Frontline Seed

Balance Sheet Overload: What to do with all dem’ coins?

Posted 23 July 2021
By Finn Murphy

If you’re a tech company doing reasonably to very well in the past 12 months, you’ve probably raised a large funding round proportional to your spending plans. Maybe you raised your next round before you’re even a third of the way through the cash from your last one.

Founders don’t necessarily need the money, but when the terms are as good as they are in this market, it’s hard to turn down a mega offer. As the old saying goes, when the ducks are quacking, feed them — and standing here today all I hear is ‘quack, quack, quack’. (Niche Margin Call ref for the crew.)

Donald Duck jumping into a pool of coins

File Photo: DevOps Founders managing company cash post Tiger led Series C.

From the institutional LPs to the fund of funds to hedgies, PE, VCs and retail, everyone is sitting on piles of cash that’s depreciating thanks to the super low treasury rates, negative rates on European bonds, and massive asset purchases from central banks around the world.

So, great! We found a place to put all this money (private tech companies), problem solved (woo!). Well, not really; moreso, problem moved. Many of these companies now have a rather unusual situation on their hands. If they want to put that money in the bank in Europe, they’re getting charged in some cases as much as 1–2% on total funds just to have their money sitting there, plus inflation is sitting anywhere between 2–8%, depending on who you talk to. Whatever way you cut it, the value of that cash is slipping away.

The problem with the current capital raising environment is that it’s just not possible for most of the companies raising these enormous sums of cash to allocate it effectively, particularly software businesses with low capex. You can only hire so many people, run so many ad campaigns and ramp your cloud spend so quickly — there is a limit to most management teams ability to deploy capital effectively, as much as investors might dream the opposite.

Companies are ending up with massive balance sheets, and many (I’m being harsh here) don’t really know what to do with them.

The smartest companies are realizing this problem and coming around to opportunity cost of sitting on that capital. They’re trying the ‘obvious’ thing and setting up their own venture funds (lol @ the fee waterfall from fund of funds to fund to micro fund to company to company fund) or launching lines of apparel to cycle the money down another layer or move into higher capex lower margin businesses, exactly as the investors had in mind when they gave them the money in the first place.

Some of the savviest companies are taking a more liquid approach and spinning up their own internal hedge funds. For years, Airbnb’s CFO used their balance sheet largesse to run a wildly successful internal fund that basically accounted for most of Airbnb’s net revenue. Some of the bolder companies are lumping chunks of their balance sheet into Bitcoin and other crypto assets egged on by the true believers of Pomp, the Winklevii and Daddy Musk. As part of a diversified treasury management approach, some crypto holding seems like a sharp move while the arbitrary ‘10%’ is shilled by people with no idea what they’re talking about.

Another group of companies on high growth trajectories are taking advantage of fearfulness in the US around a raise in capital gains tax to buy companies left, right, and centre. M&A is historically extremely difficult to do well, but two of the best tech companies in the world — Google and Facebook — were built this way. Two darlings of the modern startup world, Hopin and Cazoo, have bought a huge proportion of their growth through acquisition. So if your cost of capital is lower than everyone else’s and revenue/growth is at a premium, growth by M&A may not be the worst idea for teams that can pull it off.

Zoom acquires Five9 using stock

If you’re going to go buying companies think twice before paying with stock in the current cash environment.

A more vanilla option is to put the capital at higher risk and tie it up in SVB debt instruments paying 1–2% per year that get cycled to other startups via credit lines and venture debt. Snoozetown.

Another potentially good but also insane move could be investing in a proprietary cloud. We’re starting to see some companies do this for performance reasons already (MightyAPI.videoInferex). If they truly believe they’re going to be the mega companies that they’ve promised to be to investors, then getting ahead of a ten year COGS problem from sitting on AWS/GCP/Azure could make sense. Cost of capital now is low, so companies can roll it into CapEx and forward plan to undercut your competitors in the future with materially lower COGS and juicier margins. Big ‘potentially’ here though as building a private cloud is hard AF.

You could also blow up the hiring market (which is already happening) by offering double market rate salaries for all positions, but the short-term benefit here is knocked by the long-term pain, and you will get no favours from public market investors when you’re way above market when it comes to operating costs.

This is a problem facing more and more CEOs. The funds that are willing to pay up are getting huge and want to write bigger and bigger cheques — regardless of the needs of the companies. So if you want the high prices on offer, you’re in almost all cases taking wildly unnecessary sums of money.

Or will these dynamics change? Will a new crop of funds emerge to serve companies without an ownership requirement? Some of the world’s top companies like Stripe and Coinbase are moving to year by year stock option grants, which I think is a horrible practise that no employee should accept, especially while the talent market favours employees over employers. Could more companies also move to a more piecemeal form of dishing out equity to investors? Raising 10 or 20 million at a time for small amounts of dilution, for example. Some of the hottest companies in the world like Notion have managed to pull this off in the past, and given increasing competition between funds, it may become more common.

So the question founders and boards should be asking themselves before taking a huge (relative to stage) round is: How are we going to press our advantage with all this additional capital? Yes, it’s a de-risking option and yes, the market may not stay this hot forever, but the best companies in the world weren’t built by taking risk off the table, they were built by pressing their advantage when the right moment comes. You need to consider why it would be a competitive advantage to raise $100M over $30M (or even raising anything over using a revenue based financing product like ClearCo or Pipe). Because if that question doesn’t have an obvious answer, you’re just making your options less attractive to top talent and trading equity that’s accreting value for cash that’s depreciating the second it lands in your bank account.

There’s also real dangers to raising a large amount at high prices — you’re painting a target on your back and it limits your future options if you don’t execute. I tried to cover the pro’s and con’s in this piece.

A coda: Could this shift give rise to a new power broker position in high-growth tech companies? The CFO has been a critical role in bringing companies to public markets in the past, but does it take on new importance by optimising the opportunity sitting under many of the worlds venture backed startups? We may see offensive CFOs who can manage a treasury and allocate capital and the best corp dev teams in the world become some of the most sought after teams in tech.

Because if this set of private tech companies is anything like their most successful public comps, those cash piles will only continue to grow. And the world doesn’t need more buyback programs, but for the love of god, we could do with more skilled capital allocators.


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