Ask The VC

Why Don’t Venture Capitalists Tell You Why They Won’t Invest?

jason@foundrygroup.com — Mon, 16 Nov 2009 10:54:45 -0700

Today, we were asked the following question:

'”Why don't VCs tell you the reason why they don't invest? Any feedback would be useful. It's just plain rude.”

I (Jason) figured that this is really a personal question, so I thought that I’d post on my personal blog, as I certainly can’t speak (or even guess) the response for the entire VC industry.

You can see Jason’s thoughts here.

Preparing to Wind Down a Business: What information do you need?

jason@foundrygroup.com — Tue, 10 Nov 2009 06:50:38 -0700

We continue to work our way through wind downs in the third part of the series from Roger Glovsky. Roger, you have the floor…

The primary responsibility for shutting down operations and liquidating assets falls on the managers and/or owners of the business, at least until or unless the creditors or court system takes over. This could come as a nasty shock to some investors. Many angel investors or even venture capitalists enter a transaction with the intent of just contributing money. They may be surprised to learn some day that the management team for the company they invested in have all resigned and that no one is remaining to wind down the business, sell off the assets, or pay down the liabilities. Suddenly, one day the investor or owner receives a call (most likely from a creditor) asking what they plan to do with their company and how they plan to address the outstanding liabilities. Not a happy call for the investor or owner.

Whether you are a manager or an owner faced with winding down a business, the goal of the person winding down the company is to fulfill his or her fiduciary obligations and preserve the management's or owner's business reputation. The first step is to assess the financial situation of the business. The second step is to take note that time is of the essence and the longer it takes to do the first step, the more time, money and reputation it will cost the management or owners.

When you buy an existing business, you typically do what is referred to as "due diligence" to make sure you know what you are buying. Similarly, when you are winding down a business, you must do your due diligence to make sure you know what assets and liabilities the company still has and how best to handle them. This is what I call "reverse due diligence". Reverse due diligence involves all of the same information that a buyer or investor might request for a growing business, but for a different purpose: the purpose is for marshaling assets and managing liabilities to maximize value on the downside. In normal due diligence, a buyer will scrutinize financial information and disclosure schedules looking for hidden liabilities that may detract from the value of the acquired company. In reverse due diligence, the person winding down a business is looking for hidden assets that can maximize value and facilitate the settlement of the company's obligations.

So, what information do you need?

1. Financial Information. Most importantly, you need to get a good handle on the financial situation. Are there current financial statements (e.g., P&L, balance sheet, cash flow) prepared by an outside accounting firm? If not, start with the most recent tax return and review all information relating to income, balance sheet, assets, liabilities, and capital structure. Are there internal financial statements prepared by the company? Is there a Quickbooks file (or other accounting software) that can print a transaction report for the current or prior years? What might be the "off-balance-sheet" assets? Seek help from the company’s accountant and financial advisors to make sure that the financial information is accurate and up to date.

2. Taxes. Make a list of all states in which the company is obligated to pay taxes. What is the process in each state for submitting final tax returns? What tax good standing certificates are required for dissolution? What are the outstanding tax obligations (e.g., payroll taxes, estimated taxes, annual taxes, sales taxes)? What obligations are coming up in the near future? What tax obligations or tax filings will be required after the company ceases operations? What money will you need to reserve for payment of taxes after dissolution?

3. Hard Assets. List all assets, including both "hard" assets and intangible assets. Hard assets include computers, equipment, furniture, products, and inventory. Are the assets leased or owned? Are the assets worth more sold separately or combined with other assets (such as a product line or customer contract)? You may want to start with the most recent balance sheet to identify major assets that have been capitalized. Which assets are most valuable? Which assets can be sold easily (e.g., using brokers, auctioneers, eBay, or Craigslist)? Are there any strategic assets that may be desired by vendors, partners or competitors?

