“I am leading or involved in a company… and we are in trouble. What should I do?” In this episode, we share what do when you are in trouble and what to do if everything else fails. This is the second and final episode on this topic. For more information, also listen to episode 35

Navigation:

• Intro (01:34)
  
• Section 1: What to do, if the company is in trouble? (02:04)
  
• Section 2: What if all else fails? (34:46)
  
• Conclusion (47:21)
  

Our co-hosts:

• Bertrand Schmitt, Entrepreneur in Residence at Red River West, co-founder of App Annie / Data.ai, business angel, advisor to startups and VC funds, @bschmitt
  
• Nuno Goncalves Pedro, Investor, Managing Partner, Founder at Chamaeleon, @ngpedro
  

Our show: Tech DECIPHERED brings you the Entrepreneur and Investor views on Big Tech, VC and Start-up news, opinion pieces and research. We decipher their meaning, and add inside knowledge and context. Being nerds, we also discuss the latest gadgets and pop culture news

Intro (01:34)

Bertrand Schmitt

Welcome to Tech Deciphered Episode 36. It’s our second episode about, “My Company’s in Trouble. What Should I Do?” In the previous episode, we talked about the context. We talked about how to determine if your company is in trouble. And we talked about what being relatively safe looks like. In this episode, we are going to talk about what to do if your company is in trouble, as well as what are your options if all else is failing.

Section 1: What to do, if the company is in trouble?

Nuno Goncalves Pedro

Let’s say that actually, you are in trouble, that you’ve done the analysis, you’re running out of cash quickly. Your economics are very poor. Your burn is difficult to turn around. What do you do? What is the first thing that you do?

Bertrand Schmitt

I think the first thing that you do is as management, as a board, to acknowledge you have an issue. That’s really the first thing. Acknowledge you have an issue and then start working together, management and board of directors to get in agreement into what is, at the very least, what is our current situation, not even what we should do about it, but always a level of risk, level of tension. The analysis done of what’s happening so that you can start smartly discussing about the option for the business.

But we saw an acknowledgement across a team of professionals, execs, and board of directors, it’s very difficult to move forward. If one side believes a business is doing alright and there is no biggies, that’s an issue. If one side believes that, hey, it’s not that great in term of burn rate, but we would get financing easily. That’s trouble if the other side doesn’t believe that. And usually, that might be your board who doesn’t believe it would be that easy to fundraise. I guess it depends.

But it’s really key to be aligned about the analysis. I’ve seen companies, I think it’s less true now, but if you look at in June or May that still we’re not acknowledging what was happening in the market, it was crazy for me. It’s like, guys, this has happened for six months now. You need to acknowledge it’s a different economic condition and what was investable, and we go back to the default investable in November of 2021, is not default investable in September 2022. And the gap might be pretty big.

I can see that some people at the first bear markets really start to think, Oh, good times are back. No, no, they’re not coming back. Not so easily. And you cannot build and bet your business just based on bet ready for a few weeks. Or both sides of the table need to come into agreement about the burn rate situation, the capacity of the company to deliver on its revenues and its projections of top line, specifically, but also about bottom line and get into agreement about what it means in terms of ability to fundraise.

Nuno Goncalves Pedro

And let’s say we have agreement, so board, executives, everyone’s like, we are in trouble. What we’re going to share with you next is a little bit the menu. Okay. We’re in trouble. What do we do? This is the menu a la carte. Some of these you can bundle, you can mix and match. But this is like a menu of things you can choose to do.

The first and foremost thing you can do in terms of order, and this is in an ideal scenario, is control your own destiny. And the levers you have in controlling your own destiny are relatively simple. One is top line What can I do about my top line?

And my top line is my sales, my revenues. So can I charge more from existing clients? Can I play a little bit with pricing? Can I create distinctive pricing maybe for new customers? Can I ask some of our existing customers to pay more in advance or contracts that I’m negotiating right now, ask them to pay more in advance? Can I shift around cash and not just money?

Again, one key lever that you have is very simple, which is top line. How do I increase it? How do I maybe even make it more predictable? How do I play around with it in terms of levers to make it work?

Bertrand Schmitt

I think on this one, I totally agree with that reason. That’s the first thing to do, it’s made so little tactical, but in a situation where you have higher inflation, the least you could be doing is immediately work on readjusting all your contracts with automated readjustment clause based on inflation.

That’s the minimum thing you have to do about changing your pricing. You have certainly to take that into account. You cannot be stuck with clients who are going to spend for the next, I don’t know, three years as much money every year for the same service. They need to end up having to pay more. And that has to be an expectation. I’m talking must see a B2B context. B2C, you don’t need 10 people doing that, but it’s going to increase by that much.

But in B2C, as we have seen from Disney to Netflix, all of them are readjusting their pricing. So please work on this one. It’s an easy one. It would be crazy not to use it, especially now that everyone is doing it.

Nuno Goncalves Pedro

It is a good time to justify it. I mean, it’s like inflation and there’s all these things happening and we need to pay more to our employees. And it’s a good time, as you were saying, Bertrand, it’s not just really about the B2B companies, also B2C, the ones that depend on subscription. Even in-app purchases. If you are a gaming company, you could actually tweak the promotions that you’re pushing to your gamers and to your users on a weekly basis.

