This week’s Silicon Valley Bank (SVB) failure was unexpected and happened in less than 48 hours. I’ve chatted with a few founders and venture capitalists whose companies have assets with SVB. As of Friday afternoon, SVB accounts were frozen, meaning customers couldn’t add or withdraw any funds. Most of the people I talked with were busy establishing relationships with other banks in anticipation of being able to move their funds. The venture capital firms were assessing their own exposure and the exposure of their portfolio companies and updating limited partners on the situation.

The FDIC insures deposits up to $250 thousand. Insured deposits will be available Monday morning. Anything above $250 thousand likely won’t be available until the FDIC sorts through everything, which could take time. My gut tells me that SVB customers will likely get most of their money back, but when that will happen isn’t clear. The longer it takes, the more difficult decisions there will be for SVB customers to make.

I’ll be watching this closely as it unfolds.

Yesterday’s post was about in-kind distributions that venture capital (VC) funds make to their limited partners (LPs). A friend pointed out that some larger funds, such as Sequoia, A16Z, Thrive, and a few others, may be focusing more on making in-kind distributions to their LPs. These and other firms are starting to become registered investment advisors (RIAs), which my friend assumes is related to making in-kind distributions. I’ve been reading about funds becoming RIAs, and I don’t think it’s related to making in-kind distributions to LPs.

A VC fund that makes an early-stage investment in a company doesn’t need to be an RIA to do in-kind distributions. If one of the fund’s portfolio companies goes public or is acquired in a deal where some or all the purchase price is paid in stock of the acquiring company, the general partners can distribute that equity to their LPs. There may be reasons to wait to do so: for example, an IPO lockup period or wanting the acquirer’s equity value to increase before distributing stock to LPs. There are nuanced rules around VC funds holding a material percentage of fund assets in something other than private companies, but I won’t get into those details.

All the firms my friend mentioned are run by very smart people who have had a lot of success over several years. I don’t have any inside information on their strategic reasons for becoming RIAs, and I’m curious and plan to learn more. I wouldn’t be surprised if it’s related to their ability to invest in and hold a broader variety of assets for a longer period. Said differently, I wouldn’t be surprised if it allows them to expand their firms into areas outside traditional venture capital investing.

Today I was chatting with a “spotter” entrepreneur about the details of an opportunity he’s considering pursuing. He plans to build a business to solve an overlooked problem of solopreneurs. He needs capital to launch the business but doesn’t have experience raising capital from investors, so he asked for my thoughts on structuring a deal that includes investor capital and bank debt.

As we chatted about the business model and numbers, we began discussing the bank debt portion of a possible deal. In the past, he’s used his own capital and bank debt to launch businesses. But interest rate increases mean that debt service on a loan would materially reduce cash flows from the business. This spotter has his own capital, but not enough to finance this entire project. Nor does he want to take on that much risk. Given this reality, he’s considering, for the first time ever, raising capital from investors. The problem is, he doesn’t know where to start.

When interest rates were low, spotters could partner with banks exclusively. The principal and interest on their loan payments didn’t materially impact cash flow, and they maintained 100% ownership. They preferred to work with a banking partner and cheap debt rather than give up equity to investors and have to report back to those investors.

In today’s interest-rate environment, selling an equity stake to investors can be a more attractive alternative. Deals where bank debt would significantly reduce returns or cash flows because of high rates can be more palatable with investor capital. Of course, this depends on how the deal is structured. The devil’s in the details.

Today’s conversation got me thinking. How many more spotters are doing the same math and coming to the same conclusion: I should consider raising capital from investors. If it is—or will be—a material number of people, this could be an interesting market that will likely be underserved.

I had a conversation with a friend about the difference between wealth and income. They’re not the same thing. I realized through this conversation that some people aren’t aware of the difference between the two.

Wealth is the value of the assets you own (minus your liabilities, or debts). Assets include real estate, personal property (art, jewelry, etc.), and equity (i.e., ownership) in public or private companies.

Income is the money generated from your labor, wealth, or ingenuity.

