An interesting diatribe has just come out in La Tribune and instantly grabbed the French VC market's attention. The aim is to expose a perceived "dirty" practice of the venture community know as "le coup d'accordeon" or the "accordion squeeze".
[Article Reproduced here - Olivier Pinaud: "Ces entrepreneurs pieges par les fonds de capital risque" - 10 April 2008].
The "accordion squeeze" is basically an Escargot-style extreme cramdown (where losses are used to reduce the value of capital) followed immediately by a capital increase and washed down with a cheap Cahors. In and out, leaving the investors in control of the company, wearing the beret.
<--- Et hop
0.01% is good enough for you !
The article plays on the "dark side" of venture aspects and presents this as a usual trick in the book of the VC trade. I find it interesting because it breaks the silence about what can happen when a venture goes wrong. As we are heading into what may be a lasting downturn, "accordion squeezes" may well make the headlines again. But let's dig a bit deeper here.
A look at 3 possible scenarios:
- The Supportive restart: company A raises $40M for its telecoms equipment play but gets hit by 2002 downturn. Management has merit and talent but capital structure is screwed. Hence, cramdown and immediate refinancing allow (a) the removal of liquidation preferences inherited from the past and (b) a clean incentive structure for management with a new option plan or shares.
- The Punitive wipeout: management underperforms badly, squanders investor money at the speed of light or engages in fraudulent behaviour. Investors are understandably pissed and throw the book at management.
- The Dark Side of VC: investor has decided he does not like management anymore but sees value in the business, uses his superior behaviour of the law and board processes to screw management and throw them out. Management has under-performed but probably not so badly that they deserve to be thrown out on the pavement. From harsh to ugly, depending on your point of view.
Focus on the entrepreneur
If you are a VC worth your weight in salt, you will understand that entrepreneurs are the lifeblood of your own business, and your "clients". Sure you will drive management hard and not shy away from difficult decisions, but you will do so in a way that is respectful, never forgetting that without them, there would not be a business to fund in the first place. This is why some VC's will always the extra mile to help an under-performing founder find a place or achieve a graceful transition. Take the 30-year view, and never screw an entrepreneur.
If you are a VC active in France, you will be tempted to act sometimes in a slightly doubtful manner by a law that protects investor representatives and board members way more than US or UK law, making "corporate governance" a bit of a joke and leading to some downright questionable behaviour. Lack of consequences has an impact on behaviour, particularly when your partnership is breathing down your neck and pushing you to recover money.
Focus on your legals
If you are an entrepreneur, you will be well advised to negotiate hard on board consent and investor consent matters and make sure that you are not at the mercy of financially minded investors. Don't ever think that legal matters can be left to your lawyers. More importantly you will do your best to ensure that you have investors who understand your sector, have deep expertise in your business line and respect you.
When in France ...
As for the article, I would describe it as a hodgepodge because of the case studies it mixes. One is B-Process, where I understand that the founders have been accused of defrauding the company, one is Sarenza where the company reportedly burnt through its financing with a vengeance (€5M in 12 months), and one is Glowria, which seems like it may well be a questionable "accordion squeeze". Here is a company that had its fundraising mysteriously pulled from the market and a decent sale only a few months after the wipe-out. The guys pursuing the case, Crasneanu and Bachet, always struck me as honest fellows who would not do this without serious cause. I understand that together the founder and former MD owned a mere 0.02% of the business at exit. Surely that can't be right. I am not sure about the company they are keeping in this Tribune article though :-)
Finally it's probably worth mentioning the obvious: if you are playing for upside, a cramdown is clearly not what you are shooting for ! The best way for entrepreneurs to protect themselves, regardless of the ethics of their investors, is to manage their cash carefully and generate measurable value-creating steps between financing rounds.
Here is Jean Bourcereau trying to look older then he is :-)
Eric "au naturel" Huet
Alain Caffi 
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