4. Soft Assets. Soft assets are intangibles that include securities, accounts receivable, contract rights, bank accounts and cash. Intangibles also include intellectual property such as patents, copyrights, trademarks, websites, blogs, and domain registrations. Is there technical information or process know-how that employees (or former employees) could document and make available for sale? What is the value of the brand and how can it be transferred? Is there software or technology (or other IP) that could be licensed? Can customer lists be sold?

5. Potential Buyers. Can you identify a specific list of potential buyers? Who might have a strategic or competitive business interest in some or all of the assets? Consider vendors, contractors, customers, strategic partners and affiliated entities. Would business brokers or investment bankers be able to find potential buyers? If not, are there auctioneers or liquidators who would help fire sale the assets?

6. Lenders. What loans or financings has the company entered into? Are there other credit arrangements? Make sure that you review executed (i.e., final) drafts of all documents. What do the documents require? Which creditors or obligations take precedence? What happens in the event of default? Are there any personal guarantees? Can the loan or financing arrangements be renegotiated?

7. Employees. What are the current payroll obligations? How should they be managed during the wind down process? What bonuses, vacation pay [Ed. Note: and sales commissions] and accrued expenses are owed? What payroll taxes will be due? What employee benefit plans need to be cancelled or terminated? How will this affect employees on COBRA? Can you save money by switching to a Professional Employer Organization (PEO)? Are there any other forms of compensation (stock, deferred compensation or other incentives) that have not been documented or paid? What employment contracts exist and what restrictions will remain enforce? Can you or a potential buyer solicit employees? Are you treating all employees fairly and equally? How will your actions affect employees that you might want to hire again for a future venture?

8. Customers. Make a list of all current customers, past customers, and prospective customers. Which customers have outstanding receivables? Are there open orders? Should open orders be cancelled or delivered? Which customers have you collected money from but won't be able to deliver products or services? What prepayments from customers should be refunded? How much of the receivables can be collected after the company ceases operation? Which receivables should be written off as uncollectable? At what point should you notify customers that you intend to cease operations? How long can you hold out for a buyer to take over a product line or business? Are there any long term agreements for services? What goodwill can be salvaged or business reputation maintained by transferring unfinished projects to another service provider?

9. Vendors. Make a list of all suppliers and contractors. Be sure to review current versions of all agreements, including any addendums or renewals. Which vendors do you owe money? What leases are there for real estate or equipment? Are there any long term contracts? Can you negotiate an earlier termination or buy-out of the contracts? Can you get the contract modifications in writing? What are the notice requirements and other obligations upon termination? How many days in advance must notice be given? Are some notice requirements sooner than others? Are there any security deposits or prepayments (e.g., insurance) that will be repaid to the company?

10. Records; Compliance. Review all corporate records, paying particular attention to obligations upon dissolution or liquidation of the company's assets. Make sure that you have current copies of all corporate (or LLC) records including charter, bylaws, stockholder agreements (or in the case of an LLC, the Operating Agreement). Are there any security, investment or other financing documents that affect the owners’ rights or the distribution of assets? Are there any documents that assign responsibility or indemnification upon default of obligations? Are there regulatory filings or other compliance obligations? What licenses or registrations does the company have and how should they be withdrawn or terminated? Are there any environmental issues or other compliance obligations that will continue after operations cease?

Review all of the assets and liabilities carefully. Are the assets worth more or less than the company paid for them? Are there any assets with hidden value (such as websites with significant traffic or popular domain names)? We have had some clients sell domain names alone for more than $500K. Some of these assets may have more value to competitors than they do to the failed business.

After you have gathered the information above, you should be able to make a preliminary assessment as to whether the company's net worth is positive or negative. Be sure to review the assessment with the company's accountant, attorney and other professional advisors in order to determine when to cease operations and to plan for the orderly liquidation of assets. The professionals can help to structure and guide the wind down strategy. There are many financial and legal pitfalls for the unwary. It does not have to be time consuming or expensive, but the assessment does require a trained eye to avoid potential issues that might arise later after the assets have been liquidated and the proceeds disbursed.

