6 ms·

On the face of it, it seems that if existing investor VC1 has a ROFR, it only means that VC2 can't under-bid on the next round, and that minimizes dilution for

by drfuchs 10y ago

On the face of it, it seems that if existing investor VC1 has a ROFR, it only means that VC2 can't under-bid on the next round, and that minimizes dilution for founders on that round. That is, if VC2 says "We'll give you $2M at a $10M valuation" and VC1 says "We choose to exercise our ROFR at that price", clearly VC2 has set a valuation too low; if they want in, they'll have to make an offer that VC1 won't match. That all sounds good for the founders (and other early shareholders). What am I missing here?

rdl 10y ago
Vc2 doesn't bother putting the effort in to negotiate the deal because he knows vc1 can steal the deal as soon as he has validated it.
- drfuchs 10y ago
  If VC1 chooses to steal the deal, then VC2 underbid on the valuation, no? Plus, even without any ROFRs, there are bidding wars all the time (between VC2 and VC3, say, where neither has a chunk yet).
abalone 10y ago
From VC2's perspective they are probably overpaying due to the ROFR. In your example, $10M could just be what both VCs actually value company at, so VC1 exercising their right is not a bad sign. Therefore to win the deal (if it can't be shared) VC2 has to offer >$10M.. perhaps a lot more if they want to ensure they don't waste their time with the offer. So the concern is this may discourage other VCs from bidding on the deal, knowing the only way to win is to overpay. Or that startups need to sell a bigger stake to make room for both VCs. This is illustrated in detail here: http://venturehacks.com/articles/options-open http://venturehacks.com/articles/options-open
- drfuchs 10y ago
  By that logic, even if VC1 is dead and buried, VC2 still will never make an offer, since VC3 might swoop in and steal the deal, so it's always a waste of time to make an offer. Additionally, it's implausible that two VCs will calculate the exact same "fair" valuation, since it's all so nebulous. From the point of view of the original angel investors and early employees, why shouldn't the founder push for the best, least dilutive, offer? Are you suggesting that if VC2 comes in with a low-ball offer, the founder should just say "gee, they made such an effort, I owe them the right to excessively dilute us all, even though VC1 is putting his money where his mouth is, and is willing to step up to avoid it." Let's say I helped you by putting up a down payment for you to buy your house, for which I get 10% ownership. Later, you want to sell the house (or a further interest in it). If you get an offer, and I think it's too low, is it unreasonable for me to want to "steal the deal" at that artificially low price? Otherwise, it's simply a transfer of wealth from me (and you) to the new buyer, which I'd certainly like to defend myself against. People buy houses all the time in competition with other buyers; no serious buyer says "I'm not going to make an offer on that house, because someone else might beat my offer, or maybe exactly match it and the seller could choose that other offer."
  - argonaut 10y ago
    No, because once the contracts with VC2 are signed etc. they can't change the terms, so VC3 can't swoop in anymore in the same round. And even if VC3 swoops in during negotiations with VC2, it requires the founders to be pursuing that (and VC1 would be aware). Whereas with the ROFR the founders have no choice. Finally, VCs suffer from herd behavior. So it is very plausible that many VCs arrive at the same valuation - the valuation of the VC leading the round / the valuation of the best-reputation VCs. If foo VC values a company at $10M, but Sequoia comes in at $20M, 99% of the time foo VC will second-guess their valuation and match Sequoia.
    - drfuchs 10y ago
      The founders have a fiduciary duty to all existing shareholders (angels, early employees, etc.) to exactly be pursuing VC3 at the same time as VC2, before anything is signed, and to take the best deal. They already have no choice. Your point about herd behavior is well taken, though. And the result is that the VCs moan and groan, but ultimately the price goes up, and the entrepreneur wins, because they get the best valuation possible. (I've been in the room as an angel investor, and I was sure happy when the valuation went up 25% when a second VC got interested in the B round.) The only counter-argument I can see is, in your example, if Sequoia's money really is greener than fooVC's (which there are long-standing arguments for and against).
      - argonaut 10y ago
        No they don't have a fiduciary duty to negotiate with everyone. Founders routinely arbitrarily decide certain VCs are not the right fit (basically, they don't like them).
  - abalone 10y ago
    You're confusing ROFR with simple bidding when you use the phrase "steal the deal". VC2 and VC3 are open bidding, and between them whoever bids highest wins (you call it "steals"). ROFR changes this landscape considerably. VC1 doesn't have to put their bid in until the others are locked. I cited an article explaining how this can steer away competition. Another scenario you might not have considered is that if VC1 would've bid $15M, but the highest other offer is only $10M, then VC1 gets it at $10M.
jartelt 10y ago
Sometimes you don't want to keep getting funding from the same VC so that they don't acquire too much ownership and power in your company. To diversify its investor base, Snap would have to convince VC2 to pay a price that is higher than anything VC1 is willing to pay. Maybe it would work out and VC2 would be happy to pay a premium to get in the deal. But it's also possible that VC2, VC3, and VC4 all walk away from the deal because they don't want to deal with the defacto bidding war with VC1, who has more information and knowledge from being involved with the company from early on.
TimPC 10y ago
The real damage is that ROFR's often allow partial matches rather than require taking 100% or 0%. Where this goes really badly is an Investor wants to do $2M at 10M and the other investors wants to ROFR half the deal. $1M might be below the minimum investment threshold for VC2 and the $1M from VC1 might be too small for the whole $2M targeted round by the company. So now the whole deal falls apart because you can't fill out the whole round since VC2 won't invest 50% of the round and VC1 can prevent VC2 from taking a large enough block by ROFR some of the shares in the deal.

