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Investor Concern Grows Over Founders Cashing Out Too Much, Too Early

• rexf 16y ago
  This is an interesting issue. If founder(s) get a liquidity event, are they no longer fully committed to making the business successful? Definitely depends on the person. Also worth a look is where the company is at success-wise. It makes more sense for a successful/profitable company (like Groupon) to give founders a liquidity event than a startup trying to get to breakeven.
• esoteriq 16y ago
  Admittedly, I'm a cynic, but I'm a bit suspicious of the investors' motivations behind their alleged concern. Sure, it may loosen the founders' ties to the company, but it also loosens the founders' ties to the investors. Investors cannot influence founders with more liquidity (by say, diluting the founders' shares if possible). Then again, I am a bit of a cynic.
  • davidu 16y ago
    It's really much more about losing alignment between employees, management, founders and boards. The consequences are quite negative, and if I could name the companies I know of dealing with this, I would. Unfortunately, I'm friends with the founders involves and can't out them here. Needless to say, they have some very unhappy employees who have been on board for years and who resent the founders for cashing out while they keep slaving away, especially in the face of overly generous offers to buy the company.
    • esoteriq 16y ago
      Yeah, I can see how that kind of behavior would result in resentment. You're right that a founder cash-out can have a lot of negative consequences, but one should make it clear that alignment is a big part of investors' concerns as well.
    • SriniK 16y ago
      Totally agree with you. Concerned about the whole slew of companies that are in this bucket - Groupon, livingsocial, fb, twitter, zynga, automattic, digg, etc... which had known public founder cash out. It is interesting to see VCs cashing out as well http://techcrunch.com/2010/11/19/accel-facebook-chunks-of-stock/ http://techcrunch.com/2010/11/19/accel-facebook-chunks-of-st...
      • copper 16y ago
        To offer a contrasting opinion: this is very similar to the kind of whining I used to hear from middle-management about employees who hopped from one job to another during the boom days.
• davidu 16y ago
  I totally agree with this piece, and anyone who knows me knows I feel this way. Giving an entrepreneur $250K-$500K to pay off credit card debt and give them a bit of comfort cash, is one thing. Doing so helps make sure they are invested in the long-term success, without making them eager to sell too early, but giving someone $1mm+ before driving a business to major traction, revenue and profit is dangerous for the long-term success of the company. It removes the requisite hunger level which is a determinant for success. Moreover, it actually disincentives selling at the right time, because founders who have pulled $1mm+ off the table are likely to discard even the best offers at a time when reality would dictate the should take the offer (see: digg.com).
  • edge17 16y ago
    makes sense, but there's some bubblicious wafting in the air, and typically when quantity increases, quality decreases. your point's well founded though.
    • nickconfer 16y ago
      Actually this is a good point. Could all the talk about bubbles from some investors be in part spiking this increased interest in founders wanting to take more off the table now?
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  • nickconfer 16y ago
    Are you sure Digg didn't sell because of the founders? From what I can gather from Kevin's interviews in the past, it sounded like he really wanted to exit Digg at that point, but his investors saw larger potential and it was tough to argue when they where still growing like a weed.
  • kenjackson 16y ago
    It removes the requisite hunger level which is a determinant for success. Is this true? I think the hunger is a function inherent in the person. Gates, Jobs, Zuckerberg, Page, Schmidt -- all of them could have quit years before their prime, but none did/have. The people who are hungry because they're broke are the wrong people to bet on, because if the company is even remotely successful they'll find a way to cash out. There's just no way around stopping that from happening. But if you bet on those for which shipping the next great product is what drives them then giving them some money won't cause them to lose their drive.
• JoeAltmaier 16y ago
  I guess you could chain the founders to the wall and feed them gruel too - that would keep alignment. Kidding, but wanting a guaranteed return after years of struggle is sensible. Witholding that because you like to seem the founder "hungry" is not nice, and certainly nobody's business but the persons involved. I can guess that it will sometimes blow up in everybody's face. Yet in the end, the founder has the leverage in a bull market.
• keiferski 16y ago
  I think the bigger issue is the types of companies this line of thought promotes. How is your company going to change the world when you're planning on cashing out 3 years in? No wonder there are so many trendy and knockoff startups.
• 3pt14159 16y ago
  I have a simple rule when it comes to this stuff. Liquidate the founders out of a years worth of projected profit if they stopped hiring right away. "Less than 20 million" could still be $15 million and when you've been grinding for a while sometimes you just want that damn sports car and cottage. Comes back to the fact that every additional dollar is worth less than the one before it. Throw some risk and 1x liquidation preferences and the founders have a really legit reason to just sell to Google for $20m and start something else.
• vessenes 16y ago
  I have read few articles that made me as angry as this one did in recent memory. Let me get this straight -- investors are complaining that entrepreneurs are outnegotiating them on liquidity terms? And their concern is that the entrepreneurs won't keep doubling down to get to a billion dollars once they have some reasonable fraction of the investor's personal net worth? It takes the arrogance of the very rich and highly dominant to complain that they're unable to keep their top employees poor enough to stay motivated. To also kvetch that they're getting outmaneuvered at what, fundamentally is one of their only advertised skills, negotiating terms-sheets, would be laughable if the tone of the article wasn't so earnest. That said, davidu raises good points here about company alignment; it is hard to watch your boss get rich if you don't. You'll probably end up hating them. One nice thing about an 'exit' is that your boss will leave, so you can hate him or her remotely. I'd say the solution is fair incentives up and down the chain in the company, a circumspect attitude to spending, and just keeping quiet about how the deals go.