The second side is, as you can imagine, the cost side, and that sort of goes directly to the bottom line and how can you become leaner? This is the classic one that people say, “Okay, you just cut costs, right?” Again, I would always start by looking at top line, in the first instance, but you obviously need to look at your cost base.

Are there parts of my organization that make a little bit less sense that I can become leaner in. Are there parts of my operations that I can optimize? Are there parts of my supply chain that I can optimize? Are there parts of my relationship with suppliers and logistics firms that I can optimize? Everything is up for discussion. And again, this is a good time to do it because we are in a crisis.

So it’s a good time at a global level to say, “Well, I need to tweak this a little bit. If you say you’re my logistics partner. Would you be willing to cut your costs right now for a certain amount of money and maybe we have an agreement by which we go up in the future?” “Is there something I can do around a specific area of my team that was very geared, for example, towards growth?”

I don’t want to take a stab at growth marketing because marketing can be a very important function during these times as well. But maybe there is a part of your growth marketing team that you could say, “You know what, we need to step a little bit back. We’re not going to be aggressively doing growth marketing in the next six months or 12 months.” Maybe the team needs to be leaner by default.

I’m not defending that everything here is about layoffs and cutting, but it might be about renegotiating. It might be about actually being a little bit outside of the box and figuring out what is something that’s win-win for everyone involved that we could still make this work.

We’ve seen this in the past. We’ve seen companies that have laid off almost no people, but they went to a reduction in salaries for a defined period of time to see if the company could rebalance itself where they gave something else in return. They gave more benefits in return. They gave maybe more time off in return to the team, or they made the team have more time off for a significant period of time.

There’s ways of doing this that are not necessarily the classic, I’ll just call everyone, fire people or lay them off and we’re good. There are ways to do this in a way that is absolutely win-win for everyone involved. But cleaning up the cost side, becoming leaner for a period of time might be the difference between living or dying. Cash is king, and if you run off cash, as we discussed before, you die. So, again, very important to have these discussions.

Bertrand Schmitt

I guess I might be a bit more aggressive on this, in the sense that, yes, of course, you should do everything that you talk about, in term of trying to optimize your cost in the smartest possible way and go after easy win. If we are talking right now, it’s because easy win are behind us and we are in the situation where we need to go deeper and might take that one unveilment where a lot of great companies, especially in tech, have already been going to lay off, 5%, 10%.

We thought even thinking about it, they were like, okay, markets trouble, recession coming, that the time to do a reduction in force and move fast. And you even have some companies like Microsoft who do that every year and sometime you have a few percentage of the [inaudible 00:08:15] falls that’s let’s go to [inaudible 00:08:16]. Basically to try to get rid of the lower performer. So it’s not typical of the startup culture to do that approach every year. But this is a time where not everyone is doing it.

So if you don’t do it now and you wait, it will cost you way more money, obviously. But right now is a perfect time to do it. However, what I want to be clear is that you want to do as little with as possible. You want to send a clear signal that at least for this year, this is the last one. We have done one. We have been careful. We have analyzed the business carefully. We know where we are going. We know where it’s going to bring us. And this one is enough. Maybe it’s not 10%, maybe it’s 15%, it’s 20%, 25% of the workforce. Again, some great companies are doing that.

What you don’t want to do is to do 10% one month, 10% in three months from now, another 10% three months after. That’s the worst of the worst that you could be doing. You destroy the morale of the company. And another piece, so it’s not just about laying off people, it’s also convincing the rest of the team that they should stay on your business. So you need to put a lot of time and effort and the right incentive for your best people to stay and be excited about staying.

Nuno Goncalves Pedro

I agree with everything you said. I would put a nuance in it. I feel the tech industry, even in earlier stage companies or in high growth companies, so we’re not talking about the big public companies, in particular in the US, there is a very strong skewed towards action of, oh, let’s reduce force.

I mean, if a Google or Facebook or an Amazon or whatever decide to do reductions in force or freeze hiring or do a bunch of things, honestly, you could say by no means I’m disrespecting the people that work there and the functions that they have. But these companies, by necessity, already have overhead. We’ve discussed it in the past. They already have too much capacity. We discussed engineering capacity several episodes ago where there’s sort of the hoarding of engineering capacity in companies, for example. They have capacity to let go.

Sometimes what I see is the company actually has a great team and maybe one or two people could go. But it’s not like I could reduce 20% of the team or something. And the more ingenious thinking around what other alternatives do we have? Could we actually move parts of the team or the entire team to 80% work week instead of 100%? Like one day off or something like, could we change things that we do around salaries, et cetera?

In some countries, you can’t do this at all. In my home country of Portugal, you can’t do stuff like this. But in US you could. And in some cases, I don’t see that discussion happening. To your point exactly, it has huge effects on morale. And you’re maybe laying off someone today and you’re hiring for that position in three months or six months’ time because you’re still going to need that position down the line. And the business has changed and something has happened.

