Danforth: Venture capital dreams: Just an equation of speed and distance | Opinion

Once you put money on the line to start a company, you know where the promises are, but also where the bodies are buried.

The startup craze is on display particularly in Silicon Valley, where billions are invested in the long-odds dream that a particular company will shoot the moon, making itself — and you, by extension — legends.

The case of the year involves the federal prosecution of Elizabeth Holmes over promises she made about finger-prick blood testing at Theranos. The company’s estimated worth shot up to $9 billion (based on investors’ rosy visions of future profits). But Theranos could never show that its technology worked. Doubters flooded the market and Theranos ran out of money. What’s left is a fraud trial over what was going on inside Holmes’ head during the run-up. Did she really believe in her promises all along?

It’s boring to do your homework and run some background checks. Smart investors don’t risk more than they can afford to lose at a single sitting without belching. If they can’t take a big loss as a bad day at the ballpark, they don’t stay in the game.

The real game is a mixed bag. From the outside, things look great, the investors seem talented and the financials have promise. But things rarely stay the same. Greed emerges. So do jarring potholes.

In 1999, I helped several others start the Berkeley Daily Planet. I’d already started papers, often accidentally, in Aspen, Conway, New Hampshire and Palo Alto, California. This one was backed by a thoroughly professional structure. The two top executives I’d met at Stanford’s business school. We leased space on University Avenue and put out a fine-looking product. We had a sharp editor and tracked stories about Berkeley’s overactive city government. How could we not succeed?

Enter reality. The Silicon Valley model involves a pot of money, shining like a shimmering pool. It is too enticing to execs who want to overpay themselves with board backing, but with success still months or years away. Overspending is no problem. This is Other People’s Money.

The two executives staked themselves to salaries that quickly attracted board notice. No single investor had enough stock to issue a veto, so ­reform required a coalition. The paper apparently was backed by a healthy amount of advertising. But looks can be deceiving.

Modern accounting, using the “accrual method,” allows sales to be booked as revenue. This looks great on paper, but if the money isn’t collected on time, you can earn thin air, but still legally tell the shareholders you’re making a profit.

Other shareholders weren’t bothered. “We must support the boys,” was the mantra. Investors speak the language of accrual accounting more than cash books. We were selling ads but did not have a crack business squad collecting our bills. The truth appeared in small print under “sources and uses of cash” or “changes in working capital.”

We went through four successive rounds of fundraising. In each, investors demanded “preferred shares,” meaning they’d get their money back before the original investors. After a few rounds of this, the founding funders were buried financially, but the game continued as long as the new money came in. If the paper continued to grow, real cash might swamp out the early losses. But how long might that take?

We added a couple of new board members who pressured the founders to take “haircuts” on their salaries. But it was hardly enough. I visited a major investor one day. He was a friend and mentor, but liked the execs.

I pulled out a napkin to go with our beers. I drew a tall mountain, with a plane headed straight for it. I drew a dotted flight path, with a circle around the estimated crash site.

“It is really just an equation of speed and distance,” I noted, borrowing a movie script phrase.

The board had no interest in trimming either costs or executive paychecks. Why should they? The failure of the paper would still provide a soft landing. They could walk away. If outsiders sought to place blame, it would be easy to finger the economy, a ready target.

By 2002, our three-year ride was over. The shareholders had succeeded in keeping their financial distress a secret. When the paper announced its end, the town was shocked. Even the folks on the town’s council were flummoxed, never guessing that they were reading a paper cracking under financial stress.

Berkeley’s logo and name were taken over by an activist couple running an online news site. The original investors were wiped out, though we did manage to sell a second paper we’d begun in nearby San Mateo.

The principal funder is still a friend. He framed the napkin where I’d drawn the plane crash, proud that he was once a part of a venture capital dream.

 

The writer is a founder of the Aspen Daily News (and Berkeley Daily Planet) and his columns ­appears here on Sundays.