All VC’s are Hammers, but Not All Startups are Nails

I met with a company today that is doing $1.1M in revenue per month, is profitable, but is having cash flow issues. It has a number of receivables outstanding (that are net 60 to net 90). To solve for this, the company is raising a $3M bridge round to get provide enough runway to close an impending round of equity capital (that is going to be quite big).

The bridge round was going to be on a convertible note with a reasonable cap and a discount to the next round.

But I couldn’t understand why this made sense — the only reason I could think of is because “bridge rounds” are how it’s always been done.

The founder wants to use the capital to do two things:

(1) Potentially purchase small assets — such as acquihires or other media properties, etc

(2) Manage current operational needs

If he raises the bridge round at the $50M cap he’s proposing, he’ll have sold 6% of his company when the note converts.

If all of that money was going to finance the purchase of assets (as a way to spend more capital than he’s currently earning now to buy an asset that would speed up growth later) this would make sense. But he claims it’s also to manage day to day cash flows to give him more time to raise his next round.

In that case, what he should do is take in $1M onto the note (sell 2% of his business) and then sell the receivables to someone (like me) in exchange for a high interest rate and some warrants.

Why?

Because doing so would solve his cash flow needs and would provide him with patience to raise his next round. If he paid a 20% rate on $2M of receivables for 90 days it would cost him $100k of cash. He could then issue warrants at some aggressive coverage ratio (let’s say 20%) at a strike price equal to the cap of the note ($50M), which would equate to .8% of his company.

This would save him 3.2% of his company in exchange for $100k of cash — and it would still solve his cash flow needs. In total, it would save him $1.5M of value measured in cash and equity. It would also provide me with a cheap option via $2M of a cash investment that was fairly de-risked, in exchange for some upside on the outcome of his company.

A good trade all around.

Will he take it? No. Because that’s not what he’s used to seeing. He’s used to traditional VC, where every problem is a nail that must be struck by the hammer of Venture Capital financing.

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