I feel the humanist side of me coming out in this, like, let’s be very thoughtful and everyone will lay off. Is this really a position we don’t need? Because this knee jerk reaction of let’s reduce today and we’ll hope for the best, even if it’s not to your point systematic. If not 10% today, 10% tomorrow. It’s like even if I do 15% today, do I really need to do the 15% today or there are there are other options that I could have created. And again, that creates a dynamic.

I feel in these times you can get very tactical or very operational even on your decisions regarding talent. And in some cases, you always lose the track of strategy. Now, obviously, it is about you surviving. It is about you making sure that you’re ready to be around in one year’s time or a year and a half or whenever you are able to be a growing concern again or raise more money.

Nuno Goncalves Pedro

But at the same time, think it through. It’s like, is this the right option for the company right now? Or could I do it in a different way? Could I structure this in a different way, at least for a period of time and see what happens? And that would not take away from me the option of at some point doing the riff that I need to do.

Bertrand Schmitt

Yeah, I think we can talk later on about this, but what I’m worried is really that situation of startup, this spiral. I think it’s Sequoia who talked about this. They were showing that example a few months ago of how you delay, you delay, and then when you do it, it’s simply too late and the business is going to die.

Nuno Goncalves Pedro

My proposal is not one of inaction. My proposal is one of action, but strategic action, thoughtful action. It’s not about saying don’t do anything. It’s about there are sometimes other options. And in many cases, there are other options from just doing mass layoffs. I feel that they lead to more complex discussions, but sometimes they lead to actually much better discussions and much better outcomes.

And this industry, I agree with you, sometimes there’s just delay. My point is not so much the delay point. I totally agree with you that delaying can be death. It is about the other option.

The other option of maybe we can make this work and we reduce salaries. Maybe we can make this work in a way that’s different from what we thought initially of just saying, okay, our growth marketing team, again, picking up on them needs to go fully because we’re not going to do any growth marketing. But maybe in six months, we do need to go growth marketing. It’s like, well, good luck now hiring that type of talent in six months’ time.

Sometimes there’s a little bit of a lack of strategic discussion at that level. And also I believe the board has a strong impetus on that. The board can really be helpful in those discussions. In many cases, the CEO doesn’t really open the kimono on the discussion itself. It’s like the CEO makes the decision, the board takes it, we’re all good and we don’t think through consequences, we don’t really engage in problem-solving and all of those key aspects.

Bertrand Schmitt

It’s right. I’m talking about the situation where you have six months of cash left and you might not get some additional financing. At some point, you have to do what you have to do. And realistically, if 60%, 70% of your spend is salaries, like most tech startups, there’s only so much you can really reduce beyond headcount. Yes, you’re right, some companies might readjust salaries. I think it’s very rare when it’s working. It’s very rare also when it’s authorized. So it sort of might be a very complex process.

Early on during COVID, there were some countries like in France where you could actually more easily put people at three-fourths or two-fifths for a bit. So it was doable. I’m not sure it’s actually doable again anymore this type of approach. In many countries and some countries, you are just going to have people accepting maybe for a bit and then stop looking out for another opportunity.

I think the big issue is really around how you get your top performer and you keep them motivated. If you reduce salaries for everyone it’s a tough one and just reducing salary for a few it’s also a tough one. Maybe to keep moving on.

If we go beyond revenue management, cost management, what can we do? We believe we have maybe not to the bone, but we move all to fat. And again, to be frank, I think there was a lot of fat these past few years, not just at Google and Facebook, but a lot of VCs spreading money around, sending cash by helicopter. So I think a lot of companies are definitely some fat, not all hopefully, somewhere focus on delivering great products and optimizing their spend.

But if you have reached all that, what you can do to smartly adjust your revenues, your cost, I guess some to talk about what are your dilutive and non-dilutive options, in term of financing?

Nuno Goncalves Pedro

Even before we go there, we’ve talked a lot about riffs and all these realignments. Sometimes one way to control your own destiny is identifying that the issue lies with the leadership of the company, and it might actually be the issue with you. I remember the story at McKinsey of a very senior partner that shall go unnamed, that in front of the client turned to the client and said, “With all due respect to you, sir, the problem with this company is you.”

Not something I would advise you to do as a consultant but it was an interesting moment. Sometimes the problem is with the CEO, sometimes the problem is with the executive team. So I think one last thing you have in controlling your own destiny is and this should be used very, very clearly and very thoughtfully, but when it’s done, it should be done decisively in my experience, and I won’t go into details, with the support of the CEO, even if it’s about replacing the CEO.

Actually, if the CEO is the founder that started the company, doing it in a way that is decisive but at the same time that’s very thoughtful, is pretty important. But it might be replacing a CEO, it might be replacing some of the senior people on the team. It might be restructuring how the team is working without necessarily firing everyone. But again, there is something about controlling your destiny around that.

Maybe moving first to dilutive because you’ve already alluded to dilutive and non-dilutive. My first intent, if I would be in that position as the CEO of the company, would be, can I get money from someone that’s already given me money? We call this typically, bridges, getting a bridge from existing investors. And that bridge might manifest itself under different ways. It might be straight-up the price rounds, it might be an issuance of equity straight up with a specific valuation in mind.

