#31- Most unfortunate - How lack of communication sours relationships (Part 2)
My experience of passing an early-stage deal that would have formed on the pillars of lack of communication
This is part two of a three-part series on the misfortunes of lack of communication that I have experienced while evaluating early-stage deals.
In part one, I had explained why I passed on the opportunity of investing in a company because of dishonesty and unaligned interests.
Perfect Founders with Imperfect Communication Skills
How lack of communication led to passing after issuing a term sheet
After the debacle of Disqualification & Running Family Businesses, I optimistically evaluated a SAAS company that we had been tracking for over a year. My engagement with them started on the right note, being of a similar age and background we could bond well. Bonding to the point my CIO said I was in love(!) with the founders.
It all started with their funding ask. The funding ask went from X to 1.5 X, then from 1.5 X to anywhere between 3-4 X. A couple of weeks later, it went back to X. They started with an X cr funding request at a Rs 12 X cr pre-money valuation. Somewhere in the middle, they said we stick to an X ask but will be open to receiving 1.5 X that can provide them with a sufficient runway for 18 to 24 months. Fair enough. If you need the cash, you should raise it!
In case founders are puzzled by how much capital to raise, they can read my perspective here!
All the while, their pre-money valuation remained steady at 12 X!
But, they wanted to close the round as soon as possible! They even went to the point of providing a timeline - 15th of the month for commitments, and 30th of the month for cash in the bank.
With the process ending from my side, a video call with our CIO (yes, the same person who said I was in love with the founders), and conveying our intent to cut a cheque for 0.5 X their round at 12 X the valuation; I conveyed my terms via an email, with a formal term sheet that followed later in the day.
Cue radio silence from founders for over 48 hours, they came back.
With erm.. a surprise!
They wanted to lower the round size and turn it into a convertible one with few milestones attached. They had some hard commitments (including mine), and soft commitments that would have been 85% of the original round size of 1.5 X.
However, they said that they expected more commitment from my side, and considering the apparent shortfall, and the need to keep the round open for balance ~15%(!)
Now, didn’t I share that the convertibles I like have four wheels and a roaring engine?
This came as a shocker to me - considering I agreed to fund them at the pre-money valuation that they had mentioned, without any negotiation, before the date they wanted to close commitments down. Everything they wanted, right?
We have grown considerably during COVID, and the new valuation reflects that. If we do well, everyone wins. If we dont do well, investors win!
“New valuation”? We started engaging well after COVID relaxations began!
I received their deck in late July, we started engaging sometime in late August. From what I distinctly remember, when asked about the round, I had received the following:
We have mentioned in the deck a pre-money of 12 X, and we stick to that
They had spoken to and received confirmation from other investors regarding the convertible round 2-3 weeks before I issued the term sheet - plenty of time to convey the same to me.
I confirmed my commitment over the call with my CIO & founders - they had the chance to convey it during the call.
I sent them an email informing them of the committed amount, and valuation - they had the chance to convey it post the email.
After sharing the term sheet, they wrote back saying they want to run the document by their lawyer once - they also had the chance to convey it when they got back to me in the middle!
But they chose not to!
One slippery slope indeed!
For me, a term sheet is as sacrosanct as a Shareholder & Share Subscription Agreement. This is a testament to the fact that I front-end all the work before issuing a term sheet, and do not open the dialogue for clarifications, one-upmanship, and negotiations after issuing the term sheet. Once I issue the term sheet, for me the company is as much a portfolio company as others in the stable. One of my own!
But, I decided to pass on the opportunity!
I want to take the opportunity to say that they are fantastic founders building an exciting business. But when they chose not to disclose their intent, I switched the process off. At the same time, I realized that extending the term sheet is under my control, where the process goes from the term sheet stage onwards, is a binary outcome.
Was I right in doing so?
I do not mind negotiations. In this world of venture financing, everyone is in this to make money - one way or the other, and hence negotiations are expected.
Entry valuations hardly matter in the long run- if the company is successful, everyone wins. But blindsiding matters in both the long and the short run.
I do not want to tell founders how to structure their rounds, or how to run their business. But in this highly uncertain world of venture financing, it is not unfair to seek certainty over pre-agreed terms, and facts shared. I do not want the founders to be meek and agree with everything I have to say, but I expect honesty and transparency and not blindsiding me in this manner.
In the end, intent trumps comfort.
I do not have time to play games.
There is always another company to evaluate.
In part three of this series, I will share how one company, against all odds, relentlessly overcommunicated to create value for every stakeholder!
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