U.S.S. Recapitalizaiton: an angel investing allegory.

1. The U.S.S. “Recapitalization” By Tom Tierney
31 October 2011
Recently, a company I’ve been invested in went through a recapitalization. For the uninitiated, a recapitalization
(recap) is a reorganization of the capital structure of the company: generally a reverse stock split occurs, the
company is revalued such that a new financing event is more attractive to potential existing investors and new
investors. For existing investors, their positions are generally mostly washed out, this is not a happy event.
A good visual for a recapitalization is probably the R.M.S. “Titanic” hitting an iceberg: for this exercise we’ll call the
ship the U.S.S. “Recapitalization”, or by its nickname “the Recap”. Like the Titanic, the Recap started the journey
to its eventual destination (IPO or Merger&Acquisition) but something bad happened along the way:
management over promised and under delivered, business sales never materialized or were much lower than
projected, technology took longer to develop or some other “iceberg” of business. The Recap has hit an iceberg,
is taking on water and something needs to be done.
When the Recap hit the iceberg, the board of directors and management of the company had a decision: continue
to invest more money in the existing ship and existing capital structure (simply invest more), abandon the ship to
a smaller lifeboat to try to make the destination (recapitalization) or go down with the ship (wrap up the
company, close down and try to sell existing assets for some minimal return).
The Recap board of directors and management (Captain and crew) decided to head for the lifeboat or the
recapitalization option. As sailors know, the lifeboat is much smaller than the original ship and not everyone may
get a seat. Typically, the existing large investors (Venture Capitalists or VCs) get to set the terms for how much of
the life- boat they are buying, how many seats or what percentage of the company they will take with this
recapitalization. The Captain and crew (CEO and employees) will be given limited seats in the lifeboat, the VCs get
much more of the lifeboat (company), but they still need the Captain and crew to get to the final destination.
But what about all those other investors, family and friends, business partners and individual investors who
invested in the original U.S.S. Recapitalization? Well, they are floating in the water around the lifeboat and have
to decide whether they want to buy a small seat in the lifeboat. The VCs invest “other people’s money” (limited
partners or LPs), this is simply an impersonal financial transaction. The CEO and employees get new stock options
in the recapitalization, their vesting schedule may change but it likely accelerates into an IPO or M&A event,
they’ll be taken care of.
The others who’ve invested individually, take the failure more personally: nobody likes to lose money but this
was also a loss of faith in the board of directors, CEO and employees. They’ve sunk the original ship, do we trust
them to navigate the lifeboat to a safe destination?
Unlike the Titanic, those floating in the water around the Recap simply face a decision of investing or mentally
writing off an investment. Yet, the water is still cold and lonely.
Tom Tierney lives in Encinitas, CA and is a member of Tech Coast Angels (www.techcoastangels.com). Also see
http://en.wikipedia.org/wiki/Tech_coast_angels for more background information on the TCA.