It’s a tricky discussion to have with existing investors because, on the one hand, they want to show progression, the valuation of the company, but on the other hand, it’s against their best interests to show much progression. They would prefer to have a down round or a flat from their perspective of ownership in the company, but at the same time, they want to show that progression and be fair towards the company. It’s always a difficult discussion to have on the price round.

It could come under the form of a convertible note or a safe note that will convert to equity at some point in the future, which happens mostly in early-stage bridges. To be honest, companies that haven’t raised a ton of money and are doing a bridge from existing investors. But that’s your first port of call.

And why is it your first port of call? Because they’re already your investors. They already know you, they already have investor updates. They should know your financials reasonably well. Some of them might be on your board of directors.

In some cases, if these people are not willing to give you money and there’s a different discussion to be had and they’re not obligated to give you money by any chance. Because they have other projects they can give capital to. So then it becomes a portfolio management and a portfolio allocation conversation for them as VCs themselves or as investors themselves. But it is important to see if you have them on board or not.

It is important that you know that they’re willing to back your business and move you to the next level. Now you, Bertrand, always have this comment on you have to be careful with bridges and bridges to nowhere in particular.

Bertrand Schmitt

I think that’s definitely one of the first thing to consider because you want to get a sense of what the level of interest from your existing investors. It might be easier in a time of transition, of uncertainty in the marketplace to move relatively quickly and restore existing investors. There are definitely ways to move quickly. But then, as you say, it goes back to the price. When great companies are losing 50% market cap in a year, price is not going to be easy.

And that’s true that you can go through convertible. And I would say if a new financing is coming soon and you’re preparing for a new financing, that might work with a discount. I think in this day and age it might be a more difficult one to accept for your existing investor to do on a convertible based on the discount on a future financing and you ask them to wait it out 18 months because this is a big time of risk. You should get paid for the uncertainty for the risk. So you might need to go through a price run.

To be clear, I don’t think your investors are super excited to go to a down run. They know the issues, they know the pain. Even for them, it he probably doesn’t look great, old school down run, in terms of their own mock-ups. So I don’t think you have to go too far. But at the same time, you might have to expect some people who are going to say, “You know what, I’m not interested to do a convertible. Why should I do a convertible in a time like this if I don’t have a clear certainty?”

I think if you are planning to fundraise or preparing to fundraise, if your investor believes you are in a good position to fundraise and yes, a convertible might make sense, a lot of sense. And then it’s a question of how much discount and are some good articles about this, how much discount you should put into your bridge loan. But one of the big question would be the pricing.

Nuno Goncalves Pedro

I think the pricing is very important. And to your point that there’s almost this thing, a down round is always negative. Even a flat run’s negative, let alone a down round. A flat round would be that the pre-money valuation of my next round is the same as my post-money valuation from the previous round. A down round would be where the pre-money valuation of my next round is below my post-money valuation of the previous round.

And people are, “Oh my God, I’ve lost value.” Well, you lost value, but you’re alive. Someone’s willing to give you money at a lower valuation. And sometimes, this leads to hardcore recapping. Everyone goes underwater, your investors get super mega diluted, and there’s some nasty stuff that sometimes is done around this. But honestly, it might make sense to reevaluate your valuation and to really think through what does that mean even from a capital perspective.

Again, bridges from existing investors. As an investing investor, you have to be also very thoughtful on how you put these bridges forward. It shouldn’t be a bridge to nowhere. When is the redemption happening on this bridge? Does the redemption change some of the core clauses on discounting, for example, depending on the time by which there’s a new financing at the table? There’s a lot of really interesting tricks.

The devil’s literally in the detail on how you do this, but definitely the first port of call is existing investors. Can they give me a bridge? One other port of call is, can I get new investors on board? And it might be new investors that I’ve talked to in the past, people that I’m still in touch with that are still interested in my business. That might be saying you’re a bit overvalued, but then let’s have a discussion around valuation, right? If we reduce the valuation slightly, it’s not a huge down round, but a little bit. Would you then be interested in participating, and how would that work?

It might be straight up new investors, normally a little bit more difficult as a port of call, although there are some situations where the company might be able to attract a set of investors that is not the natural institutional set of investors. It might not be your classic VC firm, it might be a corporate venture capital arm, or a strategic investing of their balance sheet, or family office, or high net worth individual that has a very specific interest in the company and what they’re doing.

There’s many ways to raise money. There’s many sources through from which to raise money. It’s not out of the realm of possibility, I’ve just gone through at least one fundraise recently that I don’t think we expected to happen quite in the way that it happened. It was actually relatively quick and it was all new investors. The old investors didn’t put any money in. I’m actually not an investor in that company, but the old investors didn’t put any money in and we had new investors at the table.

And it made sense to them to come onboard, and the rationale is eminently logic. And it wasn’t a down round, which is even more shocking. It was actually an up round. Again, there’s ways to do this, and there’s ways to bring new investors onboard, it is a little bit more art and science. It shouldn’t be our first port of call for dilutive fundraising, but definitely, if there’s existing discussions that make eminent sense strategically, etc., why not have them?

Bertrand Schmitt

Yes, totally. Why not? To be frank, I’m glad for that example. But it’s not an easy one, why existing investors are not willing to put some additional financing. You better have some good explanation to do as an investor, explaining to the new one why you are not putting any more money to work. So that might not be an easy situation typically to being just a new investor. You might not do a bridge run, but you might want your existing investors to show up if there is a new financing, as that could scare away your new investor.

