Economic Rock (Bottom) Climbing
Main actions you can take to better handle your equity when your company struggles
Economic ups and downs are a common thing in any company's cycle, since Covid-19 hit, many have been experiencing their downs and it seems like a global occurrence. Although this situation might be a bit frightening, nothing is lost yet and some things can be done to try and climb the economic rock bottom. Before considering the drastic make sure you know what your options are, this article will explain the more commonly used methods and how they should be addressed.
The FEE triangle
There is a special connection between the entrepreneur, the employees on one hand, and the founders on the other. Unfortunately, most equity solutions, in this case, are considered an “Impossible Trinity” - no more than two can benefit from any given solution. Although we will show you each alternative, it is up to you to decide which is the right path for your company.
That being said, it is a commonly agreeable concept to try and keep the employees happy. Most will consider them as the yellow brick road to success: when the employees are happy they will work harder to make the customers happy. Then, the company will grow so all investors will be satisfied, and finally, the founders could enjoy the ripe fruits. For this reason, it is important to take the allocated stock options under consideration when thinking of the best solution for any equity conundrum.
Better SAFE than sorry
This “Simple Agreement for Future Equity” was originally created as a replacement for convertible notes by the lawyer Carolynn Levy. It shows a solution both the investor and the founder can benefit from: the investor will fund a company and receive shares by an amount set in a future, predetermined event. This negates the arbitrary characteristics that a funding round usually has, as it bases the transaction on a precise valuation yet to come.
In a SAFE, the founder will enjoy a cash flow that isn’t affected by the company's current low state. The investor, on the other hand, can get involved in a scaling company just before it rises and enjoys a high potential profit. That being said, a SAFE also affects heavily the shareholders' dilution and the amount they will be diluted will only be discovered up ahead.
The reason SAFE has become very popular in the past few years relates hardly to the global epidemic. An IPO can go live without losing value if the investments went through a safe. Furthermore, founders can receive a cash flow adjusted to what they believe the company can be and not what it is right now.
Nonetheless, keep in mind that leaving your current investors in the dark on their expected dilution might not be the best move for some. We highly suggest advising your CFO or accountant on the best way to accomplish this tricky yet efficient feat.
The scenario modeling here is even of greater importance, not as uncommon as you might think, companies tend to receive a higher than anticipated funding amount. Sounds like a dream comes true? Well, it is more of a nightmare, too much is a thing, and failing to handle the amount and consider every aspect can harm more than it can do good. Know what is the range of cash you need, not only the minimum, the maximum as well.
Sometimes down is up
One of the most commonly used methods is a down round. This doesn't require any particular preparation so founders often choose this path without understanding its full consequences. It means going for another funding round at a lower company value, deriving a lower PPS (price per share) than the previous round. For a company that is sunk in the mud and in need of a serious strong pull, this might be a good solution.
Right before you decide to take your company through a down round there are two important things to remember:
- Imagination is the best practice - theoretically, you can go to a funding round and at first try to convince new investors that they should invest at the same price as your previous round. That way you can try and avoid the actual down round, only if it doesn't work, ask for lower funds per share.
This is the reason most try to avoid going through any stock valuation so there will not be a price tag they can’t go around.
- Is dilution the solution? - remember that in this case, no matter the share amount or value you offer, it will dilute all shareholders*, including you and your current investors. To understand exactly how every shareholder will be diluted and to wisely plan ahead use scenario modeling. By modeling this round you can understand what your limitations are, see what can be bent, and how low you can really go. If you use Althsare’s automated cap table it shouldn't be harder than a click of a finger.
*Sometimes, to prevent dilution, investors will receive an update on their holdings so they won't be affected by the down round.
Will you share a share?
This method is called Venture Debt Financing and it is feared by some and adored by others. Simply put, it's a loan given by a bank or a venture capital, yet because of its risk the VC includes warrants in the pricing, and the interest is often high.
Like any other loan, you pay the debt with significant interest and essentially pay a lot more than you gained. The sweeter part of the deal is that there’s no dilution, at all, you get cash and keep the company at its current shareholders' state (excluding any exercised stock options).
Some VCs also offer ARR and MRR loans, it is commonly offered to SaaS companies as it offers a monthly or yearly fund. The amount is calculated by the anticipated revenue from the company's growth and current users. As it is calculated from a linear perspective, and most companies grow exponentially it is considered highly attractive to SaaS founders.
Although sometimes things look a bit low, as the “the hitchhiker's guide to the galaxy” put it: “Don’t Panic”. There are routes to consider and a financial path that might lead you to a safe haven. In most of our articles, we offer you to decide on the path that suit you most, here we offer to take each careful step with the aid of a professional. As we showed the most popular options and you now know more than before, there are other alternatives and things to consider. And although one or two might look the best fit for you, please consult with a specialist.
Altshare is a leading, fast-growing Equity Management & Compensation Plans Administration solutions provider. We love challenges. We are obsessed with our clients. We are on a mission to redefine the way founders do equity. All our products & services are supported through the Altshare Platform - the only equity management platform built for entrepreneurs.