by drfuchs 10y ago

rdl 10y ago

Vc2 doesn't bother putting the effort in to negotiate the deal because he knows vc1 can steal the deal as soon as he has validated it.

drfuchs 10y ago
If VC1 chooses to steal the deal, then VC2 underbid on the valuation, no? Plus, even without any ROFRs, there are bidding wars all the time (between VC2 and VC3, say, where neither has a chunk yet).

abalone 10y ago

From VC2's perspective they are probably overpaying due to the ROFR. In your example, $10M could just be what both VCs actually value company at, so VC1 exercising their right is not a bad sign. Therefore to win the deal (if it can't be shared) VC2 has to offer >$10M.. perhaps a lot more if they want to ensure they don't waste their time with the offer. So the concern is this may discourage other VCs from bidding on the deal, knowing the only way to win is to overpay. Or that startups need to sell a bigger stake to make room for both VCs. This is illustrated in detail here: http://venturehacks.com/articles/options-open http://venturehacks.com/articles/options-open

drfuchs 10y ago
By that logic, even if VC1 is dead and buried, VC2 still will never make an offer, since VC3 might swoop in and steal the deal, so it's always a waste of time to make an offer. Additionally, it's implausible that two VCs will calculate the exact same "fair" valuation, since it's all so nebulous. From the point of view of the original angel investors and early employees, why shouldn't the founder push for the best, least dilutive, offer? Are you suggesting that if VC2 comes in with a low-ball offer, the founder should just say "gee, they made such an effort, I owe them the right to excessively dilute us all, even though VC1 is putting his money where his mouth is, and is willing to step up to avoid it." Let's say I helped you by putting up a down payment for you to buy your house, for which I get 10% ownership. Later, you want to sell the house (or a further interest in it). If you get an offer, and I think it's too low, is it unreasonable for me to want to "steal the deal" at that artificially low price? Otherwise, it's simply a transfer of wealth from me (and you) to the new buyer, which I'd certainly like to defend myself against. People buy houses all the time in competition with other buyers; no serious buyer says "I'm not going to make an offer on that house, because someone else might beat my offer, or maybe exactly match it and the seller could choose that other offer."
- argonaut 10y ago
  No, because once the contracts with VC2 are signed etc. they can't change the terms, so VC3 can't swoop in anymore in the same round. And even if VC3 swoops in during negotiations with VC2, it requires the founders to be pursuing that (and VC1 would be aware). Whereas with the ROFR the founders have no choice. Finally, VCs suffer from herd behavior. So it is very plausible that many VCs arrive at the same valuation - the valuation of the VC leading the round / the valuation of the best-reputation VCs. If foo VC values a company at $10M, but Sequoia comes in at $20M, 99% of the time foo VC will second-guess their valuation and match Sequoia.
  - drfuchs 10y ago
    The founders have a fiduciary duty to all existing shareholders (angels, early employees, etc.) to exactly be pursuing VC3 at the same time as VC2, before anything is signed, and to take the best deal. They already have no choice. Your point about herd behavior is well taken, though. And the result is that the VCs moan and groan, but ultimately the price goes up, and the entrepreneur wins, because they get the best valuation possible. (I've been in the room as an angel investor, and I was sure happy when the valuation went up 25% when a second VC got interested in the B round.) The only counter-argument I can see is, in your example, if Sequoia's money really is greener than fooVC's (which there are long-standing arguments for and against).
    - argonaut 10y ago
      No they don't have a fiduciary duty to negotiate with everyone. Founders routinely arbitrarily decide certain VCs are not the right fit (basically, they don't like them).
- abalone 10y ago
  You're confusing ROFR with simple bidding when you use the phrase "steal the deal". VC2 and VC3 are open bidding, and between them whoever bids highest wins (you call it "steals"). ROFR changes this landscape considerably. VC1 doesn't have to put their bid in until the others are locked. I cited an article explaining how this can steer away competition. Another scenario you might not have considered is that if VC1 would've bid $15M, but the highest other offer is only $10M, then VC1 gets it at $10M.

jartelt 10y ago

Sometimes you don't want to keep getting funding from the same VC so that they don't acquire too much ownership and power in your company. To diversify its investor base, Snap would have to convince VC2 to pay a price that is higher than anything VC1 is willing to pay. Maybe it would work out and VC2 would be happy to pay a premium to get in the deal. But it's also possible that VC2, VC3, and VC4 all walk away from the deal because they don't want to deal with the defacto bidding war with VC1, who has more information and knowledge from being involved with the company from early on.

TimPC 10y ago

The real damage is that ROFR's often allow partial matches rather than require taking 100% or 0%. Where this goes really badly is an Investor wants to do $2M at 10M and the other investors wants to ROFR half the deal. $1M might be below the minimum investment threshold for VC2 and the $1M from VC1 might be too small for the whole $2M targeted round by the company. So now the whole deal falls apart because you can't fill out the whole round since VC2 won't invest 50% of the round and VC1 can prevent VC2 from taking a large enough block by ROFR some of the shares in the deal.