Money isn’t wealth. It’s more of a medium of exchange that facilitates trade. It allows you to buy goods and services.

One of the hardest concepts for people to understand is that you can have high income but not wealth. For example, if you make $1 million a year and have $999,999 of annual expenses, you’re not increasing your wealth.

Conversely, you can have wealth but not generate enough income to pay your living expenses, which depletes your wealth.

Wealth and income are different, and it’s important—especially for entrepreneurs—to understand why.

An investor shared details of a deal he’s been evaluating. He loves the sector, loves the founder, and loves the product. He hasn’t done the deal because he has concerns around the cap table—specifically, how much capital has been raised from investors in previous rounds and how much is being raised in the current round. The company has an enormous burn rate of around $400 thousand monthly, hasn’t achieved product–market fit yet, and doesn’t have much revenue from customers. Yet, it’s raising a third multimillion-dollar round of capital.

The major concern of this investor is the amount of dilution at such an early stage. The CEO-founder will own less than 20% of the company after the current raise. If the company can raise the current round, find product–market fit, and raise additional rounds of capital at later stages, the CEO-founder could have a small ownership stake in the company. This investor sees the CEO owning less than 10% as a real possibility. If that happens, it will take an enormous outcome and many more years for the CEO’s small equity position to have a major financial impact on his life. Rather than go down that path, the CEO might leave and pursue something else with a more attractive risk/reward ratio. That wouldn’t be ideal for those who invested in the company.

This isn’t the first time I’ve had an investor tell me this, and it likely won’t be the last time this year. Raising too much capital too early can cause lots of downstream problems if the company can’t achieve significant traction. This story highlights the excessive dilution problem and why investors are hesitant to invest when the founders don’t have material equity ownership in an early-stage company.

If you’re an early-stage founder, keep a close eye on your burn rate relative to company traction. If the traction isn’t there (i.e., you haven’t founder product–market fit), don’t be afraid to adjust the burn rate.

Today I heard a story about a start-up that’s down to its last few months of cash, doesn’t have a line of sight to profitability, and is at odds with its investors. I’m not involved and haven’t spoken to the investors or the founders, but I do know the company is in a tough spot. Everyone knows it. Instead of coming together to find a way out, the founders and investors are at odds; they can’t see eye to eye, which is making a bad situation worse.

Every company is bound to hit a bump in the road. Some of the bumps will be painful for everyone involved. Today we’re in an environment where companies are facing the prospect of down rounds, which isn’t ideal for founders or existing investors. Down rounds aren’t the end of the world, though. Meta (formerly known as Facebook) did a down round in 2009. Knowing that hiccups are inevitable, founders should conduct their due diligence to understand how prospective investors have historically handled challenging periods with other portfolio companies. Depending on your circumstance, what you find out may not change who invests in your company, but it can inform how you interact with your investors or the term sheet details (number of board seats, etc.) you agree to.

It’s easy to get along with everyone when money is flowing, but the good times won’t roll forever. It pays to understand how the people you’re considering partnering with handle tough times.

Over the last few weeks, several founders have shared their 2023 plans with me. A few of them intend to fundraise—otherwise, they’ll run out of cash. With those founders, I chatted about cash balance, burn, and runway. And I always asked them what plan B is if the fundraising environment further deteriorates. Most of them have no plan B. Raising is the only option they’re considering, which bothers me.

When I hear a founder say they must raise, it makes me think of this blog post from Bill Gurley. Though it’s a few years old, it’s relevant to today’s environment. Bill was ahead of his time in his thinking. I like how he laid out the following alternatives when founders can’t raise a clean round of financing at a flat or up valuation:

• Dirty term sheets – These are terms sheets that give founders the valuation they want but come with many surprises down the road. Bill does a great job of explaining this and who “shark” investors are.
• A clean round at lower valuation – Valuations don’t only go up. Many high-profile companies raised down rounds and went on to have massive success. A down round is better than a dirty round (i.e., a dirty or structured term sheet).
• Positive cash flow – I focused on this when I bootstrapped my company. The best way to gain leverage and control your destiny is to not need to raise capital from others. Easier said than done for sure, and not an option for all founders, but a good exercise for founders to go through. I personally think we’ll move to a focus on a path to profitability over growth for start-ups because valuations will likely start being pegged to profits rather than revenue.
• Go public (i.e., IPO) – This is more of a longer-term goal. Bill makes the point that founders’ and employees’ common stock is treated as equal to investor stock after an IPO because investor preferred stock converts to common. This eliminates liquidation preferences and other rights that preferred stock has over common stock.

