👋🏾 Hi friends!

Well, here we are, at the end of September looking down the barrel of a new year once again.

There are two narratives out there in venture land:

1. We’re back and life has never been so good.

2. It’s all shot to bits and it’ll take another couple of years to resolve itself.

I take a more pragmatic approach.

Neither life nor startups follow a linear path, so it pays to expect the unexpected.

Remember that things almost always resolve themselves over the long term.

For all the Londoners, I’ll be at the London Venture Capital Network’s drinks and networking event this Thursday at Dream Factory - I’ll be hot mic’d and cornering unsuspecting founders and VCs alike to get the skinny on what they’re up to!

Drop me a line if you’re going to be there 💪🏾

In this weeks Off Balance, I’ll be chatting about:

📆 VCs Now vs VCs Then
💸 Finding a way to exit early investors
📈 The Power Law: what does it mean and why should you care?

As a side note, I’d love to give a shoutout to EmergeOne portfolio client, Continuum Industries, that just locked in its $10m Series A led by Singular 💪🏾

Read more below.

Also if you have any feedback or if there’s something you’re desperate to see me include, just reply to this mail or ping me online - I’m very open to conversations.

Give me a follow on LinkedIn, Twitter (do I really have to start calling it ‘X’ soon?), Instagram and drop me a note :)

(If you are trying to connect with me on LinkedIn, maybe read this post I wrote and make sure to start your request with “Off Balance” and, more importantly, tell me why you’d like to connect 💪🏾)

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Now let’s get into it.

Now vs Then

The meme below has been doing the rounds on social media this last week.

And once you get over the LOL imagery and take a minute to think, there is a story to be told...

For a start, over the last decade, we have been very involved in short term thinking, especially in venture land.

Too many deals were being done as a result of ‘hot rounds’, FOMO, party rounds and everything in between.

Much of the thinking was less about the fundamentals of the business, and more so around whether there was a ‘greater fool’ that would carry the bag down the track.

If you could invest early and then find someone to take the next round, you could show a paper return, increase your MOIC (multiple on invested capital), raise a larger fund and perpetuate the cycle.

Startups started buying into this hype, building fairly inconsequential software businesses (inconsequential from the perspective of the long term impact they could have on the world - let’s face it, a better to do list is hardly going to change the face of humanity).

And this could be done because of the abundance of capital out there willing to fund these businesses and then mark them up when the next investor came along.

Much of this short term thinking, along with a pretty loose attitude to cash, was perpetuated by the sort of literature that was being pushed out (and often pushed on) founders.

Books like ‘The Lean Startup’ and others like ‘Blitzscaling’ taught founders that they should move fast - the former pushing fast iteration and the latter almost vaunting profligacy in the pursuit of scale.

The problem with fast iteration is that whilst that might be ok for software products - especially ‘simple’ d2c or b2b products - it’s a lot harder for anything deeptech or in the hardware space.

You can’t build a new type of engine and fix the problems as and when they arise. The product is going to need to be almost fully baked by the time it even gets into a customer’s hands.

That takes time. And time requires money.

Sadly, too much money has been wasted not only on needless side projects or vanity features, but also on full blown businesses that had no need to exist.

It has been a very odd feeling over the last 8 years that I have been involved in the venture ecosystem, trying to reconcile this sort of attitude with my own training in finance and old school manufacturing where the most basic principle is sell a widget for more than it costs you to make it.

My shareholders would have hauled me over the coals if I just threw money at every problem, hoping they’d resolve themselves.

The reality is that scarcity breeds innovation, which is why the next epoch of the startup cycle has the potential to be transformational.

Or at least, that’s what I’m hoping.

How can did I add value?

Recently on one of the various founder groups I’m in, a couple of conversations sprang up around how to deal with early investors on the cap table.

This may be the case because you feel they aren’t adding a huge amount of value, or because you’ve got an incoming investor that maybe wants a larger chunk of equity which would dilute you more than you intended.

The solutions are similar, even if the implications are slightly different. So let’s take a look…

Share Buyback and Cancellation
If your business has sufficient capital, it might be able to buyback shares from your shareholders and then cancel them, thereby reducing the total number of shares outstanding.

This really only works if you have excess capital that you don’t need for growth - highly unlikely in an early stage business, and, you will need to get the appropriate consents in place as well as needing to convince the shareholders to sell.

On a positive note, it provides a return to those early investors as well as increasing all the remaining shareholders’ ownership.

Share Sale to a Third Party
If your business doesn’t have the cash, you might be able to find an investor that would like to purchase the shares from the existing shareholder. This means you don’t change the total number of shares outstanding, just who holds the ownership.

Again, you will need various consents for this to happen, and be warned that if an offer is made, you may need to make a similar offer to other existing shareholders.

There are potential tax implications for the seller and the buyer (in the UK at least) depending on the total value of the shares and the original purchase price. But these are the responsibility of the buyer and seller, not of the business.

This is one of the methods that might work if you have an investor looking to overfund a round. Say you have only £500k available but they want to invest £1m, you could offer the £500k as fresh equity with the balance being used to acquire existing shareholdings.

This is called a secondary share sale.

Debt / Equity Swap
Less utilised, but potentially achievable if you don’t have the capital available nor can find a third party buyer is to see if you can get the existing shareholders to essentially convert their equity into debt.

This has a few implications on the business…

• It results in greater percentage ownership to remaining investors (because essentially the shares are being bought back and cancelled).

• Debt holders typically have a number of rights that equity holders don’t - not least they will likely receive interest on the loan, or may demand that interest and capital are paid on a regular basis.

In these circumstances, knowing that the business has the cashflow to sustain repayment is critical.

If the business were to go under, debt holders are normally first cab off the rank in terms of getting repaid.

(Note: much of this will depend on your Articles of Association / Corporate Charter or equivalent, as well as any shareholder agreement and the rights associated with the specific shareholder and / or their specific share class. So this shouldn’t be taken as definitive advice and you should check with both your accountants and lawyers for the tax and legal implications of anything you might do. Things become additionally complicated if we’re talking about S/EIS shareholders).

The reality is that there are not a huge number of ways you can ‘get rid’ of early investors.

On the one hand, if the business is doing well then why would they want to sell off their chances of significant future upside? And, conversely, if the business isn’t doing great, how are you going to be able to offer to buy the shares at a valuation that doesn’t put them under water on their initial investment?

In fact, if they are S/EIS investors then they may prefer for the business to fold so they can recover some of their initial investment from HMRC.

Whatever you do, you should think long and hard about the implications, and always, always talk to a lawyer and someone that understands the tax implications for the business.

Remember it’s not your job to give tax advice to the shareholders - that’s their issue to deal with.