Cram Down – A Test of Character for VCs and Founders

Cram Down  A Test of Character for VCs and Founders

This vendible previously appeared in TechCrunch.

Cram downs are when – and I’m keeping a list.

At the turn of the century without the dotcom crash, startup valuations plummeted, shrivel rates were unsustainable, and startups were quickly running out of cash. Most existing investors (those still in business) hoarded their money and stopped doing follow-on rounds until the rubble had cleared.

Except, that is, for the marrow feeders of the Venture Wanted merchantry – investors who “cram down” their companies. They offered drastic founders increasingly mazuma but insisted on new terms, rewriting all the old stock agreements that previous investors and employees had. For existing investors, sometimes it was a “pay-to-play” i.e. if you don’t participate in the new financing you lose. Other times it was simply a take-it-or-leave-it, here are the new terms. Some plane insisted that all prior preferred stock had to be converted to worldwide stock. For the worldwide shareholders (employees, advisors, and previous investors), a cram lanugo is a big middle finger, as it comes with reverse split – meaning your worldwide shares are now worth 1/10th, 1/100th or plane 1/1000th of their previous value.

(A cram lanugo is variegated than a down round. A lanugo round is when a visitor raises money at valuation that is lower than the company’s valuation in its prior financing round. But it doesn’t come with a massive reverse split or transpiration in terms.)

They’re Back
While cram downs never went away, the inflowing of wanted in the last decade meant that most companies could raise flipside round. But now with the economic conditions changing, that’s no longer true. Startups that can’t find product/market fit and/or generate sufficient revenue and/or lacked patient wanted are scrambling for dollars – and the marrow feeders are happy to help.

Why do VCs Do This?
VCs will wave all kinds of reasons why – “it’s my fiduciary responsibility (which is BS considering venture wanted is a power-law business, not a “salvage every penny business”) or “it’s just good business” or “we’re opportunistic.” On one hand they’re right. Venture capital, like most private equity, is an unregulated financial windfall matriculation – anything goes. But the simpler and increasingly painful truth is that it’s wiseacre and usurious.

Many VCs have no moral part-way in what they invest in or what they’ll do to maximize their returns. On one hand the same venture wanted industry that gave us Apple, Intel, Tesla, and SpaceX, moreover thinks addicting teens is a viable merchantry model (Juul) or destroying democracy (Facebook) is a unconfined investment. And instead of society shunning them, we gloat them and their returns. We let the VC narrative of “all VC investments are equally good” equal “all investments are equally good for society.”

Why would any founder stipulate to this?
No founder is prepared to watch their visitor crumble underneath them. There’s a growing sense of panic as you frantically work 100-hour weeks, knowing years of work are going to disappear unless you can find spare investment. You’re unable to sleep and trying not to fall into well-constructed despair. Along comes an investor (often one of your existing ones) with a proposal to alimony the visitor unsinkable and out of sheer desperation, you grab at it. You swallow nonflexible when you hear the terms and realize it’s going to be a startup all over again. You rationalize that this is the only possible outcome, the only way to alimony the visitor afloat.

But then there’s one increasingly thing – to make it easier for you and a few key employees to swallow the cram lanugo – they promise that you’ll get made whole then (by issuing you new stock) in the newly recapitalized company. Heck, all your prior investors, employees and advisors who trusted and bet on you get nothing, but you and a few key employees come out OK. All of a sudden the deal which seemed unpalatable is now sounding reasonable. You start rationalizing why this is good for everyone.

You just failed the upstanding nomination and forever ruined your reputation.

Cram downs wouldn’t exist without the founder’s agreement.

Stopping Cram Downs
In the 20th century terrorists took hostages from many countries except from the Soviet Union. Why? Western countries would negotiate frantically with the terrorists and offer concessions, money, prisoner exchanges, etc. Seeing their success hostage taking continued. The Soviet Union? Terrorists took Russians hostages once. The Soviets sent condolences to the hostage families and never negotiated. Terrorists realized it was futile and focused on western hostages.

VCs will stop playing this game when founders stop negotiating.

You Have a Choice
In the panic of finding money founders forget they have a choice. Walk away. Shut the visitor lanugo and start flipside one. Stop rationalizing how bad a nomination that is and inveigling yourself that you’re doing the right thing. You’re not.

The odds are that without your new funding most of your employees will be left with little or nothing to show for their years of work. While a few cram downs have been turned around, (though I can’t think of any) given you haven’t found unbearable customers by now, the odds are you’re never going to be a successful enterprise. Your cram lanugo investors will likely sell your technology for piece parts and/or use your visitor to goody their other portfolio companies.

You think of the offer of cram lanugo funding as a lifeline, but they’ve handed you a noose.

Time to Think
With investors pressuring you and money running out, it’s easy to get so wound-up thinking that this is the only and weightier way out. If there overly was a time to pause and take a deep breath, it’s now. Realize you need time to put the current slipperiness in context and to visualize other alternatives. Take a day off and imagine what’s currently unimaginable – what would life be like without the visitor ends? What else have you unchangingly wanted to do? What other ideas do you have? Is now the time to reconnect with your spouse/family/others to decompress and get some of your own life back?

Don’t get trapped in your own head thinking you need to solve this problem by yourself. Get translating from friends, mentors and expressly your early investors and advisors. There is nothing worse that guarantees you permanently ruin relationships (and your reputation) is for early investors and advisors to hear well-nigh your visualization to take a cram lanugo is when you ask them for signatures on a visualization that’s once been made.

Being worldly-wise to assess alternatives in a slipperiness is a life-long skill. Life is short. Knowing when to double lanugo and knowing when to walk away is a hair-trigger skill.

In the long run, your employees, and the venture ecosystem would be largest served if you used your wits and knowledge in a new venture and took flipside shot at the goal.

Winners leave the field with those they came with.

Lessons Learned

  • Cram downs are washed-up by VC marrow feeders
    • Taking an “unfair advantage” and contributing to the toxicity of the startup ecosystem
  • Founders often believe they need to take a cram lanugo rationalizing “I’ll never have flipside good idea, I have so much time and effort sunk into this startups, I don’t have unbearable energy to do it again, etc.”
    • Founders rationalize it’s good for their employees
  • Take time to think well-nigh alternatives
  • Don’t get trapped in your own head thinking you need to solve this problem by yourself
  • You’re urgent the very people who were your early supporters
  • Walk away
    • You can do flipside startup then with your throne held high
  • P.S. if you’re prepared to walk yonder there are pretty good odds you’ll end up with a much largest deal (if you want one)