Nuno Goncalves Pedro

Indeed. Obviously, there’s other elements of dilutive plays that you can have around resetting, stock options valuation… We’ve already discussed quite a bit about valuations in general, but maybe switching to non-dilutive. And what does that mean, non-dilutive? It doesn’t necessarily dilute existing investors in the company in terms of their equity positions, although as we will discuss, some of these might over time.

The first that comes to mind is obviously venture debt. Venture debt precisely is not always non-dilutive, it sometimes may include warrants, it may convert under very aggressive circumstances, rates that are put forward are very, very, very high in many cases. It is this notion of, “I’m giving you debt instead of equity,” there’s a bunch of strings attached. In many cases, their seniority over current equity holders and their liquidation preferences.

It is very clear that it has exploded over the last few months, maybe the last year. I was talking to someone who’s in the venture debt space recently and he was saying, “Well, it’s a two-edged sword, right? Because on the one hand, it is exploding in terms of pipeline for us of deals. We have so much stuff we can choose from and cherry pick from, which is great, always having a very healthy upper funnel.

But at the same time, we are already in deals that might not be performing very well that are either defaulting where we may need to make hard choices on defaulting the agreements we have, or converting it into equity, and exercising our redemption rights, etc., etc.”

Again, it’s a two-edged sword, but the first element of non-dilutive obviously is venture debt, and taking debt instead of equity. Some industries obviously are always a little bit more well-geared towards this industries where there’s predictable contracts, where contracts are well-defined, etc., but definitely, one element that you could seek and bring to the table as one source of fundraising.

Bertrand Schmitt

Yes, I think I agree with you. It’s exactly as you say. I saw multiple reference to the fact that now venture debt was exploding. And obviously, the guys on that side, it’s not normal. They don’t want to get those elements and just invest in companies that have no tomorrow. So they will be more and more aggressive in terms of analyzing the business, and in terms of asking for very high rates. I mean, you are talking about 15% plus, and this is a credit card rate you get as a consumer, so you have to use a lot of caution.

And I’ve heard some has asking you for loans, and this is a 15% crazy close beyond that. That would not be my first choice. I would say, I would put it like this. Maybe we can talk about other type of non-dilutive line of credit. You have different type of line of credit, it can be based on your IR, on your revenues, or it can be based on what we call invoice financing. Certainly, I think these are pretty interesting things. Not everything should be financed by equity in a business.

Typically, startups might wait too long to look at this type of alternative to support some business initiatives. So I think those all values there might be difficult for too small businesses. But for businesses that are big enough, I think the opportunities to get lines of credits and… And they can come with very interesting conditions. If a banker understand your business—a restaurant, predictable, you have good line of sight—they might have some real interest to do that and to give you a loan.

Nuno Goncalves Pedro

And in lines of credit, as you said, there’s many different types. Some that are the project that are being invoiced, and accounts receivable, and all of those. In general terms in the finance world, we talk about revolving and non-revolving. The non-revolving are very project-based normally. They’re very focused on a specific project or a specific set of projects.

And the revolving ones are the ones we’re probably most used to, even as consumers, which is we have this line of credit we can use every month or every given period of time, and we can max it out or not. And it’s normally more adequate for variability of cash flow. You know that you’re going to have some variability of cash flow. And maybe it will be more difficult to make your payroll work because there’s something that won’t come through.

Whereas the non-revolving are maybe larger and chunkier sometimes, but they’re more related to, “I’ve signed a deal, I have an agreement, but I’m only getting paid 90 days out,” or, “I need something to push my inventory to market in the hardware side—that happens a lot—but I have the contracts and my customers are good for it.” So it’s just a matter of, “I need the inventory to sell to them, and I’ll get the money in 60 days or 90 days. So can you give me that capital for me to do and make that work?”

Very good ways of dealing with your cash situation without being dependent on doing massive equity raises that are dilutive by nature, so definitely a better option to your point, Bertrand. These are normally only given to businesses that have a track record where the bank can analyze their track record in terms of payments, where the agreements are very solid, etc., so it doesn’t always work.

I think in particular in the non-dilutive world, because if we do talk about the covenants and clauses that we put as equity investors in the VC world and we say, “Oh, you guys sometimes get a little bit nasty and tweaked.” Talk about that for the debt world where their seniority and the waterfalls magically change, and there’s all these funky clauses on redemption. Be very, very careful on how you sign these deals because the guys are dealing with….

Again, we’ve given that advice in the past. If you’re a company, or you’re board of directors of a company, and you’re not used to doing this all the time, be very thoughtful. I have a great law firm working with you. Go through the scenarios, think through the implications on the waterfall for the equity holders, think through the maturity dates that are on the agreement. The devil’s are all in the details, right?

In many cases, a lot of this money’s made on specifics, up clauses. So just be very, very careful because it might be that you’re signing yourself… You’re mortgaging your future today and not getting a ton in return and you’re like, “Oh, it’s such a great deal, it’s non-dilutive.” And you look one, two years out, and when finally something happens to the maturity of the agreement, you’re like, “This wasn’t what I thought it would be. And this didn’t quite happen the way I thought.”

