Why there’s no such thing as friendly capital
By Mike Nicastro, CEO and principal, Coppermine Advisors
I recently returned from the Association for Financial Technology (AFT) Fall Summit in Lake Tahoe, Nevada. As a long-time member and former President of the association, it is always a pleasure to see old friends and colleagues as well as meet the entrepreneurs leading many of the new and exciting companies that have joined as members. During the course of this outstanding event, I heard a new (to me) phrase that caused me to pause – ‘friendly capital.’
When I was the president of AFT 23 years ago, the membership makeup was very different, We still had 40+ members of AFT who were considered independent core systems providers and roughly 45 to 50 members who would be considered independent applications providers or ancillary systems.
Most of the core providers during that time were either publicly traded or had outside capital. And, the vast majority of the ancillary tech providers were founder financed, or bootstrapped. Very few had received capital from outside sources.
Today, the landscape is completely inverted. Core members account for roughly 10 members, while application vendors account for 110 or more of the AFT membership. And unlike in 2000, most of them have taken outside capital in some form. Much of the original “bootstrapped” crowd has sold over the last two decades. Or more recently, those with three decades or more of success have converted their sweat equity into cash from exits with Private Equity firms looking for mature, well-run companies.
Which brings me to my main point. Over the course of the conference, I spoke with many CEO/founders who have raised capital for their firms, and everyone acknowledged that the capital raising process has become more difficult and the terms more onerous.
It was then that I heard someone mention “friendly capital.” When asked what made capital friendly, one response was when VC firms partner with some of the banking trade associations, making it so that they require less ‘education’ on the value proposition of the product and company. Another similar sentiment was that those VC firms make the process less difficult because of their partnerships with the trade associations. The third and most astounding was that because of the association partnerships, there is less of a focus on performance and more of a focus on the entrepreneur and the product.”
Don’t get me wrong, it’s great to see the associations at both the national and state levels taking such a focused interest in technology and a segment of the VC industry zeroing in on BankTech as a whole. With a majority of application vendors now seeking funding, it’s good that they have some guidance and dedicated VCl firms that don’t necessarily have to be ‘educated’ every time they consider an investment. If that indeed has expedited the process, then that’s great too. However, none of that makes the capital ‘friendly’; it simply makes finding the sources less of a chore.
Let’s inject a little reality into the mix. Firms that provide capital have a focused mission: return on that capital. They often have limited partners (LPs) who they work with to fill their investing funds, and those LPs expect a significant return. I’m sure most of those firms have philanthropic activities and give back in some way. But unless the investment they are making is a social entrepreneurship venture (which also has return expectations), those investments are ultimately expected to make a return. If the goals aren’t met, if key performance indicators are not achieved, or if cash burn exceeds the plan, then founders find out quickly that ‘friendly’ is not an appropriate term.
As we saw in over the past two years, when uncertainty hits the market or something goes awry (as was the case with SVB), most primary capital providers leaned on their portfolio companies to cut the burn but maintain growth rates, which is an interesting juxtaposition for early-stage companies. The ‘dry powder’ that was likely promised on the initial investment went mostly untapped.
Putting the idea of ‘friendly’ aside, there are a few things founders, their executive teams and boards should always consider when dealing with capital.
- Be realistic with your valuation expectations. Demanding too high a post-money valuation at the start will come back to haunt you when you need more capital sooner than expected.
- Never assume there will be more ‘dry powder’ available.
- If your investment capital is aging, ensure the CFO closely monitors the capital stack waterfall for shareholders. There’s nothing worse than realizing that on exit the common stock you used as a recruiting tool is underwater.
- If it’s been five or more years since launch, and the company is still lingering in the low to middle single digits (millions) of topline revenue, it’s time to consider an exit. You’ll face pressure from investors anyway but falling into the “just one more year” trap is not viable. Hope is not a strategy.
- Be open-minded to all potential buyers. The major cores and the PE-backed strategics are of a size where even a successful $10 million ARR company doesn’t move the revenue needle unless it’s a technology buy, or growth rates have been greater than 40% year over year and look like they will continue to do so.
To be clear, this is not an indictment of capital firms. They have a job to do, and they have a fiduciary duty to do the right thing for their LPs and other stakeholders. This is, however, a caution to the over exuberance of founders and executive teams in FinTech, BankTech and RegTech. Raising capital is a complex and serious business. Regardless of what association partner may have played a role in helping secure the capital, if targets are missed there will be nothing that feels ‘friendly’ on the exit.