The above list is just a sample of the most common items to consider before winding down a business. There are many more items that would be included on a typical due diligence checklist. The financial information and due diligence should be performed with the utmost care and accuracy to make sure valuable assets or significant liabilities are not overlooked. Are there may major items that we have failed to mention? What information did you find the most useful in winding down a business?

Roger Glovsky is a founding partner of Indigo Venture Law Offices, a business law firm based in Massachusetts, which provides legal counsel to entrepreneurs and high-tech businesses. Mr. Glovsky is also founder of LEXpertise.com, a collaboration and networking site for lawyers, and writes blogs for iLaw2.com and The Virtual Lawyer.

Part 1: How to Wind Down Your Company

Part 2: When to Shut Down Your Company

The above content is intended to serve as a general discussion of the subject matter and is provided for informational purposes only. It is not legal advice and should not be construed as such. Do not act upon this information without seeking professional advice or rely on this website or use the content as a substitute for consultation with professional advisors.

When to Shut Down Your Company

jason@foundrygroup.com — Mon, 19 Oct 2009 21:02:30 -0700

Last week we started the blog series (written by Roger Glovsky), How to Wind Down Your Company. The response and comments were great! Keep them coming. This week we tackle the hardest problem of all: deciding when to shut down your company.

It is not easy an easy decision, especially for entrepreneurs. Starting a company is about creating a vision, persuading others to believe in the vision, turning an idea into reality, and pursuing a dream. The last thing an entrepreneur wants to do is to shut down his or her dream.

So, how do you make the decision to shut down your company? When do you decide to shut down your company? The short answer is: When the company has no other alternatives.

What are the alternatives?

Financing. If the company burns through the Series D funding, why not just raise Series E, F or G? There are plenty of letters in the alphabet, aren't there? No. Not every business problem can be solved with money. The business model may have changed. Competition may be too great. Technology may have failed to perform. Or the customer just didn't buy enough of the products. And the Series A, B, C, and D investors may already have been burnt by prior down rounds, cram downs, or failed expectations.

Sale or Merger. This may be the best option for an entrepreneur, if it is available. The sale or merger of a business is often regarded as a success even if the sale price is well below the amount contributed by investors. Why? Because the sale price may not be disclosed. The typical press release of a failed business simply states that a small company was acquired by a big company and that together the new combined company plans to do great things. The big company may get strategic assets (often technology or intellectual property) at a discount and the small company preserves its reputation. Win-win. The public may not ever know that the business failed.

Bankruptcy. The company could file for bankruptcy and leave it to the courts to handle it. This can be an expensive and inefficient process. Why? Because the courts have required procedures to ensure fairness to those with potential claims including lenders, suppliers, customers, tax authorities, employees, investors, shareholders, and others. The process of sorting out potential claims takes time and the resulting delays may reduce or destroy the value of certain business assets. Often, the disposition of business assets can be handled better outside of bankruptcy through private settlement processes.

Crash and Burn. You could simply leave the company on "autopilot" and let the business hit the wall at 200 mph. As I mentioned in my first post, the end result is "crash and burn". Complete loss of life. No one walks away. It isn't pretty. The business dies and no one takes responsibility for its failure. No regard for any of the trust relationships created during the visionary, start-up and operating phases. Just "oh well, we tried." The problem is personal assets could be at risk and the law may hold directors, officers, and stockholders (or other business representatives and owners) responsible long after the business entity ceases to exist.

Deciding "there is no alternative," should not be a last minute determination. In most companies, you can see the end coming well in advance. Either the company is gaining customers or losing them. The energy is either flowing into the management team or out of it. The products are either shipping with fewer bugs or more bugs. The cash flow is either improving or getting worse. If you are paying any attention to the business at all, you know what's happening.