Bertrand Schmitt

Yes, on the governance side, you want to be quite careful about some ratios that you are supposed to respect during the life of the loan. And I’m saying that because I think a lot of companies don’t fully realize that this is not the equity world, this is not a non-dilutive world, this is a loan word. The institution giving you the loan, the bank, might force you to have some reissue about cash, cash to [inaudible 00:29:14]. And you might realize at the end that the loan is not so interesting because giving you money only in the conditions that you don’t really need the money, so you have to be very careful about what this is.

Another piece of the puzzle, and I’m seeing that in [inaudible 00:29:29] a lot of these loan financing are often done typically at the same time as your equity financing. It’s a bit before, at the same time, albeit after, a few months after. But then if you wait too long, at some point, they might not be interested until your next fundraise because they will feel that your ratios are not that good anymore. They were good at the time of your raise, you had a lot of cash equity. But now, they are less excited to provide you a loan, and this is trouble.

Another piece for me also for the puzzle is ideally, you don’t wait to need one, to get the loan. You get it as soon as possible, and that should be best practice right after, or sometimes, as raising an equity financing to look for this because it would be harder at some point. And those are pieces is around…

If you have a line of credit, you have to be careful. I mean, some are playing the game, not to draw the line, or to wait. You probably want to draw it relatively quickly. Is that something that makes sense? Because if you wait too long, the condition may change of your business, of what they’re doing. So personally, cash in the bank is much more save than the promise to have cash once you want it.

Nuno Goncalves Pedro

Again, devils are very much in the detail. How good is your consulting CFO or your CFO? How good is your finance team? You have to optimize your tax situation over the company and think through that as well. One element that I often see in venture debt or debt in general that is quite misunderstood, is a lot of founders—and some of them are repeat founders—they have this understanding of the discussions they’re having on venture debt. Not so much maybe the line of credits, which is more of a banking relationship, but the venture debt one.They’re talking to partners, they’re talking to people in the firm. I don’t want to bad mouth the industry. I think it’s a wonderful industry and it’s an industry that makes a huge impact at scale in our industry of venture capital firms. But a partner in a venture, that firm doesn’t quite behave the same way as a partner in a venture capital firm. This whole thing of being in it for the long run, and we are on your board of directors, it’s not the same.

A venture debt person really can be long term focused, but in all actuality, the way they’re thinking of making their money is very financially-driven. Again, the way they’re going to support you through your lifetime, some of them are extremely supportive with their Rolodex, with their own skill sets. But just be thoughtful that you’re not getting the same type of support. It’s horses for courses, it’s different things.

And it’s because it’s different things, you have to be, day one, very clear that, “Okay, I’m dealing with this venture debt firm. This is the relationship I’m going to have. Hopefully, they’re going to be supportive and help me out,” but they’re in this to make their returns very clearly. So are VC firms, but the time horizon of a VC firm is not the same. The way that a VC firm behaves is not the same.

Again, I’m talking about an average VC firm investor versus a venture debt’s investor, rather than the exceptional ones at both ends or the crappy ones at both ends. But on average, it’s a very different type of setup. It’s a very different type of support. Again, don’t confuse it. This is not the same thing. You’re getting something different from someone different. You’re getting something different from someone different. And that’s very important to take into account.

Bertrand Schmitt

Yeah. And to your point, I remember the values of some firms that are very visible, very known with good reputation, for instance, a secondary bank. But I have also seen and heard about some that are very bad and shitty reputation. I was told that, “No, that’s a guess. You know, I want to talk to…” You talk to them, I guess when we talk about our next options, when… What happens when all fails, you are not there for the long run. You know that you have basically some sort of agreement as a devilment, but might still be better than the worst of the worst situation.

Section 2: What if all else fails?

Nuno Goncalves Pedro

Good segue to what if all fails? You’ve tried all the stuff we just talked about. You can’t raise money, or existing investors don’t want to give you money, you can’t really raise debt, you’ve tried a bunch of stuff. Where do you start? There’s many places to start. I think one obvious one to take a look at is what I would call the normal sale scenario, a normal sale option.

A normal sale scenario normally arises from existing partners, potentially even existing investors that you know for sure would have an interest in the company wanting to put an offer at the table and saying, “You know what? In these conditions, we would take the company off the table for this reason.” The circumstances under which you do a normal sale honestly can end up in a fire sale option, which we’ll discuss later. So unless you have interest from two or more parties, unless you have a little bit of a bidding competition, it’s difficult to really extract much value out of this. But in some cases, it might still work.

It might be that you have a strategic investor that wants to buy you out. And because of the relationship he has with other investors, he’s not just going to screw you, so to speak, on the deal. They’re going to do a fair deal. Everyone will make a little bit of money and we’re all going home. More cents on the dollar, but we don’t all lose our shirts. I think as a first option, the normal sale is really within your realm of internal possibilities of existing strategic investors, existing partners, potentially even existing customers or suppliers.

