July 28, 2005

"Have a downside scenario in your financing strategy"

Fred Wilson has great advice on how start-ups should plan for their next round of financing:

So how do you go about hoping for the best and preparing for the worst?

I think its best to start with the downside scenario. What happens if your company can’t get anyone to step up and do the financing on terms that are acceptable?

Well there are a couple approaches to this. The first is to do the financing when you don’t really need the money. That’s a great strategy. Maybe you’ve got nine months of cash left in the bank. Maybe you go out and talk to three or four potential investors to see if you can get something done with them on terms you’d like. If you can’t, you stop the process, go back to work, and come back to market in another six months.

If you don’t have that luxury, then you need to turn to your existing investors as your downside scenario.

There are a couple of ways to think about this.

The first is to get the existing investors to tell you on what terms they’d be willing to do an insider round. Get that locked down and then go out and see if you can do better. If you can’t, then you come back with your tail between your legs, but comforted in the knowledge that your company isn’t going to hit the wall.

The second way to deal with this is to put a bridge in place. Get the existing investors to loan the company enough cash to fund the company for say six months and agree to convert the bridge into the next round.

You can even marry these two approaches by getting the investors to bridge a portion of a potential insider round while you go out and try to find a new investor to provide the balance of the round and set the terms.

Arun Natarajan is the Editor of TSJ Media, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of TSJ Media's Venture Intelligence India newsletters and reports.