Shutting down a business is really a process, not a decision. You don't just wake up one morning, look at your to do items and then write "wind down company" at the top of the list. It's a process. You have to go through the painful, possibly agonizing process of evaluating your alternatives. You should consider carefully who will be affected by the shut down and seek advice from trusted and knowledgeable sources. You should consult with your board of directors (or other governing body) as well as your legal counsel and financial advisors. In the end, you need to make a thoughtful, well-reasoned decision and then take the necessary actions. The earlier you deal with the issues, the more alternatives you will have and the easier it will be to transition to the next venture.

During the mid 1990's, I was President of a software development company faced with the decision of shutting down its business. We were selling Mac software to enterprise customers at a time when almost every major corporation in America stopped using the Mac in the workplace. And we were competing against other vendors, including Apple, that were literally giving away a similar product for free. We had some good years and were profitable, but we were selling into a legacy systems market and saw the end coming well in advance. We reviewed various options with our board of directors and made several attempts to develop new products and pursue other opportunities, but in the final analysis, we decided that the various options did not match our talents or resources. Instead, we wound down the business and simply distributed the remaining assets to the stockholders.

You don't have to "pull the trigger" right away, but you do need to begin planning well in advance. Whatever you do, don't wait too long to start the process; it gets messy. What do I mean by "too long"? The company can't meet this week's payroll. The Company doesn't have enough money to pay its taxes. The company already missed a loan payment. You are wondering what happens to your personal guarantees when the business fails.

What is the likelihood of business failure? I can't vouch for the information, but here are some interesting statistics. We would like to hear your war story about winding down a business. What made you decide to cease operations? What actions did you take? What alternatives did you consider?

Roger Glovsky is a founding partner of Indigo Venture Law Offices, a business law firm based in Massachusetts, which provides legal counsel to entrepreneurs and high-tech businesses. Mr. Glovsky is also founder of LEXpertise.com, a collaboration and networking site for lawyers, and writes blogs for iLaw2.com and The Virtual Lawyer.

Know Your Communication Strategy When Raising Money

jason@foundrygroup.com — Mon, 19 Oct 2009 07:26:51 -0700

Today’s interesting post is from Matt Eventoff and talks about how startups need a communications strategy while raising money – not all that dissimilar from a disgraced politician. Thanks Matt!

How To Wind Down Your Company – New Series

jason@foundrygroup.com — Wed, 07 Oct 2009 09:51:47 -0700

Of the most popular posts that Brad and I have created are our series on Term Sheets, Compensation, and Mergers and Acquisitions. One of the subjects that we've wanted to tackle has been the dissolution of companies. It's never fun to think about failure, but it happens a lot.

Unfortunately, we haven't gotten around to it yet, so it was with great joy that my friend Roger Glovsky elected to write the series himself. This is post one of the series and I'm really excited to introduce Roger to our readers. Take it away, Roger.

This is a follow-up to Jason Mendelson's recent interview on how to handle start-up failures. It is a timely topic for entrepreneurs who may be running low on cash or worrying about "hitting the wall." Jason offers critical advice about how entrepreneurs should manage their relationships with directors and investors and why they should reserve enough money to wind down operations in an orderly manner. Although much has been written about how to start a new venture, very little has been written about how to shut down a failed venture. It was Jason's suggestion that I write more about it. This is the first in a series of blogs about how to deal with business failure, how to minimize liabilities, and how to keep your spirits up and your business reputation intact.

Every entrepreneur or investor who lived through the dotcom bust has their "war stories" or knows an entrepreneur who failed. In fact, the venture capital model is based upon failure. The NVCA estimates that 40 percent of venture backed companies actually fail (another 40 percent produce moderate returns and only 20% actually have high returns). Therefore, failure is part of the business of investing and starting companies. The key to success may be in knowing how to deal with failure, which is what we want to discuss in this series of articles. There may be more than one way to successfully fail and we hope this series will encourage more people to discuss (or perhaps debate) the proper way to shut down a business venture.

