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Avoiding the Death Spiral

    

People in finance often talk about or hear about the death spiral. Traditionally speaking, this usually involved a loan from investors to a company, and the investors would receive a kind of convertible debt in return for making the loan. This sort of debt would give the loaning investors the option of changing that debt (i.e., converting it) to stock shares for far less than the existing share price. Basically, a company would get a bit of a cash infusion, but it ended up giving away a lot of value and power to get it.

 

The idea of a death spiral has gradually expanded, but it basically entails a path toward inevitable destruction if the financial picture is not addressed in time. It is probably safe to say that most would caution against a death spiral, and here are some thoughts on that sage advice for anyone still questioning that or contemplating going for it anyway:

Don't Let Easy Money Entice You

Plenty of companies have been strapped for cash at some point during their existence, and thus forced to borrow funds on less than ideal terms. The need for immediate cash and subsequent willingness to receive it at all costs essentially started the whole death spiral problem. These days, however, it does not seem necessary, not to mention wise, for fledgling companies to take on this value plunging tactic. If the money is easy to obtain, then there is probably a catch. And, with venture capital funding at an all time high, there just does not seem to be a scenario in which going that route is necessary. 

Don’t Drown in Debt

There is a lot to be said for a company that manages to bootstrap its business. It forces the leadership team to carefully consider all decisions and expenses, and it can really set a company up for financial success in the future. Many of the folks that were able to bootstrap would likely attest to its many virtues. Although a cash infusion may seem like an absolute necessity, taking on debt is a serious burden that can have lingering effects, so it must be considered more as a last resort rather than an initial funding measure. 

Don’t Over-Acquire

In some cases, the path to cash may seem faster by acquiring similar but smaller ventures. These acquisitions may increase production capabilities and capital access, and bring along various other benefits since it is essentially an instant expansion. However, some companies become so enthralled with acquiring that they end up having to finance the process, and eventually become mired in complicated financing anyway. This may be an indirect approach, with a longer and slower spiral, but the outcome will ultimately be the same.

Don’t Merge Beyond Recognition

Rather than merely acquire another business, other companies may seek to merge with a firm, ideally on somewhat equal footing. This obviously brings a myriad of financial benefits, but it sometimes happens at the expense of the business’s very purpose. Some consider this a kind of hidden death spiral because one of the merging companies may be swirled into something completely unrecognizable, which seems an awful lot like the very result that was meant to be avoided. 

 

Starting a business is exciting, but funding its operations is a completely different story. Regardless of a company’s financial potential, figuring out which money to take and on what terms is a major decision that cannot be taken lightly.

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