October 9 2014
by Todd Hixon

What To Do When Hope Is The Enemy

[This post first appeared at on October 8, 2014.]

A wise and experienced VC colleage, talking about a mutual portfolio company, remarked: “I feel sorry for Bob [the CEO]; he’s trapped trying to make AnyCo successful, but it’s going nowhere.” That was three years ago. AnyCo struggles on.

Entrepreneurs and investors alike get committed to a company, and we each have big investments that we carry on our resumes/balance sheets at an assumed value. We see the upside case and work feverishly to bring it off. We work together like a family: not always happy but bound by shared interest and history. And there is always a way to stoke more hope: entrepreneurs and VCs are very good at selling hope. Often, hope is the enemy.

Look for these warning flags:

• Growth is stalled below 50% per year and selling has not become easier.

• The company has tried for transformational customer or partner deals repeatedly, but the big fish are not biting.

• The business model or go-to-market have been pivoted twice already.

• Raising outside money from quality investors is not in cards.

• Key employees leave too frequently.

• The cap table has more layers than Kim Kardashian’s make-up, and the early equity is worthless.

• The company is five plus years old, and it loses money and scrapes the bottom of the cash barrel persistently.

When most of these flags are red, management and the board must face facts. Residual hope and inertia are powerful, and the board too-often keeps on keeping on. [As one CEO said to me, “The show must go on.”] The board needs a leader to step up and say: this is not working, there is no case to put more money in, we need to realize what value we can and divide it fairly among the stakeholders. Sometimes it helps to specify a time frame during which to try for the upside, and implement Plan B if that fails.

Most likely the company’s exit options are not pretty: when you force the sale of a struggling start-up, you often get surprisingly little. In the best cases I’ve seen, capital is returned and entrepreneurs get a bonus in six or low-seven figures. Usually the result is a small fraction of that. Often investors receive $ zero, with all proceeds going to creditors and stay-bonuses.

When a “Zero” happens, unrealistic expectations are often the culprit. Bankers, managers, and the board convince themselves that the sale can be (somewhat) lucrative. All agree to not ask too high a price, but buyers can smell aggressive expectations and may decline to engage because they think they will do a lot of work and then say no to the price. I’ve had this feedback from likely buyers several times. So the sale process drags on for 6-9 months, the company keeps burning money, and result is near-zero.

The best course is to make the call: agree that the status quo is creating no value, and all the stakeholders are better off to put their energy and resources elsewhere. Engineer a realistic strategy to realize value. Often this will not involve a banker: in a low value sale, management and investors probably know the likely buyers already. Set modest value expectations so the deal gets done quickly. The upside here is avoiding the downside of a long, expensive sale process with a zero at the end of the trail. And divide the proceeds as fairly as possible. No one gets a big pay day. The goal is to part friends and find a better opportunity.

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