Start-up failures are legendary. The classic image is that of a race car driver that hits the proverbial wall at 200 mph. The end result is "crash and burn." However, if you crash and burn, you don't live to race again another day. As an entrepreneur, hitting the wall means running out of money and burning bridges; you will likely end up destroying relationships with all the people who supported your start-up venture. If you value the entrepreneurial life, then you may want to do a second or third start-up. You don't want to hit the wall at 200mph. You want to walk away, and live another day to do a new start-up and pursue a new dream, and this time win the race. Brad Parker, a successful entrepreneur, once described professional racing as a "series of controlled crashes". I think the same theory applies to start-ups. The operative word is "controlled". The question is how do you wind down a business in a controlled manner so that you can preserve your relationships and start a new venture again someday.

When a business fails, anyone with a financial interest could have a potential claim on the failed entity including investors, lenders, trade creditors, employees, suppliers, customers, and the government (e.g. the IRS or state taxing authority). If those interests and claims are not properly addressed during the wind down process, the officers, directors and stockholders could be held personally liable. How you treat each of the affected persons is critical to successfully shutting down a business. From the moment you first decide that failure is a possibility, it is important to take control of the process and work with legal counsel as well as tax and accounting professionals to properly address the issues.

The articles that follow will strive to outline the process for shutting down a business in practical terms. The questions we intend to address are: When should you decide to shut down a business? What approvals are needed to shut down a business? Who do you tell first? How should assets be disposed of? What is a fair price for the sale of assets? How do software and web-based businesses differ from traditional bricks and mortar? What happens to intellectual property like software and domain names? What happens to customer lists and customer information? How should debts be paid? What business obligations can you be personally liable for? What business records do you need to have? How long do you need to keep them? When is the business officially terminated? These are just a few sample questions. Feel free to suggest your own.

We welcome your comments on this topic and encourage you to share your own real-life experiences in shutting down a business. Why did you shut down your business? What steps did you take? What would you do differently? How would you advise others?

Thoughtful Analysis on the Dynamics of the VC Industry

brad@feld.com — Tue, 25 Aug 2009 09:58:11 -0700

I tend to stay out of the “VC is dead, long live the VC Industry” discussion but I couldn’t avoid Bill Gurley’s fantastic post titled What Is Really Happening To The Venture Capital Industry? All I can say to this post is “what Bill said.”

How to Run a Great Board Meeting

jason@foundrygroup.com — Fri, 07 Aug 2009 10:47:47 -0700

Today, the great post is by my partner Brad. He has a great post on how to run a great board meeting. Should be required reading in my opinion.

Ruminations On Whether Seattle VC’s Suck

brad@feld.com — Tue, 04 Aug 2009 08:51:05 -0700

Today’s post of the day is from Andy Sack titled Do Seattle VCs suck? In it, Andy states:

“Moreover, I wanted to explore the question: Do Seattle venture capitalist suck as much as their public opinion suggests? In a nutshell, the local venture community is getting a bad rap. However, it's also easy to understand why entrepreneurs have come to view them the way they do. Here are the pros and cons as I see them.”

Andy currently runs Founder’s Co-op in Seattle. I’ve made and lost money with Andy in the past and he’s had plenty of exposure to VCs (good and bad). Useful stuff and relevant to all VCs (not just Seattle ones).

Another Way VCs Outnegotiate Entrepreneurs

brad@feld.com — Sat, 18 Jul 2009 08:55:07 -0700

Jeff Bussgang from Flybridge has today’s great VC post titled In VC deals, Price Doesn't Matter - But The "Promote" Does. While I personally dislike the phrase “promote” to describe the concept Jeff is describing (I think “founders post-deal ownership value” - or FPDOV - is a much better phrase, although I realize “promote” is catchier.)

If you are an entrepreneur negotiating a VC financing, you should read this post carefully. Jeff does an excellent job explaining one of the key ways that VCs outnegotiate entrepreneurs while making the entrepreneur feel good about the outcome.

Finding Companies to Invest In

brad@feld.com — Wed, 08 Jul 2009 11:54:02 -0700

Today’s great VC post is from my partner (and co-author of this blog) Jason Mendelson. Jason post Where Do Venture Capitalists Find Their Companies? has a detailed breakdown, from Jason’s point of view, on where VCs find (and look for) companies to invest in.

