Life around the world continues to change as governments and citizens grapple with the persistent presence of COIVD-19. It has impacted every area of both business and private lives, and the world of venture capitalists has felt the influence as well.
Though once a thriving and steadily growing market opportunity for investors and venture-backed companies, the future of this investment area seems a little more precarious.
As a result of the pandemic, companies that had once sought new ways to grow fought to merely survive. Going forward, venture capitalists like Mark Stevens have some tough decisions to make.
The need for a financial strategy
In light of the toll COVID-19 took on economies around the world, there are questions of fundraising and financial foundations.
Investors need assurances of recovery and growth in a post-pandemic market, but it is still too soon to tell for many of the companies that are in desperate need of finding.
In the time crunch, investors aren’t afforded much time for deliberation. As a result, both the company in need and the potential investor have to consider extended sales or payment cycles, the current funding needs, any potential market liquidity, any current or potential constraints, and the overall expectations for the market.
Venture capitalists need to protect their assets and investments before they can consider moving forward into new areas of opportunities.
However, they need to decide on their financial strategy now, as the cry for funding help will only grow louder as more startups are threatened by the impact of COVID-19.
Change your liquidation preference terms
With the finance environment favoring investors, those who know their business should re-examine the liquidation preference rights that are given to stockholders with preferred stock.
The conditions should move in favor of the preferred holder that wants to “de-risk” their investments.
You could achieve this by using the special rights of the preferred shares through an initial public offering, change the terms of the preferred participators, and increase either the priority of or multiple of invested capital.
Liquidation preference is usually set at an amount that is based on a multiple of the invested capital. Investors could request an increase in the multiple or at the very least, their multiple receive priority over pre-existing preferred holders.
However, changing toward high liquidation preferences can also limit the potential for receiving the process in a liquidation event for any existing shareholder, employees, or the founders.
Request more participation preferred rights
For an investor to make this request, it would all the investor to receive his or her multiple on the invested capital as if the shares of preferred stock had been converted into common stock, in addition to receiving the pro-rata share of distributions that are issued to the common stockholders.
This practice was not as favorable over the last 10 years, but the impact of COVID-19 may have more investors demanding more favorable investment terms.
Participating preferred terms won’t be met with a lot of enthusiasm by many companies and the existing stockholders because the practice potentially reduces the returns of the existing stockholders when the shares a distributed.
Push for extra protection with an Initial Public Offering (IPO)
Changes in the control of a company or a sale of the company often trigger a preferred stock liquidation preference right.
An IPO isn’t generally considered a deemed liquidation event, so when an IPO is completed, the preferred stockholders don’t have to be given their liquidation preference. Instead, the shares are converted into common stock as it related to the IPO, but also according to any automatic conversions provisions that have been written in the company’s charter document.
Because of the risks that are looming on the horizon, wise investors will try to negotiate for extra protection in the event of an IPO. It could be that investors require new preferred shares to have a certain price and automatic conversion into common stock.
Another protection could be requesting that any shares of preferred stock be converted into the same number of common shares that would have been received had the IPO been a deemed liquidation event.
Increase preferred stock voting protection
In every stage of venture financing, there are special classes or series voting rights.
Within these practices, one more series of preferred stock, and any series of preferred stock on a combined voting basis, special privileges of approval for certain company actions.
Such actions generally include amendments to the charter or bylaws, the repurchasing of common stock, the creation of senior preferred shares, and change of control arrangements or transactions that affect the capital structure of the company.
Venture capitalists may be in a position to push for greater control by asking for additional consent rights.
These are just a few of the changes that the savvy investor may push for in the months and years following COVID-19. There will definitely be greater demand for funding and investments, putting those with money in the driver’s seat at the negotiation table.
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