Venture Capital and Prop23

George Rebane

Liberal websites like TriplePundit.com tout the “cleantech” investments by venture capitalists (VCs) as the proof in the pudding that a vote against Prop23 is good for California’s economy.  There are a couple of serious questions you need to ask before you use this promotional information to decide your vote on the proposition to limit the application of the remaining parts of AB32, California’s draconian ‘leadership’ display of tax, regulate, and control your life in the futile pursuit to affect global warming.

The economically innocent layman is led to believe that VCs are the crème de la crème of shrewd hardnosed conservatives and true believers in free markets.  Little is further from the truth.  VCs are capitalists who look for maximum bang on their buck for the minimum risk possible.  Free markets do not spell low risk, government mandated and managed markets do.  The VCs, who supposedly have put $9-11B into ‘cleantech’ investments, are expecting to clean up, not because their investments will do well in free markets, but that they will achieve the next best thing to guaranteed returns when their investees become the suppliers of things and services that California’s Air Resources Board (CARB) deems you must use when AB32 gets fully implemented.

But let’s revisit that much touted $9-11B, ‘the largest cleantech investments in the nation’.  Have the VCs really written checks totaling that much?  At this point, are they really on the hook to their own investors for that sum?  I very much doubt it, and so should you.

During my career in business - thirty years of it involved dealing with VCs on both sides of the table – as an entrepreneur I was trying to get their money, and as their consultant I was advising them on how to invest in (technology) companies.  Here’s a rough but accurate overview of how the VC game is played.

An entrepreneur who brings his business to a certain credible stage of development will go to an institutional VC (like the ones on Sand Hill Rd in the Bay Area), and offers to give up a hunk of ownership for a hunk of cash needed to take his enterprise to the next stage in its business plan.  This involves a lot of presentations and convincing by the entrepreneur, and a lot of research by the VC to confirm the claims of the always enthusiastic and confident entrepreneur.  Finally, if the VC decides to invest, the current valuation of the company is agreed upon which determines how much the VC will get for his investment – i.e. the cash the company needs.  But at this point the party is far from over.  Now come the terms on how and under what conditions the VC will write the checks.

Here we need to take a little detour to understand business and cash – and I mean CASH, the long green, moolah, the stuff you can spend to buy stuff and pay workers, what the eagle does when it lands, and nothing else.  Cash is simply the lifeblood of a business.  You run out of cash, you run out of business.

Savvy business people always deal with cash using the fundamental Rules of CASH (if you don’t know them, get pencil and paper), which are –

• When receiving cash – get as much as possible, as soon as possible, and under any and all conditions.
• When paying cash – pay as little as possible, as late as possible, and then only when absolutely necessary.

In our case, keep your eye on the second one.  The VCs have these rules tattooed on their hearts, or often when absent this organ, on the inside of their eyelids.

This means that they will structure the terms so that cash goes out as slowly as possible, only when certain milestones (which they interpret) are met, and with maximum recourse if things don’t go their way.  This means that you may also have to hock your firstborn or wife or something less valuable like your total net worth.  And you may not get the agreed upon amount as an equity investment, the VC may want to reduce more risk by getting you the cash as a convertible loan.  Of course, the conversion to equity is again done on contingencies most favorable to them and with recourse.  The recourse quite often is that you lose your company to the VC when it hits a speed bump in its forecast revenues or margin.  Anyway, you get the drift of all this.  These guys are not fools.

So now we return to California’s venture capital investments in ‘cleantech’ enterprises.  I would be very surprised if the actual amount of checks written to date by these VCs comes close to 10% of the ballyhooed amounts.  Every one of them has written in contingencies that include how Prop23 comes out, and what kinds of favorable AB32 regulations CARB can write subsequent to the outcome of the coming election.  And they may have written in other contingencies like the future of the Fed’s discount rate, and GDP growth, and whether the Giants win the National League Pennant.  You can bet that they have written in ‘exits’ that are more complex than the hidden provisions in Obamacare for nationalizing healthcare.

And you can also bet that no one has written checks totaling north of nine billion dollars.

BTW, vote YES on Prop23 and launch California’s new dance craze called the CleanTech Scramble, the state’s for-profit companies will thank you for it and may even cancel their moving trucks.

Comments

[Dixon Cruickshank]

Good article clearing up the game, I mentioned something similar when you were gone someplace around here on prop 23, much more general in nature though.

[John S]

How true it is.
But remember George, if you were a Liberal, you wouldn't want to say anything about this reality. The only really important part is that there is a lot of money out there waiting to invest in something. Then if you attach the words "like clean tech" to my last sentence you have a really catchy statement that could generate some excitment. What they leave out are the hidden words "if it is viable, feasable, cost effective, our only alternative" which it is not.

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