This Is How a Venture Capital Deal Dies
You’ve raised several seed rounds from founders, friends and angels. You’ve bootstrapped your way to nearly $5M of annual revenue – the magic number for institutional investors to put real capital into your company. Term sheets are about to arrive and you’re hoping for a smooth close in 90 days, just as your cash is running out. Finally, you’ll be able to work like a real CEO with the resources to grow like never before.
Unless you can’t close the deal.
Venture capital deals can go sideways in a hurry, especially for those who are unprepared for the rigors of due diligence. Here are some things that kill venture capital deals… and some things you can do to avoid it.
It Takes Too Long to Close
This is probably the #1 killer of deals. Due diligence has a shelf life of about 60-90 days. Investors work on many deals and appreciate when the process flows smoothly. That means being responsive to the due diligence checklist and passing along documents that are complete, well organized and understandable.
You’ll know things aren’t going well if your deadline passes for the first draft of a purchase agreement and your investor is not explaining why. If they haven’t started yet, it means they may have found something that is holding them back. Get ahead of the story and find out why. A friendly “I noticed our deadline passed without a draft agreement and wanted to make sure we are still on track,” lets the investor know you are paying attention to deadlines and are interested in the deal.
Only 1-2% of all companies looking for venture capital get it. To join that group, prepare, hire great advisers, and be flexible.
Financials Are a Mess
Your financials tell the story of your company. How they are presented is as important as what they contain. Financials that are improperly or incorrectly prepared will turn off an investor. Two areas we typically see problems are proper calculation of gross margins and unrecorded liabilities on the balance sheet. Gross margins are important to investors as they indicate the ability of your company to generate enough cash to cover overhead and profit. Unrecorded liabilities are amounts your company owes but are not reflected on the balance sheet. Investors can’t stand putting money into a deal only to see it immediate evaporate to pay off past debts.
Many companies get tripped up when they provide supporting schedules to the financials… the numbers on the supporting document don’t tie to the financial statement. Don’t turn your investors into your accountants. By all means, make sure the historical financials in your pitch deck match the ones you are giving your investors! Nothing damages credibility more than financial data that doesn’t tie out. Don’t fix your financials during due diligence – find a good accountant to make sure your financials are in order before starting.
Legal Documents are a Mess
Investors want to make sure the company has taken the proper legal steps to defend and grow its business. They want to ensure their equity position is genuine. Proper legal documentation provides comfort. If an investor cannot get comfortable the company has legal, enforceable protections in key areas they will not make the deal. They also want to be absolutely certain everything has been disclosed during due diligence. Lack of disclosure kills deals.
Here are a few documents you’ll want to make sure you have signed and readily available:
1. Employment agreements with all employees
2. Customer agreements
3. Supplier agreements
4. Equity grants
5. Debt agreements
6. Founding & incorporation documents, board meeting minutes
7. Intellectual property protection
Spend money on a good lawyer with experience doing venture capital deals. Their counsel on getting to a close will be invaluable… many good attorneys have worked both sides of a deal and are up to date on the latest terms that will get a deal closed.
Company Runs out of Cash During Due Diligence
You’ve been representing to your investors all the great things you’ve been accomplishing and they’ve assumed that you have sufficient cash until the deal closes. Then you let it slip that you won’t be able to make the next payroll. This is a huge turnoff for an investor. It indicates one of two things:
1) You don’t know how to manage your cash or
2) You can’t identify and communicate bad news before it happens.
This is not a good impression to make especially if it is the first time raising institutional capital.
Founder Negotiates Unreasonably
Every entrepreneur believes his or her company is worth far more than an investor will value it. Some founders get hung up on valuation and simply won’t move away from a number. Savvy investors may give in on a number but crush the company with terms so onerous that the founder won’t get paid until some multiple is first paid to the investor.
This is where your decision to hire great counsel comes into play. He or she should know the current investing marketplace and advise you on workable deal structures. Work with them to rank in order the terms that matter to you and what you are willing to negotiate. Every deal requires tradeoffs that may be tough to stomach. Figure out what yours are and work the deal until it closes so you can live on to fight another day.
The 11th Hour Demand
Practically every venture financing has a last minute issue that springs up that threatens to kill the deal. Usually it comes from the investor – they’ve uncovered something and they are getting cold feet. Sometimes it’s a negotiating tactic, often it is not. Don’t take the bait – find out what the legitimate concern is and get your investor comfortable with it. Keep in mind this investor is about to become your partner for years. How you handle unwelcome news will set a tone for your relationship.