Capitalization and Financing for a Turbulent Market

As we continue to see how tougher market conditions impact startups, there's a deeper, more nuanced reality that depends heavily on the deal terms.

When things go consistently great, everyone wins, and when things go consistently poorly, everyone loses (especially at the early stage).

When a business OR the market they operate in and are financed in fluctuates, it introduces outsized risk to founders, employees and early investors who all sit together at the bottom of the liquidity stack. Remember: primary preferred stock investments work very differently from publicly traded common stock.

Arguably the worst scenario is when you work at or invest in a company early, it struggles a bit along the way, but is ultimately very successful yet you see no returns. This can happen in a variety of scenarios, but we’ll likely see it most commonly with great companies who raised at valuations that were just too high, resulting in the need for a down round, which does not affect all stockholders equally when there are multiple classes of shares with different rights and features. Doing everything that you can to keep your cap table in alignment regardless of the market conditions is critical to keeping the company growing in a healthy way.

The headline or implied valuation of a financing is a hurdle: if you clear it, that’s great. If you clear it by a lot, then it might have been good to make it a bit higher (i.e., lower dilution). But if you run into it, it’s very difficult to recover and still win the race (i.e., future down round).

It's critical to remember that almost every company (and every market) experiences ups and downs over the 5-10 year period that early stage companies plan to operate in to find success. As a result, focusing on the terms and scenario modeling is super important for long-term and shared success. In a slight variation on the saying “hope for the best, plan for the worst,” I think early stage companies should “hope for the best, assume it may not work out at all, but make sure that you can still do really well with a positive thought modest outcome.”