Bail Out Entrepreneurs, Not Big Auto

So, the Auto Bailout bombed in the Senate. Good. (Never thought I’d be writing about it in Venture Files . . . but then, I never imagined it might affect entrepreneurs — including me — directly.) It’s an intriguing tale of desperation, fear tactics, and ironyLa-192-car-pileup2003.jpg.

Desperation because the auto industry leaders are out of options, and doing everything they can to avoid the only solution that makes sense: filing for Chapter 11 protection. (I used the word “˜protection,’ rather than “˜bankruptcy’ because it’s exactly that — a means of legally keeping at bay those who might otherwise come after you for moneys owed.) I’ve been through it with one of my startups, and I’ve written about it here.

Fear tactics because the auto industry leaders would have us believe that the world will end if they file for Ch. 11. In fact, it makes survival possible. It enabled the airline industry to survive. So why would the industry leaders oppose it? It wipes all the existing stakeholders clean — all stockholders, creditors, pension plans, and — most important of all, the unions. And it will wipe out industry leaders’ individual stockholdings . . . and probably cost many of them their jobs.

But it’s the only solution. Lending the big automakers money to make payrolls is a short-term fix at best. There’s nothing they can do in the next six or even 12 months to turn their battleships around. I get as sentimental as anyone about GTOs of the past, but the model is broken, and dead. It’s time to clean house, start over. I feel for the folks who will lose jobs, but sorry — your management screwed up . . . and they’ve been doing it for decades. Instead of spending on R&D for new technologies, Big Auto spent on lobbyists to get relaxed efficiency and emissions standards.

It’s not about casting blame, or punishing anyone. It’s about survival. The crushing debt burden, inflated wages, and inefficient manufacturing infrastructure will never enable a US auto maker to return to profitability, even if it had a next-generation car ready to go. Unions are an antiquated and unnecessary burden, a throwback to times when bosses literally beat employees to make them more productive. The tech industry works fine without them (although there were several attempts to unionize them over the decades). More to the point: Foreign automakers have set up shop in the US without them.

I wonder if auto workers were given a choice of losing their jobs or taking a comparable job at two-thirds of their current salary at an electric-vehicle plant, which would they choose?

Ironic. Because there’s already a fully approved $25,000,000,000 in loans available to car makers. That’s right — $25B in direct low-interest loans (the Federal Funds Target Rate, currently at 1.0%). It’s the Department of Energy’s ATVM Loan Program (for Advanced Technology Vehicle Manufacturing), and it’s fully approved by Congress, under Section 136 of the Energy Independence and Security Act of 2007. So why aren’t they taking advantage of it?

Because they’d rather keep operating as they’ve been for the past 50 years, than do what they should be doing. And they’re woefully unprepared to shift manufacturing to projects that meet the ATVM criteria.

So, despite the fact that, it’s all there, fully approved by the House and the Senate, with applications due by the end of this month, and decisions to be rendered by March 31, 2009, there’s that hitch: applicants have to have bona fide projects that meet the criteria of an Advanced Technology Vehicle. That could be anything from new high-efficiency gas-sippers to plug-in electrics. (You can read all about it in the Interim Final Rule.) The funding is not designed to resurrect Oldsmobiles.

For decades, Big Auto chose to avoid the transition to alternatives. Not that they didn’t do some work on them. (If you haven’t already, be sure and rent the documentary, “˜Who Killed the Electric Car?’ GM built one — the EV1 — people loved it, and every last one of them was destroyed . . . by GM.)

The automakers should be forced into bankruptcy. And rebuilt. Federal funding should be provided — but only to fund the new businesses emerging from Ch. 11.

If I seem personally peeved, I am. On behalf of my new company, I attended the DOE public meeting for the ATVM Loan Program in Washington DC last week. See, the loans are also available to makers of components for ATVs, which is what we are. I’m fairly confident we’d qualify for the program (although not in time for the year-end deadline, but no problem — there will be rolling application deadlines — and 90-day decisions — every quarter.)

But there are a couple of gotchas: 1) the bailout that just failed (thank God) was going to “˜steal’ $15B from the program (since the money was already approved); and 2) even though it will go forward, a subtle point came up in the DOE public meeting — once a ‘magic number’ of $7.5B targeted for bad debt (based on the committee’s analysis of aggregate applicants), after which the loan program is ended. That means, say, GM receives a $4B loan to set up a plug-in hybrid plant, but the committee calculates a 50% probability that GM won’t be able to repay the loan. Then $5.5B is left for the others. You get the picture: the DOE might only end up lending a total of $15B — mostly to the big guys — based on a 50/50 chance that they won’t make good on the loans.

And us little guys — the entrepreneurs who should be getting the money for new technology — will be squeezed out. We were all there (at two separate meetings) at the DOE meeting last week — lots of technology companies developing radical new engine designs, patent-pending alloys with greater strength at a fraction of the weight, energy-efficient components, electric alternatives (including Tesla Motors). Oh, and a few representatives of Ford, GM, and Daimler, and the Japanese car contingent.