And – as a bonus post – Mark Suster has a dynamite rant titled Is VC too Fat and Happy?

How To Cold Call A VC

brad@feld.com — Sat, 20 Jun 2009 10:55:58 -0700

Mark Suster of GRP Partners in LA continues to crank out great posts, including today’s titled Getting Access to the Old Boys’ Club (how to approach a VC).

I like investing in LA (we’ve got three investments there – Oblong, Topspin, and Memeo) and I’ve got a long term evil plan for the city. In the mean time, I’m going to be speaking at Twiistup 6 in LA on July 30 in case you are interested in coming and hanging out with a bunch of startups in the LA scene.

Betting on A Big Wave

brad@feld.com — Tue, 16 Jun 2009 08:54:48 -0700

Mark Suster of GRP Partners is blogging like a fiend and has the best VC post of the day titled Sorry Guys – It’s the Size of the Wave, Not the Motion of the Ocean. Entrepreneurs – wander over and take a look. Plus, he’s got some title alliteration.

When Failure Is An Option

brad@feld.com — Sun, 07 Jun 2009 22:56:09 -0700

Today’s great post is from David Cowan of Bessemer Venture Partners and is titled Israeli Venture Keynote: When Failure Is An Option. Embedded is his keynote presentation from last week at the Israeli Venture Association Annual Conference. While David focused on lessons for venture capital in Israel, they apply broadly to venture capital anywhere in the world, including the United States.

Key Characteristics of a Great Startup Culture

brad@feld.com — Sat, 30 May 2009 20:06:16 -0700

Today’s great VC post is by Greg Gottesman (a managing director at Madrona Venture Group) and is titled Thirteen key characteristics of a great startup culture. It shows up in John Cook’s column in TechFlash – the article is solid and the comments (all 66 of them at this point) are priceless. I’m baffled by the super-negative anonymous commenters as they add absolutely nothing to the conversation. If you are going to be critical (which is fine – and often helpful in sharpening up the ideas), be bold and comment with your real identity!

Start-up Cost Projections For First Time Entrepreneurs

brad@feld.com — Mon, 25 May 2009 19:12:24 -0700

Q: At a pub in Los Gatos, CA a casual conversation with some young, first time entrepreneurs lead to an interesting comment:
"...the business plan outlines our estimated (operational) expenses but how do I know an investor is not going to look at these numbers and say...'are you f'ing kidding me' and right then and there we can loose this guy (his interest)..."How can an entrepreneur build these projections most accurately and in a way that will maintain credibility with potential investors? What could be defined as the "best practice" for entrepreneurs dealing with this subject?

A: (Brad) As I’ve said in the past, I’ve never met a financial plan for an early stage company where the revenue side was correct. However, I’ve met plenty where the cost side was correct (or – at least – appropriate). The key here is simple – you want to have a cost structure that makes sense, covers all the bases, but doesn’t assume a big revenue ramp to be supportable.

If you are in the very early stages (e.g. a few people and an idea), recognize that your investor is likely going to be funding you for about 12 months to see how things play out. The biggest mistake first time entrepreneurs make is that they fall prey to the idea that they need to put together a five year P&L forecast and cash flow projection. I can guarantee – with 100% certainty – that this model will be wrong. As an investor, I don’t really care about this; rather I want to see how you are thinking about getting to “the next stage” of your business. You get to define the next stage, what it’ll cost you to get there, and what things will look like when you get there.

If you are a first time entrepreneur, go find an experienced entrepreneur to act as a mentor. She can be a first line of feedback your cost model and likely will know a few “financial people” that can help you put together a simple, yet credible model. In addition, when you spend time with potential investors, don’t try to bluff. Tell them it’s your first time building a model like this and that – while you had help – you know you lack experience and are looking for feedback. Try to engage the investor in the process. Listen the potential investors feedback and iterate on your model.

Simple message – don’t be afraid to ask for help.