"RIFs." "Cram Downs." "The Zone of Insolvency."
Those are some of the buzzwords associated with today's harsh economic climate, all of which were addressed at last Thursday's very timely panel at the law firm of Fenwick & West. The 90-minute discussion -- titled "Operating and Financing a Venture-Backed Company in a Down Market" -- offered advice on how entrepreneurs, investors and directors can navigate the tricky morass known as the U.S. economy.
Just how bad is it out there? Fenwick employment attorney Daniel McCoy said his wife has taken to calling him the "grim reaper" because of the large number of layoffs he's been dealing with recently.
But maybe things are changing. "It's Thursday at 9 a.m. and I haven't done one layoff this week for a client, so that is a great sign," McCoy said. "Hopefully, I get through the end of the day tomorrow and I can say that this is the first week in a long time that I haven't done one or helped a client with one."
It's certainly ugly out there, but corporate attorney Michael Piraino offered some hope for the two dozen or so people in the room.
"Those companies that figure out how to adapt to this environment and really understand how to focus appropriately, I really think on the other side of this, those companies that survive are going to be in a fairly enviable position," he said.
Getting to that point is the key. And the four presenting attorneys offered ideas on the best way to achieve that in today's climate. And for those who don't, Piraino said they at least wanted to make sure those companies have a "soft landing" when they wind down.
Since venture-backed companies require capital to survive, Piraino said one of the key things they must first do is determine where their angel investors or venture capital investors stand. And that goes beyond what might be discussed in the board room, he said.
Too often, entrepreneurs are "surprised" when financial backers -- who once talked a "big game" -- don't have the capital to support the venture, he said.
Entrepreneurs also can underestimate the time commitment in the current fundraising environment, with Fenwick's Bill Bromfield saying it is taking about six months to close an early-stage deal.
"Be prepared for a long haul," he said. "This is not like the early days when people were giving you term sheets, and basically saying: 'hey can we be first on the list? There are a lot of question marks in the environment right now, so just be prepared."
One of the big issues facing venture-backed companies is how to handle "inside rounds," a venture deal where existing investors set new terms. Oftentimes, these involve lower valuations that can wash out the founders' holdings, said Bromfield. Those deals can be "very, very ugly," he said.
Bromfield's seen companies that were valued at 50 cents a few months ago, which are now being valued at 10 cents. In some cases, he said that puts the "squeeze" on founders who can see their ownership stake decline from 10 percent to as little as one percent.
That's an incredibly tough situation for an entrepreneur who needs cash to grow his or her business. And it could create potential legal problems if the company turns out to be successful, since the board members who approved the deal may have been conflicted in setting better terms for themselves in the down round.
In those "cram down" situations -- where existing shareholders have their stakes reduced -- directors and officers need to be very careful to make sure that it is absolutely the best deal for the company. In fact, Bromfield said people should avoid using the term.
"Remember, cram down -- bad. Creative dilutive financing - good," he said.
Whatever happens, entrepreneurs should not assume that they are going to "buck the established trend" on valuations or fundraising timeframes, said Piraino.
And he said that companies can also look at alternatives to angel or venture financing, tapping customers for pre-payments. They also can renegotiate venture debt, working with bankers to make sure the company is primed for long-term survivability.
Startup companies should also be looking hard at reducing the cash burn, while at the same time making sure that key elements of the business remain intact amid the cost cutting. It's a delicate balance, but those entrepreneurs with the proper focus might be able to survive.
"It is often hard to let go of that broad vision -- that billion dollar vision -- of what you aspire to be as a company," said Piraino. "But, if the choice is between survival and maybe narrowing that vision -- I don't want to say compromising it because that implies that you are giving up on it -- but perhaps taking a more narrow focused view now so you can get to the other end. It is better to live to fight another day."
If a layoff or reduction in force (RIF) is necessary, McCoy said that companies should set up a clear documentation process in order to protect themselves against discrimination or retaliation claims. In a bad economy, it is more likely that companies will be sued, he said.
Companies also need to be careful when implementing salary cuts or deferrals where they promise that workers will return to previous compensation levels once the financing is secured.
"Once you've done that, you've put yourself in harm's way in terms of making a commitment to that person," said McCoy, calling some of the 409A deferred compensation regulations a potential "minefield."
In fact, minefield is a good word to describe the overall situation for startups, which are hard enough to run in good times. Today, any number of things could cause a blow up.
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