And although the Interim Final Rule makes no provision for ensuring that small companies get a piece of the pie, there is still hope: Section 136 also provides for grants, but the lawmakers haven’t gotten around to defining that part. Let’s hope the new Administration sees the wisdom in targeting that money for those who will put it to best use — the entrepreneurs. (They’re ahead of us in the UK on this one.)

Still, the (sitting) President is pushing the rescue, this time from the bank bailout fund. I reiterate: ‘Oh, Thank Heaven . . . for Chapter 11!’

Chapter 11, Pt. 2: Hard Lessons from the Chapter

This is a continuation of the series that began with Chapter 11: To File or Not to File

t shirt final.jpgConvinced that we could get all our creditors’ cooperation without formally filing for protection under Chapter 11, we proceeded nonetheless to get experienced professionals on board. The workout team was assembled — insiders including myself and my CFO, our chairman, a bankruptcy attorney from our law firm, and a workout specialist, Ralph. Except for the two pros, we were all new to this . . . and school was now in session.

Lesson No. 1: Make sure you have the right workout team.

Ralph was not what you’d expect. Rumpled, belly-over-the-belt, pinky ring. (We later concluded his approach was effective because the creditors would never confuse him with being a ‘slick suit’ out to take advantage.) But we were awed by his work. Like Harvey Keitel’s character in Pulp Fiction who masterfully wipes away every trace of a grisly crime, then goes out for breakfast — Ralph was more artisan than artist. With speed and precision he wended through our 97 creditors, triaging them into three buckets, getting cooperation to his plan — in writing — from nearly all of them in a matter of weeks. The guy knew what he was doing.

He also knew well the brick wall that lay ahead: the largest, secured creditors. When it came down to it, it took just three of the 97 creditors — the owner of our million-dollar testers, the bank holding the lease on our 100,000-square-foot facility, and our primary equipment lessor — to nix the deal.

Lesson No. 2: Large secured creditors know that their chances of recovering debts depend on a company’s survival — and chances of that are much better behind bankruptcy law’s skirts.

By law, the big guys had the power to force us to file . . . and they did. Lord knows I wanted to avoid it, from a personal standpoint. See, the secured creditors had also sealed the fate of my founder’s shares, roughly 15% of the company. Why? Because in a Ch. 11 reorganization, all bets are off — the capitalization chart is wiped out, and a new one gets put in its place. If not handled properly, this could be a big problem for your stock-incentivized employees. (Remember the importance of those neurons.)

Lesson No. 3: Take good care of the workforce.

Without any cajoling, the Board agreed to reconstitute employee stock options — a design engineer with options for 1% of the old company would end up with 1% of the new company. Simple, straightforward. As for me, I was at the mercy of the Board, who couldn’t see their way clear to reconstituting my ownership entirely since, despite all good intentions, I was a member of the management team that presided over the meltdown. (Unlike today, people once believed in management accountability.) But as the saying goes, 2% of something is better than 100% of bupkus.

What followed was nothing short of a casebook classic on Chapter 11 — if not a Guinness record. The company went in and out of bankruptcy in 88 days. We had done everything right, and it was a beautiful thing.

Lesson No. 4: Provide a sufficiently creditor-approved plan to the bankruptcy judge on the day you file.

More often than not, companies in trouble file for Ch. 11, then take three months or more to develop the plan, only to have it stall somewhere between the bankruptcy judge and disgruntled creditors. We had nary a complaint from any of our creditors, and here’s why.

First, the 74 smallest ones — those owed less than $10,000 — were paid 100% on the dollar. (Ralph knew the little guys would make the most noise, and it’s never worth the trouble to pay them anything less.) Total paid to this group: $294,000. The next class of creditors (the 19 owed between $10,000 and $100,000) would receive 75 cents on the dollar. This group too had no issues. Total paid out: $343,000. Lastly, the four secured creditors — owed a whopping $4.2M — were paid 10 cents on the dollar, plus given low-priced warrants to purchase shares of common stock. Everyone took the deal (technically, they had to — once the judge’s gavel comes down, it’s the law), with the exception of the bank, which had a policy against owning shares in customers’ companies, and forewent the warrants.

New money was of course equally crucial to the plan. Most — but not all — new funding came from existing investors. The proposition was: “œYou’ve already put $4M into this fine company, which bought you 15%. You could write it all off “¦ but why not put an additional $400,000 in, and reclaim your 15% in the newco?” It worked with every investor except a few of the European ones (Europe still hasn’t fully grasped the Ch. 11 concept). In all, $2.5M of new money came in — enough to get the company through to solid profitability and positive cash flow. (Don’t forget, we were growing our business of building and selling chips all through the process. Customers have less of a problem with it than you might think — after all, who of us didn’t fly Delta or United through their bankruptcies?)