  • ojbyrne 16y ago
    That last paragraph definitely resonates with me. Especially if your bosses's names were just above yours on the Series A, and one of them now is an angel investor with some top tier investments, and the other bought himself a Tesla and a multi-million dollar home in Mill Valley. I try not to hate...
  • sokoloff 16y ago
    I don't get a sense that investors are complaining about being outnegotiated. Investors that I respect that are quoted in that article are basically saying, "We didn't like the terms the founders were offering, so we passed, and they went and got terms to their liking from someone else." I didn't see any particularly complaining evident, just a disagreement/difference of opinion on whether a proposed deal made sense to them or not. It didn't, so they didn't.
• johnrob 16y ago
  The investors are looking at this the wrong way. If buying employee equity doesn't seem like taking candy from a baby, then perhaps they should not be investing in the deal to begin with. I'd gladly buy shares in Groupon if the price looks right; and if the sale happens because employees want to buy a house then great - distressed asset sales are great buying opportunities, and that's what this is.
  • nickconfer 16y ago
    Groupon has a proven model though. What the article is focusing on are the companies that haven't made large income or profitability. I assume the 20m example was probably from a company spending significantly more than that. Either way if a founder wanted to sell a large stake of shares, wouldn't that concern you to some extent that they saw an iceberg up ahead?
• nickconfer 16y ago
  I can see the investors side on this. Its one thing to be concerned about general finances but if your founder is asking to become a millionaire before making a business viable, and is willing to sell his shares before his company reaches its true potential, it makes you wonder how much the founder actually believes in his own company.
  • dedward 16y ago
    Then they shouldn't have structured things so that the founders COULD cash out early.... once you're able to cash out, it's YOURS....
• ares2012 16y ago
  Where's the follow up article: "Founders Angry Over VCs Cheating Them Out of Equity"?
• rdouble 16y ago
  After watching the history of Silicon Valley video which told of the raw deals old school founders got from their VCs, it's hard to have much sympathy for the investor class. Mark Zuckerberg cashing out enough to buy an Acura TSX probably isn't going to raise eyebrows about future liquidity terms. However, the recent Slate article about Sean Parker chartering private jets and buying a $20M carriage house might be what's really causing investor concern.
• mkramlich 16y ago
  I think one's perspective on whether it's smart/dumb or right/wrong for founders to seek liquidity "too early" is going to depend a great deal on whether you yourself are "post FU money" or "pre FU money". If you've achieved FU money, meaning you don't really have to worry about money or working a regular job ever again, then it's hard to imagine what an early $100k or $1m liquidity event can mean for another person. And it may not even be the case that the founder wants it for bling-and-hookers reasons: he may want it for health reasons, or to help out family members in some way, where there's not really an option to put it off another 5-10 years. Now add to the equation that founders may very well be underwater on a home mortgage, may have debts racked up, unpaid college loans, etc. and early liquidity, even if it means a smaller potential total payday overall, starts making a lot of sense. Emphasis on potential -- the future is not set in stone. And no deal is real until money hits your bank account.
• jabrams 16y ago
  Unfortunately this article ignores the reasons that pre-exit liquidity for founders is so important. The average founder of a VC backed startup typically only owns around 10% of the startup at exit, and is actually not even likely to still be there at exit time in many cases. Between first funding and exit, the startup may go through a cram-down recap that washes out founder equity or at least a highly dilutive down round. This is much more common than the company simply going out of business. Another issue is that VC backed startups often raise too much capital and sell for less than the overhang of the liquidation preference. Noam Wasserman from Harvard Business School studies founder issues and says that 4 of out 5 founding CEOs get fired from their startup. Even if it's half that, it's still a sobering statistic. When startups sell for less than the liquidation preferences, a carveout is often given to current management to close the deal, but that may not include the founders. Founders also often work for sweat equity for years, and then get paid less as CTO or founding CEO than they would working at as senior engineer at Google (in contrast to many VCs who get multi-million annual salaries from their management fees even if fund performance is poor). All of the risks above is why the book "The Illusions of Entpreneurship" claims: "Even successful founders usually earn 35% less over 10 years than they would working for others. The typical, median, right-smack-in-the-middle entrepreneur is a failure. You have to hit the top 10% to have income as an entrepreneur better than what you would have gotten working for other people." The reason that pre-exit liquidity is so important for founders is because the chance of making money AT AN EXIT is so low, and because raising tons of venture capital often reduces the likelihood of a founder profiting from an exit. Update: I also forgot to say that VCs can usually block a sale, another big risk for founders.
• rafaelc 16y ago
  You could see this coming at least 6 months ago: http://blog.rafaelcorrales.com/2010/10/markets-upcoming-reaction-to-talent.html http://blog.rafaelcorrales.com/2010/10/markets-upcoming-reac...
• roel_v 16y ago
  Maybe a bit OT, but when I read articles like this, I look at the VC scene here in Europe and feel sad. It's hot here (amongst MBA types) to be able to say that you're affiliated with a VC-, 'innovation-' or 'seed' fund (leaving aside that many of these are funded at least in part themselves by public money) but the sort of talking in this article is widely foreign to the type of people who typically get the reigns in such organizations. Over here, they don't see 'founders' as such; tech people or people who actually build things for customers are seen as commodities who just execute simple rote tasks and who are really just employees that don't need to be paid a salary until the point the company is bringing in money and then they get paid (x years times double or triple median salary). 'Liquidity event' for founders in an investment round? They'd look at you as if you had gone nuts if you proposed something like that over here. (again sorry for OT and the above may come from observation bias - I'm just bitter today I guess ;) )