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It was an illustrative, mathematical example, of what I'm talking about. If the shares are worth $3.5 million, how much do you think the guy leaving can raise

It was an illustrative, mathematical example, of what I'm talking about. If the shares are worth $3.5 million, how much do you think the guy leaving can raise on short notice? If you say anything over $100,000 you are delusional. Investors don't even see the value in companies that are provably worth $1 billion. Even in retrospect you say, "well yeah history showed it is worth $1 billion, and the founder made a good case for that, but actually that is like a founder making a good case that he will role 10 "6's" in a row on a die, and then proceed to do that. The chances that he was going to do that are actually just 1 in 60,466,176 so the correct value of that "$1 billion" share is actually $1 billion / 60,466,176 = $16. That seems a little low - I'll give you a $100 for it. That's my annual budget for lottery tickets." Investors don't value startups correctly and the idea that a guy can quickly raise money for a buyout of a stake in a company he's leaving borders on delusional. Plus, who would invest in a company with a negative signal that strong: that a guy who owns 1/3 of it wants to leave it. There is obviously absolutely no way for a cash-poor founder without prior exits to raise anywhere near $3.5 million for a 50% buyout of a company raising a round at $7 million. honestly - have you tried raising money around the seed stage? It's brutal, if everyone is on board and there are no negative signals of any kind. I wouldn't be surprised if no poorly networked, cash-poor founder has raised significant (>$1 million) for a shotgun buyout of a company he's leaving, on short notice, ever. I might be wrong though, and I'd love to know if so. In my model it's really, really hard to raise money.

beagle3 9y ago
Yes, I have raised successfully at the seed stage several times. If the company is worth $3.5M and no vesting schedule, no investor will touch it (and the 3.5m valauation was reached either out of thin air, or on the back of a sucker). If you cannot raise (with e.g. 20% discount for the trouble), the valuation is wrong.
- logicallee 9y ago
  I think we're saying the same thing. The example wasn't of raising a round - it was raising money for a shotgun buyout, so you can leave a company completely while the company tries with other principals and other investors. Using your money - but not using the guy you're giving your money to, who will go home. That's the scenario that I don't think is very realistic. As a result the poor founder will not be given a fair offer. Which is why I don't get how shotgun clauses are supposed to be fair. This is pretty "obvious" to me. So I might still be missing something.
  - beagle3 9y ago
    No, we are not saying the same thing. I say that the situation you described is so far fetched as to be irrelevant to a discussion of "shutgun buyouts" in general. How did the company reach a $7M valuation? They might have sold 1 share out of 7M shares for $1. That, technically, would make it worth $7M. But practically, it isn't. Let's say company raised $3M at $4M pre-money => $7M post money. That's not unreasonable. At this point in time, the company has $3M in the bank, so it is indeed worth at least $3M. Let's say "cash poor founder" only has $100K in the bank. If "cash rich founder" offers to buy 50% for $500K (five times what "cash poor founder" can afford), then it is extremely easy to raise $500K, for a promise to pay $550K from company coffers the next day, because in fact those $500K will buy control of $3M. And that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc - because the investor who put $3M into that company is likely to lose it in a variety of real world cases without those clauses. I say your cases are not impossible, just extremely improbable. In practice, it is easy to borrow against a grounded valuation with some. The poor founder will likely get an "unfair" offer, but "unfair" here is within 10-20% of a fair offer, not a 50% or 90% as in your examples. I assume poor founder is a smart founder, of course - he might not have access to lenders/investors, which could get him treated unfairly; But of course, that's also the case for having illness, immigration problems, disability, etc. Money is an advantage, lack of money is a disadvantage -- but it is not fatal in these cases in general.
    - logicallee 9y ago
      Thank you for the detailed write-up! I have some questions, I would like to understand it better. You are a real expert and I appreciate your taking the time to understand my question and help me understand better. 1. Why do you say cash-rich founder's offer of $500K is within 10%-20% of the market price of the shares, when in fact the market has just priced the company at $7M, half of which the market has therefore just priced at $3.5M? It seems to me that $500k is 1/7th of $3.5M, so the offer is only 14% of a fair offer... For example, what if one partner is greedy and wants to buy out the less greedy, but also poorer, technical founder, after they have some huge windfall that gives huge value to the company. (Some of which is reflected in the $7M valuation they've received - which is not at all low.) 2. You write "that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc". Would you say under the typical clauses offered by VC's, they would allow the remaining founder to spend an unexpected and large amount of money from the company coffers in order to buy out the other partner? (Or repay a debt investment they had raised to do so)? Why would the investors allow that? Especially if it was not envisioned explicitly under "use of funds" and, of course, they'd rather have two partners work on it than one. (But the greedy, cash-rich funder would prefer to own and have the company by himself.) 3. You write - "he might not have access to lenders/investors, which could get him treated unfairly". Would the company be able to raise debt to finance a buyout of one partner by the other or is that not something a company can raise debt for? Thanks for your answers. I'm pretty shocked at everything you've said. (As you noted at the top of your comment, I misinterpreted you also.) By the way, this does not apply to a situation I am in - and I hope won't apply in the future. I simply do not really understand the clause and its implications in the real world, that well. Thanks for your help.

