Recapitalizing a Startup
Jeff
6 Comments
Andreas writes:
I am the CEO of a biotech company which is yet entirely drop financed by a VC. We are looking for additional investors but times are difficult. However our warrant scheme (2 founders and me) got diluted over the last 2 years and I like to make a fair proposal to the board. What is a reasonable % of the company for founders and CEO for a small biotech company aiming for an exit in 2010.
Hi Andreas. This is a very difficult question to answer without a lot of additional information. Based on the limited info I have here, I'm am working under the assumption that the company is small, there is just one investor, and for their investment that investor has been given warrants. You are now looking to bring in additional capital, but have concerns that the company is still small and struggling, even though you've given up a lot in the way of dilution up until this point, and the question you struggle with is "is it really worth it to go on like this?"
In short, you are faced with three possible options.
Option 1, and probably the least desirable option is to simply try and raise the money and suffer the full effects of the dilution. Depending on how the existing investors are structured, this may have extra negative effects (particularly if the new investment comes in at a lower valuation than the old investment), or may be difficult to secure because of the onerous nature of the previous investment.
Option 2 is to walk away and start fresh with some or all of the same team, seek new investors, and pretend the old company never happened. Depending on what intellectual property is held by the company, what non-compete agreements you have, and the nature of the relationships between founders, investors, and each other, this may or may not be practical. If you have an investor who is simply not compatible with the team, then this may be your only option. However, if you do have a working relationship with your investor, then I would suggest you first propose...
Option 3: Restructure the current business before seeking to raise additional capital. Nothing will scare off investors faster than a complex capitalization structure with all kinds of formulas, extra warrants, accruing dividends, and the like which an existing investor may have, and which may be changing on a daily basis. My suggestion would be to have a heart-to-heart conversation with your existing investors, explain why you need to raise capital, what you are going to do with it, and why the current capitalization structure makes it less-than-appealing for the founders to go through that effort. Then, propose a new equity breakdown you can live with.
I would try to convert everyone into either common stock or preferred stock, and eliminate any accruing elements, warrants, or clawbacks. The idea is that things are clean and simple, with investors holding X% of the company in preferred stock, and founders holding Y% of the company in common stock. I would be prepared to offer that the founders shares be restricted (or re-restricted) as I described in my earlier article "How to structure equity for the founders."
The idea here is that that you are giving up something (vesting) in exchange for the investors giving up something. Then, with everyone on the same page and committed, you can together move forward on trying to secure additional investment.
Make no mistake, this is not an easy conversation to have. However, if you've thought it through and can make a reasonable and fair proposal, a good investor will engage you in the dialogue. It's pretty likely that they saw this day coming anyway, and they probably need the founding team as much (or more) than you need them as investors.
I would not be overzealous in what you ask the investors to take. You need to weigh what they've done for the company and the risk they've taken with their capital, along side the need to keep your founders motivated, and with a final eye on having a simple structure a new investor will be comfortable. Fairness and simplicity and what you are going for here, and I hope you have an investor who desires the same.
Best of luck!
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