Look within your stakeholders, if there’s anyone that might have interest. The way to approach them, shockingly enough, is not just to say, “Oh, we’re up for sale.” The way to approach it is more what I call the soft sale pitch, unless it’s the strategic investor that knows how the company’s doing. It’s more about having a conversation, how to scale the interests of the company itself.

And from there, really move the discussion from what I would call a classic business development discussion to maybe a corporate development M&A discussion. That’s the art of these types of deals. That’s where you can actually extract premiums. If you are looking desperate, guess what? The person on the other side will know you’re desperate. Life is tough. You might end up in that fire sale scenario that we obviously want to avoid.

Bertrand Schmitt

I will say that a normal sale situation, as you say, especially one where you managed to get some bidding between multiple parties, that can be really a great option. If we are in a situation where a lot of things are happening in the business, you should see that very positively if you can make it happen.

Nuno Goncalves Pedro

And there is a side option to this, which is the more articulate side option. In particular, your investors—if they’re institutional investors that have a portfolio of several companies—should consider this, which is, is there a play here that some company in my portfolio might benefit from acquiring this other company?

Now, here you need to be very, very cautious. I’ve had cases that ended up in very good solutions for everyone involved. It was a win-win for everyone around the table, investors, companies, etc. I’ve seen cases where clearly everyone was ripped off except the one investor that managed to take one asset from one side to the other. Here, the devil is definitely in the detail, but it can end up well. It’s not always a bad case scenario. Even for other investors or for the founders of the company that selling could be actually a good option.

Again, think a little bit outside of the box as well, and have these discussions with your VC firms. Maybe they’re not thinking about it for some reason, because they don’t want to be the douchebags at the table saying, “Oh, I have this other company that can just buy you guys out.” But honestly, if it’s not preemptively being put at the table, have that conversation.

Say, “Look, there’s this other company in your portfolio that might be a good acquirer for us. Could we structure something here? Could we have a discussion even with a team on the other side that is a positive discussion? Although this is more of an external play, in some ways, it’s still an internal player that’s acting a little bit as the intermediary or gatekeeper in the relationship.

Bertrand Schmitt

Yes, I think it’s a reasonable option. One thing I have seen is in scenarios where the company is not in trouble, but also in scenarios where a company’s in trouble, is to consider a different approach. Where you believe that you have different type of assets inside of business and you believe that some assets might be better running separately.

Maybe they are going faster, maybe they are more sexy in a way in terms of investment and trust. But you realize that a new investors might be interested for this business, but not for the rest. You realize that in terms of team, some people might be more interested to be part of one story, but not yours of story.

So from my perspective, that’s something to keep in mind and to really have an open mind. It doesn’t happen at last minute suddenly, “Hey, how do I cover this stuff?” Usually, it’s because you end up realizing for quite some time that you have built up different line of products, or you manage to sell to very different type of verticals. And I think that are some of the options that you should be considering.

Nuno Goncalves Pedro

Definitely. In some cases, there are very innovative ways of doing this, where you carve out a bunch of stuff. There’s IP Plays. I think you’re sharing this Alex Rampell tweetstorm on his own experience with TrialPay and what they did there, which is interesting. An IP sale, a spin out or spin off, and then going back to core, and how do you make it work.

The other option is obviously an external fire sale. Options like, “I’m going to go to the market, I’ll get maybe a banker really quickly—or what I call, the two men in the dark—type advisors on the M&A side that helped me just try to push a very rapid fire sale. I’ve rarely seen these ones work. Normally, you need a little bit more time to do these processes properly where an external player is interested in buying your company.

Some founders have this mythical idea that by getting a banker at the table, that magically, there will be interested parties in buying them. I always said that I’ve said this in previous episodes. You can never sell a company at a premium. You can only be bought at a premium. I don’t think there’s anything magical about it.

Unless something magical happens that buy… You’re desperate, you have a ton of assets, and you get a bidding war in place, which is very, very rare. But if that happens, that’s the perfect storm. And someone in external buys you, maybe that will work. These external fire sale options are very rarely conducive if the company is in the process of selling.

And then the final option in this realm of exits that we’re still talking about is what I would call the Plan Z exit. Plan Z exit is the last type of exit I can try, which is normally under one of these forms. One form is maybe one of my existing investors or players that are involved with me. Again, customers, suppliers, etc., is willing to acqui-hire a team, or I can do an asset sale to them, so this is last resort.

They’re not buying a business, they’re not buying a company, they’re just getting stuff out of it like other people or assets. There is a play around that and it sometimes works. It’s normally someone’s going to get pissed off at someone else, but honestly, as a last resort, who cares?

And there’s the other one, which is I call it the recap and start anew, which is almost like, “Guys we’re going to die anyway.” And there’s some white knight that is not quite white, just to be clear. Quite white knight, might be someone is a bit smudgy around the edges. Who comes to the table and said, “Oh, I’ll give you 1 million, but it’s at the valuation. That’s a 10th of the last valuation.”

So basically, if I’m actively taking ownership of the company or I’m taking a significant portion of the company. And we recapped the whole thing and we go forward. And this is a new structure and it might have some variations to what you were talking about earlier, about some of the carve-out option, right, where we just take part of the business and we recap that and do something around that.

