Pretzel Problems
An ill-fitting capital strategy can leave even the best founders tied in knots.
Whether it's marshaling the resources to get started or securing cash to fuel growth, funding a business is hard, messy, and less fun than it looks on TV.
The complexity isn’t just in finding money. It’s navigating all that comes with it. The costs, consequences, and contortions required when taking on outside capital can leave even the best founders tied up in knots.
Behold the Pretzel Problem. When an entrepreneur seeks or takes on capital that’s not a great fit for their business, weird things happen. With ‘pretzeling,’ perceptions and expectations about a company's future–needs, trajectory, terminus–get stretched in ways that can be hard to sustain…or worse, hard to live with.
Trouble is, pretzels made by ignorance or innocence can cause as much trouble as those made with malice–like when an investor kneads a company into whatever shape they want to see. When it comes to building a capital stack, these aren’t shapes you slip in and out of. Some will stick, whether you like it or not.
It’s hard to untwist a pretzel without breaking it. So before you go full Bavarian to get the cash, here are a few pretzel shapes to be wary of:
🥨🥨Shopping a Story You Can’t Sell
When hunting for resources it’s normal to project the BEST version of a company. Beware the pressure–internal or external–to project or promise outcomes that are likely unattainable under even the best of circumstances.
A founder recently showed me a deck projecting company revenue growing from $400K to $17M in three years. It was obvious that the founders didn’t have an authentic rationale for why this growth goal was plausible, proper, or necessary. There was also scant evidence they could build an operating structure to support this growth, should hell freeze over and it actually happened.
This company had a lot going for it, and the founders weren’t stupid. I wager that they were coached into these projections by mentors / advisors who take the bigger is always better bus to school. These founders got caught up in a story that was hard to carry, taking the “go huge or go home’ pretzel shape even when they probably didn’t need to.
Navigating the delta between big dreams and being delusional takes finesse. Beware telling a story you can’t substantiate in hopes of attracting investors. It’s a fool's errand more likely to attract the wrong fit than the right one (more on that below).
🥨🥨Differing Definitions of Success
What is “success” in entrepreneurship? Demonstrating that an innovative technology is worth further development? Improving the life or experience of a group of people? Becoming the most beloved tool / platform in a category? Creating profit for founders, and wealth for investors?
Depends on who you ask. IRL, these outcomes rarely all happen in tandem, and sometimes they are mutually exclusive–almost aggressively so. A company’s capital strategy has a huge impact on how success is defined and measured. When there’s misalignment here, the consequences of an “I want what you want... only not really” pretzel can be especially high risk.
I work with a founder who was ready to sell when a buyer for the company came along. The offer had significant upside for the founder: a fair price, resources to rapidly bring the company’s product to a much larger group of customers; a great role inside the acquiring org; and meaningful compensation for someone who hasn’t had a real paycheck in five years.
While the offer was good for the founder, it was rejected by the preferred stockholders who needed to approve it. They wanted a higher purchase price and an all cash transaction, caring far less about founder comp or equity in the acquirer. Having only been in the company for less than two years—and, as new money investors seeking outsized returns—the investors felt they could hedge their bets and wait for a better deal to come along. End of story.
Only time will tell if that better deal comes along, or if it will have the same founder upsides. In the meantime, the experience irrevocably changed the founder’s relationship with the board, and in some ways, dimmed hope for what the future might hold…and there is little joy in entrepreneurship without hope.
🥨🥨Unintended Downstream Consequences
If capitalizing a company was all about selecting correct options from a set of clear options, what a wonderful world this would be. In reality, we make the best decisions we can at the time we make them.
I work with a company that raised a significant amount of money early on. As is common, the path to success was longer, bumpier, and directionally different than anticipated. On the upside, the company figured it out and is stronger for it. On the downside, much of the money they raised was invested into the wrong things, with little remaining to redirect.
This puts the company into a bind. With more traction and mounting proof that they are on the right path, the company could raise money to fuel growth. However, the amount and structure of funds already raised means that founder equity is already significantly diluted. Raising more would likely mean the founders lose majority ownership of their company. Aside from the implications for who has operating control, this dilution would require a HUGE exit for the founders to see any cash come their way when it’s time to sell.
So, here they are: everything finally working. Obvious opportunities for growth, darker times safely in the rearview mirror. But with little gas in tank to take advantage of all they have accomplished. In hindsight, the founders wish they’d raised more slowly, sought better counsel on funding structures, and not listened to the “go big or go home” hype that punctuated the moment.
Pretzel Prevention
There’s plenty of blame to go around for turning early stage funding into a pretzel factory: 1) Founders may lack the expertise to know which types of funding make the most sense, short and long term. 2) Options may be limited and the consequence of not having what you need can be dire. 3) The capital decisions we make today can span years, well beyond the horizon of what founders or investors can predict with any reasonable degree of certainty.
Avoiding the pretzel problem IS complicated, but it’s not all doom and gloom. We can make fewer pretzels with changes in how mentors, investors and educators talk about fundraising, especially with first time founders.
Specifically, we can have more candid conversations about scenarios like the ones above. If a mentor or entrepreneurship educator doesn’t have a drawer full of their own examples about bad pretzels, then maybe they shouldn’t be giving advice at all!
For founders, a good Pretzel Prevention approach is to find a capital mentor. Someone who can riff with you on all the kinds of capital you might consider using, rather than taking a myopic focus on raising linear rounds of equity.
While advisors, mentors and current investors may strongly influence funding decisions, founders need to educate themselves. Your capital structure has an outsized impact on strategy, execution and results. It’s critical to be well informed for the journey.
Above all, be honest with yourself. If you don’t match the pattern, twisting into contortions is probably not the fix you really need. After all…knots are for pretzels, not people.
RevUp Capital Managing Partner Melissa Withers is a bullish advocate for innovating the ways in which new companies are funded and supported. Beyond building new economic models for early stage investing, Melissa is also committed to directing more entrepreneurial funding to those underserved and overlooked by traditional VC.
More About RevUp Capital
RevUp Capital invests in B2B and B2C companies that are revenue-driven and ready to double down on growth. We deploy cash and capacity to help companies grow from $1-3M to $10-30M, quickly and efficiently, using a revenue-based model. Companies enter our portfolio with $500K-$3M in revenue, a strong growth rate, and a team that’s ready to scale. Our typical investment range is $300K-$500K.
We invest into a company's market-facing activity using a cash and capacity model. We pair our cash investment with dedicated support from the RevUp Growth Platform: a powerful resource to build a data-driven growth engine, delivered by people who get the work done. Rather than take equity, companies return investment through a small percentage of revenue over time. More at www.revupfund.com