Editor’s note: Jim Verdonik and Benji Jones are the cofounders of Innovate Capital Law and are regular contributors to WRAL Techwire
RALEIGH – Viruses aren’t the only things that are contagious.
Fear is even more contagious.
Fear makes people stand still. Like a deer that stands in the middle of a highway watching your car speed toward it, fearful people freeze up. Fearful people stop investing. They become obsessed with holding onto the money they have and forget about making more money.
Fear kills deals.
Did your deal get sick during the virus shutdown?
Lots of deals have.
Some deals have died.
Others are on life support.
We are Deal Doctors.
We see lots of sick deals.
These days we’re seeing many more sick deals than usual, and the mortality rate is increasing.
THE OPERA AIN’T OVER TILL THE FAT LADY SINGS
Yankee catcher Yogi Berra wasn’t the first person to say that, but he popularized the phrase.
We’ve all seen dramatic last minute turnarounds. Who can forget the Atlanta Falcons blowing a 25 point third quarter lead in Superbowl 51?
It’s the same with deals. Deals can die at any stage.
When is deal immune to death? Never.
Deals die at the last minute all the time.
Take the time where we were representing a venture investor. All the documents were signed by both sides and laid out in stacks in a conference room. We were waiting for our investor client to tell us to deliver the documents and close the deal. The documents sat in those stacks for several hours while the CEO of the company sat staring at them. Finally, our client called – we are not closing. Do not deliver the signed documents. We are not wiring money.
In another deal we were counsel to a company that was trying to do its initial public offering (IPO). We cleared final SEC comments and had SEC permission to file the last amendment to make the offering effective. Great! We had done our job as securities counsel. But the stock market was falling. The underwriters were getting nervous. The client was even more nervous. When the market closed that day, the company and the underwriters held the all-important pricing phone call. After several hours discussion, they decided to delay pricing.
The next day the underwriters cancelled the deal in a ten minute phone call. Four months of work went down the drain.
In the IPO world, they call this the “window closing.”
On the bright side, the next year we helped our client successfully completed its IPO with a different set of underwriters at a much higher company valuation.
With these war stories in mind, let’s talk about the four stages of sick deals:
Once you get a term sheet, you want to be able to close quickly.
You can’t spend a term sheet.
Unfortunately, many young companies don’t have their ducks lined up to do that.
They neglected taking care of many loose ends. They didn’t properly document prior transactions. They didn’t get shareholder approvals. They treated their employees like consultants and created potential withholding tax liabilities. They mishandled equity compensation. They promised people stock and never gave it to them. They made oral promises to customers they can’t keep. The list of potential pitfalls goes on and on.
We had a good deal die this year, because the founder had promised shares to a co-founder. Later, the two disagreed about company direction. Investors were ready to invest, but backed away because the co-founder threatened to sue to get his shares. Investors don’t invest in law suits.
All of these problems are discovered when investors conduct their due diligence. And investors won’t part with their money until the company fixes these problems.
The best way to ensure you can close a deal quickly is to not create these problems in the first place. Pay attention to details and do it right the first time. Second best is to begin cleaning them up long before you begin negotiating a term sheet. Maybe think about trying to cure these problems now, while we are all stuck in virus mode.
In difficult times like the virus shutdown, don’t leave potential investors or buyers in the dark. What they imagine about what is happening to your business may be worse than the reality.
Doing deals is about relationships. Relationships need active maintenance.
So, as much as you might want to pull a blanket over your head until the misery stops, stay in touch with your investors.
Find out whether they are getting nervous. Find out what they are most worried about.
In doing so, however, resist the temptation to pressure a quick closing. It may scare them into cutting off the conversation. Your main goal at this point is continuing the conversation and creating calm.
Investors invest in management teams. This is an opportunity to show investors you are a good manager who can deal with a crisis. When the crisis is over investors will remember which management teams panicked and which fixed problems and made mid-course adjustments.
Realism is always the best medicine to cure a sick deal.
For the next several months or so, valuations will be lower than before the virus shutdown.
It doesn’t matter that a company like yours closed on $10 million at a $50 million pre-money valuation last year. Investors are going to be putting in less money at lower valuations for the near term.
Either live with that fact or suspend capital raising until investor psychology changes.
Of course, valuation is a big issue, but it’s not the only issue. Investors may change the deal structure. Maybe they want convertible debt instead of equity or want to invest in tranches over time. Prepare to be flexible about deal structure in difficult times.
We’re doing one creative deal now where is founder is personally entering into a side agreement that helps protect investors from downside risk. That does two things. First, it makes the deal more economically appealing to investors, but it’s also demonstrating that this founder hasn’t lost faith in his ability to create value even in this strange time. We expect we will close this deal before the country reopens.
Some deals can’t be saved. The reasons are numerous.
· The investor is too nervous to make a decision.
· Your investor’s goals have changed.
· Your investor is in financial trouble.
· Your value proposition has changed.
Be realistic and adjust your plans.
· Reducing your burn rate.
· Delivering a product to market with fewer bells and whistles.
· Doing a channel partner deal to generate revenue at the expense of reduced margins.
· Offering customers discounts to generate cashflow.
· Finding different investors.
· Selling all or part of the business instead of raising capital.
There is no single easy solution. If it was easy, everyone would be rich.
We’re Deal Doctors.
We’ve seen it all thorough many problems.
Talk to us about your problems. We will try to prescribe a remedy for what ails you.