There was a repeated focus on capital control by entrepreneurs at Digital Hollywood’s Venture Capital panel in Los Angeles which I chaired a couple of weeks ago http://bit.ly/cpbI4w .
Trends still tight
Economic trends are still tight for entrepreneurs, and also for VCs looking to replenish their own Funds from their institutional investors. This is driving a trend to invest in early stage companies that can show a proven record of how they control their cash.
Investors’ due diligence questions
- How cost-effectively did the founders develop their product using available tools, barter, and sweat equity?
- What salaries are they paying the team, and what salaries do they expect after funding?
- Are they a virtual team or are they spending on office space? If in an office, is it in an incubator or a reduced-rent situation?
- Are their books in order, showing an understanding of the financial side of the business, and a rational balance of spending to revenue?
- Does their history of spending show a waste of money or a penchant for indulgence?
- Have they created debt which is burdensome?
- Do their projections anticipate the reality of time to market, channel building, and other market factors that can slow growth?
The venture capitalists also recommended more rational control by entrepreneurs when setting their valuations. If the valuations are set too high, and based on benchmarking, and the benchmark is missed, a down round is sure to follow. In terms of driving the value of the company over the long run, to its acquisition multiple or IPO valuation at its exit, it is wiser to take more controlled steps to avoid a down round. That means controlling the valuation, the benchmark, and the step up to each benchmark, so that the growth curve of the company looks continuously rising, to an ultimate exit. This discipline is part of the capital control the VCs are seeking.
An uptick in new investments
There is indeed an uptick in investing again, in new companies and first rounds, not just bridge loans and mezzanine rounds. I think the press is hyping how much of that new investing is occurring, but this panel definitely indicated several first rounds in new companies.
So, although we’ve heard about capital control before, it is now becoming a more formal part of the review of any company before green lighting a first meeting or an investment. It is wise for entrepreneurs to get professional help in presenting their current books and in building out their projections, carefully delineating their assumptions and plans.