask other entrepreneurs who have lived through it.  When you are raising, you should be optimizing for finding the right long term partners who can help you grow your business and worry less about maximizing price.  Valuation does matter.  But a higher, unjustified valuation can also hurt you down the road.

Convertible Notes vs. Priced Rounds

Certainly for early rounds, convertible notes and SAFEs are becoming more popular than traditional priced rounds.  I get it.  Entrepreneurs talk about how notes are easier and cheaper to execute.  But what I don’t hear them admit is the real reason many of them prefer notes – they want to avoid the valuation discussion. They would rather deal with that later.  But as with most difficult discussions, the sooner you deal with it, the better the outcome.

Here is what really happens with a note.  Let’s say that the entrepreneur and the investor agree to a valuation cap of $5 million, with a discount.  Here is what is going on in their heads:

Entrepreneur: “I just got a valuation of $5 million for my business this is awesome!”

Investor: “I will live with the $5 million cap, because I think the next round may be below that and I will get my 20% discount so I will be protected.”


An analogy would be if you sold your product with a price range instead of a price.  You tell the buyer it costs “$80 - $100.”  The seller only thinks about the $100 side of the deal while the buyer only thinks about the $80 price. You are not aligned and will have more trouble closing that deal than if you agreed to a single price in the first place.  Sounds crazy to quote a price for your product as a range instead of a single discrete price, why would you ever consider having a range of price for your company!

To be fair, there is a time and a place for convertible or bridge notes.  Let’s say you have a big sales contract or distribution agreement that will be signed in the next quarter - or a brand new product release that will change the company and you need a little capital to get you there, then a bridge note makes sense because you have a bridge to somewhere.

Venture Debt

I love debt.  What a fantastic tool and great leverage to help you operate your business – once your business is stable and you have predictable and consistent cash flows.  Just like with higher valuations or Convertible Notes, at MATH we are starting to see a troubling trend of companies earlier in the life-cycle, taking on Venture Debt.  The truth is debt can be a fantastic tool.  It can also be the death of many companies.

All debt comes with covenants.  What happens when you breach your covenants?   There are both micro as well as macro trends that can affect your business – some within your control, many outside of your ability to affect change.  What happens if you miss your quarter?  If there is a sales slow down?  A delay in shipping your next product?  Or, what happens if 2008 happens all over again, and outside of your control the markets take a dive?  We’ve seen perfectly rational lenders, make totally irrational decisions in turbulent markets.

We get it; sometimes Venture Debt might seem like a great, or the only, alternative.  But, you are truly putting your business in the hands of lenders who might not always make, or have the ability to make, the most appropriate decisions about your business given stressful times.  I’ve lived through 2000 and then again 2008/2009 and saw many good businesses shut down or forced to liquidate/sell by banks.

So let me be clear – I love venture debt – when the company already has proven the product-market fit and there is consistency and predictability to revenues.  Otherwise – tread thoughtfully and carefully my friends.

Optimizing for the long-term – beware the easier solution!

Most of us think and optimize for the short-term.  Makes sense, when you are a start-up entrepreneur.  A higher valuation on the surface seems to make sense (who wouldn’t want a higher valuation); or a Convertible Note is easier and cheaper today; or Venture Debt seems less dilutive (or maybe is perceived to be the only alternative).  All true – but beware!

Each one of these can have much more troubling longer-term consequences.  Many times the easier or more obvious path is not the right one.  Unless your company is one of the very rare rocket ships, then more often than not, it is actually the harder path that is the right one to take.  Don’t kick the can down the road.  As hard as it may seem in the moment, it’s always better to optimize for the longer-term and not just in the moment.