CVCs Imploding

There’s an issue that’s plaguing the early-stage space at the moment, a lot of the Corporate Venture Capital (CVC) firms that opened up and exuberantly invested over the last few years are shutting up shop. This has already presented a number of problems from communication difficulties to having convertible notes recalled. While there is little that early-stage companies can do, I think it’s useful to highlight the current environment so entrepreneurs can be more careful in subsequent cycles.

Firstly, there are some companies that have convertible note maturities coming up and no one to speak to as the CVC landscape has turned into a ghost town.

Secondly, there are companies trying to complete funding rounds but getting limited support from existing CVCs who have a relatively large chunk of the cap table, which doesn’t exactly instill a lot of confidence in incoming investors and results in what I’d call “wilted equity” left on the cap table.

Thirdly, there are other companies that have had convertible notes mature and subsequently have been issued redemption notices by note holders.

Ghost towns

For the lucky few who have been able to break even or better, they now need to determine the relevant conversion price with the existing convertible note investors if the conversion mechanics on maturity aren’t spelled out. There were a number of notes that were written in a manner that didn’t envisage the notes actually maturing and relied on a qualified equity financing event to trigger their conversion. If the CVC holds a majority of the convertible note, then it can make it difficult to have a discussion and determine how the conversion process should be dealt with if they don’t pick up the phone. There are a lot of CVCs that have dissolved their teams and are attempting to let their portfolios run off. This is likely less problematic when the companies are at a later stage and the CVC has a small proportion of the outstanding issue or cap table but for early-stage companies it can prove more of an issue.

Wilted Equity

We can differentiate “dead equity” from “wilted equity” in the sense that there was likely a material financial commitment in the formative stages of the business, something significantly beyond the sweat equity that a founder would commit, and there could be some continuing support in the form of customer introductions subsequently. However, it has become apparent that the CVC will no longer be able to maintain their pro-rata or any meaningful financial support.

There are situations where a CVC has a large portion of the cap table, that may no longer reconcile with the effort that they will be able to put into the business. It’s questionable whether that “excess equity” should be restructured in a format that enables the business to continue as a going concern or CVCs should draw a hard line – even though they likely had a hand in putting the early-stage company into a questionable position to begin with.?

Maturities

This last issue is somewhat scarier and could spell the end of several early-stage companies if they aren’t careful with their corporate governance. Founders need to be aware of the maturities of their convertible notes and negotiate extensions well in advance of the maturity of convertible notes.

If CVCs are unwilling to negotiate an extension, then a second solution could be attempting to find another form of financing, which will likely be at worse terms considering the current market environment. However, this could be tempered with encouraging the CVC to take a haircut on the face value of their current convertible note – something is better than nothing.

Finally, early-stage companies need to be ready for the worst-case scenario if they are dealing with CVCs that aren’t willing to accept the realities of early-stage businesses e.g. if they aren’t willing to extend the deadline or accept a discount on the face value of their convertible note, then they will likely push the company to failure and will need to go through the liquidation process to see where they stand. This sounds hectic but investors aren’t necessarily rational – this is why we have fluctuations in market prices – so while we’re at a depressed level, psychological biases could prevent CVCs from acting in their own best interest.

What to do?

We are going to see more and more of this happening in the near future so early-stage founders need to stay on top of their maturities and get extensions where applicable. If there are stronger investors on the cap table, then it could be worthwhile having them negotiate to take over the positions of CVCs that have decided that they no longer want to have a strategic exposure to early-stage companies.