There is an article in the Wall Street Journal (sorry-requires subscription) today on pre-emptive financings or financings that happen when a company is not actually looking for capital. It is common wisdom amongst the investment community for entrepreneurs to "eat when dinner is being served." In other words, companies should take cash even if they don’t really need it because you never know when the next meal will be served. This can be great for a company because it can provide a nice cash cushion for the operations, allow a company to spend real time with a potential investor, and help them avoid spending too many cycles on financing down the road. The article also points out that this is a new trend not unlike one that happened during the bubble period. To be honest with you, I don’t see this as a new trend and a negative thing for VCs to do. It is a VC’s job to find the best investment opportunities which means being proactive about generating deal flow and not sitting back waiting for new deals to come to us. Being proactive about new deals means spending time with entrepreneurs before they need money, staying in dialogue with them as they grow their business, and helping lead discussions on the next round of financing.
Being an early stage investor, I have played on both sides of the fence. I have been on boards where we have been approached preemptively by other investors. In those cases, it is helpful to think about two points:
1. Valuation isn’t everything – sure, you want to take cash at a good price but if you take too much cash at too high a price too early, it builds unrealistic expectations for you, your company, your existing investor, and your new investors. You may end up chasing too many different opportunities, losing focus, and having a fractured board because of these lofty expectations.
2. Having too much cash can be a curse and not a blessing – speaks for itself (see my last post)
On the other side of the fence, it is important for us proactive VCs to maintain our discipline, value the opportunity fairly, and really understand and work with the company to determine how the money will be used. In addition, we need to be careful about helping our companies use their bullets on the right opportunities and not every opportunity. Let’s not forget the lessons learned during the bubble where companies with too much cash just crashed, burned, and died faster and more spectacularly than ones with less cash. In general, pre-emptive financings can be a great thing for both VCs and entrepreneurs, but we must be careful about managing expectations and staying focused.