Again, all of these are possible options and I’ve seen some of them actually sort of work. They are not… Again, as I said, there’s always going to be someone pissed off. So unless you went through a normal sell option where one of your existing investors really wanted to buy you out or you magically did a very complex carve-out spin off play that worked really well at scale. The other options are always, I would say, very low probability of happening. I’m sure there are cases of people that are listening to us who said, “Oh, I know this case of this guy who tried to do an external fire sale and they managed to sell at a premium.” Please do send us your comments and tell us who those companies were because we’re really interested in that. But in general, it doesn’t happen.

Bertrand Schmitt

Yeah, and I would say especially these days and hopefully next year it’s a different story. But this year acquisitions would be tight. When you’re uncertain about your own valuation and when the acquirer is itself uncertain about its own valuation, let alone your valuation, that is a tough time to do an acquisition, especially when most bigger companies are going through layoffs, cost reduction. I mean, that’s not the time where you are making a lot of acquisitions. At the same time, are you becoming at least much more selective than you used to be?

It’s not about cross-cost calls at all cost anymore for them as well. So that’s to keep in mind, these are the selling process that’s great when you are not doing great, but the rest of the market is doing great, and the rest of the market is not doing great and you are not doing great, that might be tougher.

I think you touched briefly on the IP sale. In that situation, that might be something interesting because an IP sale might be easier for acquirers and acquiring a full company. It might give you some cash to run for 12, 24 months. So there might be some value in considering this approach in these times and days.

Nuno Goncalves Pedro

At this stage in time, you’re dead, right? So you’ve tried everything that we just told you and nothing worked. So you’re literally dead. Then a couple of options that you might have, many people would know, even ones that are not based in the U.S.

There’s Chapter 11 in the U.S., which is a bankruptcy of sorts. It’s not a classic bankruptcy. It’s a position in which you’re put under reorganization, typically in front of a judge where there is a plan to find that just protects you from creditors and for most of the parties that have claims on you.

Very atypical for startups to do anything around this, you need to be a larger company that has actual assets and things that are to be managed around where there is an option to be reorganized, smaller startups. I don’t know anyone that has gone through a Chapter 11 in early stage. There’s obviously Chapter seven, which is like the more classic bankruptcy of liquidation. Again, very atypical. It’s a costly process from what I understand, and that very follow through.

And then finally, in many states, there’s other processes that are leaner, that are more applicable to startups. California, for example, we have the California assignment for the benefit of creditors process, which would allow you to be put in the face of someone else that takes care of your assets and tries to sell those assets and make money for all your creditors, not only debt holders, but also your equity holders. And there might be some value extracted from there at the end of the day.

So again, you’re dead or you’re quasi-dead and you don’t have that many assets in there and good luck to you. Maybe there’s some value that we can still extract out of this.

Bertrand Schmitt

Yeah, and I would say before you reach that stage, make sure that you try to put your company as much in order as possible. You don’t want to reach a stage in a position where you didn’t pay salaries for two months. That’s not good at all and it’s bad for you, it’s bad for your reputations, and bad for your team—it’s a problem for board of directors. So please don’t do that. Organize a proper shutdown in time, not after it’s too late. Do it a bit before it’s too late.

Nuno Goncalves Pedro

In some countries, actually, this is interesting to know, but like for example, in Portugal, there was a direct fiduciary duty of the board of directors. So in the sense of, for example, if social security or the tax authorities say, “You still have money that you haven’t paid us,” there’s the direct individual liability of the person that is on the board, not just the investor, not just the executives, but the person that’s on the board, even if they’re representing a VC, etc.

So again, be very thoughtful. I’ve learned this the hard way because I’ve seen VCs in Europe play all sorts of games around this, vacating board seats and they’re like, “I don’t know anything. Oh, the company’s failing. They haven’t paid taxes. I don’t know.” So again, if you’re an investor, be cautious. If you’re an investor of any type, an institutional investor, an angel, someone who’s on the board of directors of a company in general, even as an independent, because the laws of the country might be different. And just getting to know them is very important.

Bertrand Schmitt

And how can we say Europe is not always investor-friendly?

Nuno Goncalves Pedro

Yes, yes, they will come after you, for sure. I mean they won’t be like, “Oh, where’s my taxes?” well mate, my company failed.

Bertrand Schmitt

And then I can tell you in France, and it’s true of quite a few countries, you have to be careful as an investor, as a board member, not to be seen as having to have too much into the management of the company. So if you try to help, you have to be careful. You have to state who, what is typical of a board member is supposed to do, not going into management of what’s happening because then they might consider you might have been part of the problem.

Again, as an investors of this firm, you also one with deep pockets and potentially will try to find ways to go after you. So you have to be careful if you [inaudible 00:45:37] everything is closing down in an orderly way.

Section 3: Conclusion

Nuno Goncalves Pedro

And this concludes our episode 36, our duology on What if your company fails? What should I do? In this duology, we talked about and shared some context on what’s happening in the market today. We shared how to know that the company or your company is in trouble. What does being relatively safe look like? What to do if the company is in actual trouble, which is probably the most important part of these episodes? And finally, what should you do if it all other things fail? What if all fails? Thank you for joining us.

Bertrand Schmitt

Thank, Nuno.