Bill’s post is thoughtful and contains a lot more great material relevant to the current environment. It’s worth a read for founders and anyone else in, or considering entering, the start-up world.

I had the chance this week to catch up with a founder who hasn’t gotten the traction he’d like in his fundraise. He has a solution that’s working. It’s generating revenue and has a small, but loyal, customer base. But the long-term viability of the solution doesn’t resonate well with all investors. They wonder if it can be scaled.

I know a little about his industry. I keep up with thought leaders and have formed my own views on the direction of the industry. I shared my vision for where the industry is going. As we chatted, I realized that his pitch is missing a vision for the future. The current solution is likely a stepping stone to something bigger, but his pitch doesn’t communicate that because he doesn’t say what his vision is for the industry. Nor how his solution helps turn his vision into reality. Therefore, investors fixate on the scalability of the current solution instead of thinking about how it can evolve to create value in the world of the future.

Having strong opinions about what the world will look like in the future and how your solution fits into that future world is important for a founder. And not just for pitching investors, but also for recruiting team members and landing business partners.

Creating a vision for the future isn’t easy. It requires understanding a problem so deeply that you can predict how the world will evolve because of the problem. Founders should have conviction regarding their vision but also understand that it might not be 100% accurate—and that’s OK. The important thing is to have a vision you can support with an understanding of the problem that others don’t have along with conviction that makes others want to be part of the mission to turn your vision into reality.

Had a great chat with the founders of a new start-up. They’ve been pitching investors and trying to close their current fundraising round. They’ve had some success but haven’t been able to raise all the capital they need. Part of the challenge is the fundraising environment. The founders can’t control that, so today we focused on what they can control. Here’s what we discussed:

• Origin story – Their pitch jumped right into the problem. This didn’t do the founders justice and was a cold way to begin the pitch. They’ve been in this space for two years, learning and experimenting. One of the founders built a large company before starting this new business and is applying the learnings from that start-up to build this one. We refined the origin story and made sure it includes how the founders discovered the problem they’re solving, how much time they’ve spent obsessing and tinkering with solutions, and how their experiences uniquely qualify them to solve this problem.
• Analogy – The solution made sense, but it took time to understand. I had to ask pointed questions about the value of the solution. Eventually, I said they’re “XYZ for 123 space,” and it clicked. That analogy was to the point and will connect the dots for any investor they pitch.

With these tweaks and some practice, I think these founders should be able to raise the capital they’re seeking.

Pitching isn’t easy. It takes time to refine a pitch. Sometimes going over the pitch with friendlies who can provide honest feedback will accelerate the refinement process. For early-stage founders, I highly recommend including the origin story in the pitch.

The rise of remote work led to many people and companies leaving high-cost coastal cities. This redistribution of talent has changed how early-stage venture capital is deployed. Before, investors would invest only in entrepreneurs whom they could meet in person. Many investors preferred to not travel, so founders migrated to cities with a high concentration of venture capital investors. But the pandemic and the redistribution of talented entrepreneurs changed this. Investors now regularly invest in founders whom they’ve met only over Zoom.

I’ve been thinking about the tech layoffs by large companies like Amazon and Google and what they’ll do to the distribution of talent. I suspect that a material number of people laid off by these companies will rethink living in their high-cost cities, especially if their job was the main thing keeping them there.

I could be wrong, but if this does play out, I’m curious about how venture capital will adjust. If a lot of talented founders no longer want to reside in the Bay Area, for example, how will these firms adjust? Will they continue to stay heavily concentrated in places like the Bay Area and do even more investing over Zoom? Or will they rethink where their firms or their firms’ investors live?