beagle3 9y ago

Yes, I have raised successfully at the seed stage several times. If the company is worth $3.5M and no vesting schedule, no investor will touch it (and the 3.5m valauation was reached either out of thin air, or on the back of a sucker). If you cannot raise (with e.g. 20% discount for the trouble), the valuation is wrong.

logicallee 9y ago
I think we're saying the same thing. The example wasn't of raising a round - it was raising money for a shotgun buyout, so you can leave a company completely while the company tries with other principals and other investors. Using your money - but not using the guy you're giving your money to, who will go home. That's the scenario that I don't think is very realistic. As a result the poor founder will not be given a fair offer. Which is why I don't get how shotgun clauses are supposed to be fair. This is pretty "obvious" to me. So I might still be missing something.
- beagle3 9y ago
  No, we are not saying the same thing. I say that the situation you described is so far fetched as to be irrelevant to a discussion of "shutgun buyouts" in general. How did the company reach a $7M valuation? They might have sold 1 share out of 7M shares for $1. That, technically, would make it worth $7M. But practically, it isn't. Let's say company raised $3M at $4M pre-money => $7M post money. That's not unreasonable. At this point in time, the company has $3M in the bank, so it is indeed worth at least $3M. Let's say "cash poor founder" only has $100K in the bank. If "cash rich founder" offers to buy 50% for $500K (five times what "cash poor founder" can afford), then it is extremely easy to raise $500K, for a promise to pay $550K from company coffers the next day, because in fact those $500K will buy control of $3M. And that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc - because the investor who put $3M into that company is likely to lose it in a variety of real world cases without those clauses. I say your cases are not impossible, just extremely improbable. In practice, it is easy to borrow against a grounded valuation with some. The poor founder will likely get an "unfair" offer, but "unfair" here is within 10-20% of a fair offer, not a 50% or 90% as in your examples. I assume poor founder is a smart founder, of course - he might not have access to lenders/investors, which could get him treated unfairly; But of course, that's also the case for having illness, immigration problems, disability, etc. Money is an advantage, lack of money is a disadvantage -- but it is not fatal in these cases in general.
  - logicallee 9y ago
    Thank you for the detailed write-up! I have some questions, I would like to understand it better. You are a real expert and I appreciate your taking the time to understand my question and help me understand better. 1. Why do you say cash-rich founder's offer of $500K is within 10%-20% of the market price of the shares, when in fact the market has just priced the company at $7M, half of which the market has therefore just priced at $3.5M? It seems to me that $500k is 1/7th of $3.5M, so the offer is only 14% of a fair offer... For example, what if one partner is greedy and wants to buy out the less greedy, but also poorer, technical founder, after they have some huge windfall that gives huge value to the company. (Some of which is reflected in the $7M valuation they've received - which is not at all low.) 2. You write "that's exactly why investors insist on vesting schedules, first rights of refusals, tag-alongs, bring-alongs, etc". Would you say under the typical clauses offered by VC's, they would allow the remaining founder to spend an unexpected and large amount of money from the company coffers in order to buy out the other partner? (Or repay a debt investment they had raised to do so)? Why would the investors allow that? Especially if it was not envisioned explicitly under "use of funds" and, of course, they'd rather have two partners work on it than one. (But the greedy, cash-rich funder would prefer to own and have the company by himself.) 3. You write - "he might not have access to lenders/investors, which could get him treated unfairly". Would the company be able to raise debt to finance a buyout of one partner by the other or is that not something a company can raise debt for? Thanks for your answers. I'm pretty shocked at everything you've said. (As you noted at the top of your comment, I misinterpreted you also.) By the way, this does not apply to a situation I am in - and I hope won't apply in the future. I simply do not really understand the clause and its implications in the real world, that well. Thanks for your help.