Soaring on Ridgelift

Venture Debt – Check your security blanket!

Many venture backed companies take on debt at some stage of their life borrowing money from a bank or specialized venture debt lender. This money is far from being "cheap" carrying high interest rates, transaction fees and warrant coverage (usually in the form of a stock option for preferred stock).

Debt can make sense in an environment where customers are buying and next round valuations are expected to be significantly higher than previous rounds. The premise is that venture debt can lengthen the amount of time a company can operate before having to raise a new round of financing. In an "up" environment, more time can translate to a higher valuation and hence less dilution to existing shareholders (especially important for common shareholders who generally don't invest in rounds of financing to protect their ownership).

Debt can also make sense when a company is expanding sales – debt in the form of a line of credit can be used to supply working capital to cover the time from shipment/invoicing to cash collection. The line of credit allows a company to borrow some percentage of its account receivables – generally with a better rate than pure venture debt.

In addition to high interest rates etc., one of the other attributes of venture debt is that it typically requires either a UCC-1 filing (Uniform Commercial Code, article 9 public filing perfecting a security interest in underlying assets) or a Material Adverse Conditions (MAC) clause. Either of these conditions allows the lender to "call" the debt due under certain conditions. The lender also requires that you either place all your funds (existing and borrowed) in their bank (where the lender is a bank) or execute an account agreement that provides the lender with account control over all of your funds.

In todays "down" environment where revenue growth is uncertain and credit is tight, venture debt can give a company a false sense of security about the remaining cash runway it may have before raising the next round.

Remember that the debt lender has an obligation to protect their asset and so keeps a close eye on the company's current cash balance and compares it to what is owed on the loan. As the cash balance gets close to the outstanding loan, the lender will call the CEO and investors in the company to determine the plans for the next round of financing – basically looking for a "guarantee" that the investors will continue to finance the company (thereby insuring the loan doesn't default).

Any hesitation or lack of conviction in the certainty of the "next round" may cause the lender to invoke the UCC-1 or MAC clause and cause the note to come due. The lender then sweeps the accounts to recover their outstanding principle and the company is immediately out of cash.

Given the current climate and challenges facing financial institutions of all kinds, cash is just a much "king" for them as it is for startups. You can pretty much guarantee that lenders will protect their cash as the first priority and worry about business relationships or possible legal challenges later. We saw this exact scenario unfold many times in 2002-2003 as the business environment was challenged by the aftermath of the Dot Com bubble, 9/11 and the pull back in telecommunication capital spending. 2009 is unfortunately shaping up to be worse…

So, if your company has a venture debt line and you forecast your cash balance going below the outstanding amount of the loan, take a long hard look at whether that cash balance is going to be real at the time you need it most. Chances are the cash will be swept.

Confront the issue now while you still have plenty of time – consider the possibility of the accounts being swept and talk the issue through with your investors. Get a contingency plan in place - perhaps getting a small "top-off" round and immediately paying off the loan (thereby saving interest expense) or figuring out other ways to stretch your remaining cash either to the point of break even or getting a new round of financing closed earlier.

Don't hold on to venture debt as a security blanket – you may get caught out in the cold!!!

 

 

The other side of cost cutting

Like me, you've probably had enough with comments from VCs on how to cut costs/plan to weather the deepening recession. For sure, there has been much well-meant advice on the cost-cutting front.

Inevitably, people focus on the cost-cutting front first – it's the foundation for longer survival and sadly has profound impact on people's lives and careers. As I've written in the past, getting to cash flow breakeven places the control of your destiny squarely in your own hands – no longer dependent on infusions of capital for meeting the next payroll.

However, cost cutting is only one of the levers you can pull to reach breakeven. I haven't seen much from VCs on driving the sales front so here's input for the other side of cost cutting – revenue generation.

Sales leverage

Even in a growth market, startups face a headwind in getting their message out and making it heard above the noise. In a down market, it is even harder. It's expensive to knock on doors and find potential customers that a) have the problem only you can solve and b) who are willing to spend money to fix it!

Companies put a lot of effort (and expense) into lead generation programs. Purchasing prospect lists, advertising, trade shows, telemarketing etc. are all tried and tested tools but are still part of a push sell – you want to convert this to a pull.

You have to make it easier for customers to find you.

Simplify the message

When I start working with a company, I listen to how the team describes the problem they are solving and try and put myself in their customers' shoes. Does the customer describe the problem in the way the company does or would they describe it differently? Then I go ask some customers or prospect how they describe the problem.

9 times out of 10, the customer's description of the problem is simpler, more concise and in a phrase suitable for a Google search.

You can guess what I do next… I take that simple phrase and run it through Google to see where (if at all) the company ranks in the search results. Sharing this with the team can be an enlightening experience especially if the marketing folks defined a "new category" to describe themselves; often they are the only occupant of the category and customers give you a blank stare when you describe the category.

So, step 1:

• Make it easy for your customers to find you!
• Describe yourself the way your customer describes YOU
• Use plain language, don't define a complex category

Make it obvious

How many web sites do you look at and instantly "get" what the company does from its home page? Try it for yourself (especially with your own company web site!) – While some sites deliver the message with punch, all too often you have to drill down several levels in the web site to get a plain answer – assuming you can find one at all!

In a world of attention-challenged people, do you think a customer prospect is going to drill down into your site to find out how you can solve their problem? Obviously NOT!!!

Step 2:

• Make sure you have a clear message on your home page
• Match the description of the solution to the customers definition of their problem
• Include an obvious "call to action" (get more information, free trial, demo… etc.)

This isn't just SEO

DO NOT let your marketing folks tell you this is about search engine optimization. Simplifying the message and making it obvious is a critical first step – you want to make sure that your site ranks high in the searches for the RIGHT message – the one that the customer uses to describe their own problem and to which they resonate when visiting your web site. Once you have the message down you can turn it over for SEO.

 

If your sales process is dragging and you're trying to figure out why – start by following the steps above. If the message isn't simple and obvious – FIX IT before you do anything else. Likely, this won't be a simple process because positioning is complex to get right and effects many other things – sales collateral, product specs, and product!

I will leave you with the following food for thought: if you can't deliver a simple and compelling message that resonates with your customer via your web site, how effectively do you think your sales person is going to deliver a value proposition?