Lesson No. 5: Do your best to maintain morale, but remember — the employees that stick around through tough times are the only ones you should have hired in the first place.

The final elements to consider were the intangibles — company culture and morale were big ones. (Don’t underestimate the importance of changing the logo!) We knew at this point that it was really just about the employees, now down to 75 die-hards. True, despite every effort to retain them — the ‘Oh, Thank Heaven . . .’ t-shirts (playing off the popular convenience-store jingle at the time) were a touch I’m especially proud of — you’re bound to lose a few. But as the manager of the team that remained, I still get misty thinking about the quality, perseverance, and attitude of the group.

Filing for protection under Chapter 11 is a grave decision — and not the right prescription for every ailing business. Our company was a superb candidate because it had the right fundamentals — strong demand for its products, a solid asset base in intellectual property, willing investors, and leadership capable of boosting morale while managing the day-to-day business.

Chapter 11, Pt. 1: To File, or Not to File?

Misery final.jpgIt’s a timely topic, but when asked to detail my experience with Chapter 11, the line that came to mind was from the end of ‘Misery’, when James Caan is lunching with his agent: “Gee, if I didn’t know better, I’d think you were asking me to dredge up the worst horror of my life, just so we could make a few bucks.” But though I never hope to put the experience to use again, it provided valuable lessons (plus, my company — Lattice Semiconductor — prevailed, and grew to a quarter-billion dollars in sales) and serves as a cautionary tale to entrepreneurs as we enter some tough times ahead.

So here is the tale — of a company that ran up expenses too far ahead of revenue, hit the wall, then succeeded with a ‘do-over’ by putting one of America’s great pieces of legislation — the 11th Chapter (Reorganization) under Title 11 (Bankruptcy) of the United States Code — to work.


The old regime ousted, my new CFO and I (promoted to COO) — several months into a salary moratorium, since the company was down to the very last of its cash — were on a mission to raise fresh capital. First on our list of VCs was NEA, and we were hiking up Knob Hill (ridiculous, but we were trying to save cab fare) to the exclusive San Francisco club where the Sand Hill Road VCs had deigned to meet us. We hurried through the massive portico, past — was that a cellist? — down a triple-wide marble staircase to an enormous room with nothing but an easel and elegantly set table.

But we weren’t to dine that day.

The VCs motioned to us just as lunch was being served, and we earnestly began the pitch for our hot computer-chip company. But by the time we realized we weren’t getting fed, it was pretty clear they weren’t going to invest either.

What we did give us that day was a lesson — etched forever in my memory of pristine crystal and gilt-edged china on crisp linen. (Was it because it served as so perfect a metaphor for the venture capitalist ideal . . . or were we just hungry?)

“œWe VCs like to pull ourselves up to a fresh table,” the lead partner said, stroking the linen and aligning his silverware for emphasis. “œYou’re going to have to clean house.”

We knew what he meant — or thought we knew. Though we had sales exceeding $1M a quarter and referenceable customers like Compaq, we had problems. A burn rate that would snap your neck, for one — $750k a month, anchored by a 10-year building lease and a crushing debt load. Then there was that undigestible shareholding of my megalomaniacal co-founder, whom we had forced out only weeks before: an eye-popping 35% ownership in the company.

These were problems we naïvely believed a fresh round of financing could fix. But the VCs had dosed us with reality that day. Despite how hard we’d worked to get where we were — endured three months without pay . . . gritted through laying off a third of our 175 employees . . . pulled off the board coup and CEO ouster — the barons of Sand Hill Road had declared us unfundable. To pound the table-setting metaphor one last time: we were the morning after a bacchanalian orgy.

The Unutterable

Back at our offices, none dared utter ‘Chapter 11’ outside the board room. It wasn’t shame we feared, but the booming voice of conventional wisdom: as a chip company, you’re dependent not just on intellectual property, but on know-how — an asset buried deep in the neurons of key engineers. Spook them, and you’re liable to ‘lose the recipe.’ (The semiconductor business is legendary for nuances wildly affecting yield, also known as KGD or known good die per wafer — the all-important metric that dictates profit and loss.) The thinking was, if you so much as mention Chapter 11, key employees flee, production goes to hell, and you’re left with . . . nothing.

Management and investors gnashed and thrashed over whether to file. While the Code was drafted with us in mind — keeping the creditors at bay and allowing you to conduct business as usual as you work out a plan to repay them — we couldn’t get over our fears. So, like others before (and many to follow), we came to an ill-informed conclusion: We’ll work everything out without filing for Chapter 11. Surely everyone will go along with it, since it will have a much better chance of success! Who wouldn’t prefer it to being crammed down by a curmudgeonly bankruptcy judge? It will be so much more . . . civil!

Only, it doesn’t work that way. Next in Part 2: Hard Lessons in the Chapter.