There’s an issue plaguing the early-stage space at the moment: a lot of the Corporate Venture Capital (CVC) firms that exuberantly invested over the last few years are shutting up shop. This has already presented a number of problems, from communication difficulties to having convertible notes recalled. While there is little that early-stage companies can do, I think it’s useful to highlight the current environment so entrepreneurs can be more careful in subsequent cycles.

Firstly, some companies have convertible note maturities coming up with no one to speak to, as the CVC landscape has turned into a ghost town.

Secondly, there are companies trying to complete funding rounds but receiving limited support from existing CVCs, who hold a relatively large chunk of the cap table, which doesn’t exactly instill confidence in incoming investors. This results in what I’d call “wilted equity” left on the cap table.

Thirdly, other companies have had convertible notes mature and have subsequently been issued redemption notices by noteholders.

Ghost Towns

For the lucky few who have been able to break even or better, they now need to determine the relevant conversion price with the existing convertible note investors, especially if the conversion mechanics on maturity aren’t spelled out. Many notes were written in a manner that didn’t envisage the notes actually maturing, relying on a qualified equity financing event to trigger their conversion. If the CVC holds a majority of the convertible note, it can make it difficult to have a discussion on how the conversion process should be handled if they don’t pick up the phone.

There are many CVCs that have dissolved their teams and are attempting to let their portfolios run off. This is likely less problematic for later-stage companies where the CVC has a smaller proportion of the cap table, but for early-stage companies, it can be a significant issue.

Wilted Equity

We can differentiate dead equity from wilted equity in that there was likely a material financial commitment during the formative stages of the business, something beyond the sweat equity a founder would contribute. There may be continuing support in the form of customer introductions, but it has become apparent that the CVC will no longer maintain their pro-rata or provide any meaningful financial support.

There are situations where a CVC holds a large portion of the cap table that may no longer align with the effort they will be able to put into the business. It’s questionable whether that excess equity should be restructured in a way that enables the business to continue as a going concern or if CVCs should draw a hard line—even though they likely had a hand in putting the early-stage company in a questionable position to begin with.

Maturities

This issue is perhaps the most alarming and could spell the end for several early-stage companies if they aren’t careful with their corporate governance. Founders need to be aware of their convertible note maturities and negotiate extensions well in advance of the maturity dates.

If CVCs are unwilling to negotiate an extension, an alternative solution could be finding another form of financing, though this will likely come with worse terms considering the current market environment. However, this could be tempered by encouraging the CVC to take a haircut on the face value of their convertible note—something is better than nothing.

Early-stage companies need to prepare for the worst-case scenario. If they are dealing with CVCs unwilling to accept the realities of early-stage businesses (e.g., not extending the deadline or accepting a discount on the note's face value), they may push the company toward failure. In such cases, companies may have to go through the liquidation process to determine where the CVC stands. This sounds hectic, but investors aren’t necessarily rational—this is why we see fluctuations in market prices.

What to Do?

We are likely to see more of this happening soon, so early-stage founders must stay on top of their maturities and secure extensions where applicable. If stronger investors are on the cap table, it could be worthwhile having them negotiate to take over the positions of CVCs that no longer want a strategic exposure to early-stage companies.

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Blurb:

As CVCs withdraw from the early-stage space, many start-ups face challenges with convertible note maturities, “wilted equity,” and communication gaps. Founders must stay vigilant about upcoming note maturities, negotiate extensions, and explore alternatives to avoid liquidation risks.