4 ms·

How did that happen? The acquirer just purchased a certain class of shares, i.e. preferred stock and didn't care about owning 100% of the company?

dsjoerg 12y ago
It's called a "liquidation preference". http://www.investopedia.com/terms/l/liquidation-preference.asp http://www.investopedia.com/terms/l/liquidation-preference.a... The mechanics & technicalities are beyond me, but the consequence is as described above.
icedchai 12y ago
Basically, the investors (with preferred stock) get paid out first, sometimes at a multiple of their original investment. The amount "left over" goes to the common stock holders. Sometimes that amount is zero, so they get nothing. I had this happen to me in a previous start up. I wasn't really surprised.
ChuckMcM 12y ago
It works as follows, there is a line of people who need to get paid, If the startup took on any debt, at the front of the line is a bank. Their 'note' usually gets paid first. $POOL -= $BANK When people invested in the Series A, B, C, ... their stock came with a 'liquidation preference' (which can have a few variants, but the two most common are, the investor chooses if they want the liquidation preference or the common value, the investor gets their liquidation preference and the common value. Note that these numbers are in $dollars not in $shares, so if VC A puts in $1M dollars with a 2X liquidation preference they get back $2M dollars. $POOL -= $LIQUIDATION Sometimes at the same level, or just behind the investors, are convertible note holders, who gave money or equipment in exchange for shares. They often have the choice of getting either their money back, or the shares. $POOL -= $NOTE. At this point, if there is anything left in the pool it gets distributed to common shares. A nice rule of thumb is that the most common liquidation preference is 2X (these days anyway) so if the price is < 2X the amount of money raised to date, the common stock will not have any money allocated to it. And in those situations it makes no difference if your stock 100% vests on acquisition or not, it is still worth 0.
- hamburglar 12y ago
  Tell me if I have this right: given a list of all the investors and note holders and their liquidation preferences, you can calculate a fixed dollar amount that gets subtracted from $POOL before it's divided up among the common shareholders. In the example above, if you've got $2M in $LIQUIDATION and $NOTE is $1M, that means that common shareholders dreaming about buyout money should simply subtract $3M mentally from any sale price they hear. That about it?
  - ChuckMcM 12y ago
    Yes, pretty much. It is always possible to work backwards from the capitalization table and the termsheets from previous funding and other notes, to figure out how much has to be subtracted off before common sees any return.
- bradleyjg 12y ago
  The implicit question is—where the acquisition allocates $0 to common, in what sense are the board of directors fulfilling their fiduciary duty to common shareholders in approving the deal?
  - dkfmn 12y ago
    Well, their fiduciary duty is to all shareholders and common generally holds a minority ownership interest. It depends heavily on circumstances, but in a less than amazing sale the acquiring company often wants an incentive for employees to stay. So the acquisition offer will ensure that common gets nothing but they'll be covered by an earn-out over the next year(s). As you can imagine the negotiation gets very tricky because investors do not generally participate in the earn-out.
    - bradleyjg 12y ago
      This 2009 case from the Delaware Chancery Court seems on point: In re Trados Incorporation Shareholder Litigation (http://courts.delaware.gov/opinions/download.aspx?ID=193520 http://courts.delaware.gov/opinions/download.aspx?ID=193520) The whole thing is well worth reading for anyone involved with VC funded startups. It involved an acquisition with a management incentive plan and preferences that together left nothing for common. Among other things the court held that where there is a conflict of interest the board must prefer the interests of common shareholders over those specific to preferred (the interests of preferred over common being contractual). It also found that the board had acted procedurally unfairly and in several places suggested outright dishonesty. For those reasons it applied the harshest standard under Delaware law (entire fairness). In the end however, it found that the company's value as an ongoing concern though not nothing, was not enough to overcome the large liquidation preference and cumulative dividend. Thus, since prior to the deal common stock was worthless a deal valuing them as worthless was fair within the meaning of Delaware law. Note that the litigation lasted 8 years, and at the end of the linked decision it was an open question whether the defendants were going to have to pay plaintiff's legal fees despite having won. (I couldn't find any information on what was ultimately decided there.)
sgk284 12y ago
Suppose the following scenario: A VC invests $10MM at a $100MM valuation and owns 10% of the company with preferred shares. For simplicity, we'll assume they are the only holders of preferred shares. An employee is given $500,000 in common stock, equal to 0.5% of the company at the same $100MM valuation. The company then sells itself to an acquirer for $11MM, substantially below the $100MM valuation. The VC, with preferred shares, gets paid first. So they get their $10MM back. The remaining $1MM would then be divided among common stock holders. The employee above would get $5,000, instead of the $55,000 that 0.5% of $11MM would imply. In the real world, founders, executives, and VCs often get preferred shares, which ultimately screws regular employees.
- harryh 12y ago
  Correct up until your last sentence. Founders & executives do not often get preferred shares.

dsjoerg 12y ago

It's called a "liquidation preference". http://www.investopedia.com/terms/l/liquidation-preference.asp http://www.investopedia.com/terms/l/liquidation-preference.a... The mechanics & technicalities are beyond me, but the consequence is as described above.

icedchai 12y ago

Basically, the investors (with preferred stock) get paid out first, sometimes at a multiple of their original investment. The amount "left over" goes to the common stock holders. Sometimes that amount is zero, so they get nothing. I had this happen to me in a previous start up. I wasn't really surprised.

ChuckMcM 12y ago

It works as follows, there is a line of people who need to get paid, If the startup took on any debt, at the front of the line is a bank. Their 'note' usually gets paid first. $POOL -= $BANK When people invested in the Series A, B, C, ... their stock came with a 'liquidation preference' (which can have a few variants, but the two most common are, the investor chooses if they want the liquidation preference or the common value, the investor gets their liquidation preference and the common value. Note that these numbers are in $dollars not in $shares, so if VC A puts in $1M dollars with a 2X liquidation preference they get back $2M dollars. $POOL -= $LIQUIDATION Sometimes at the same level, or just behind the investors, are convertible note holders, who gave money or equipment in exchange for shares. They often have the choice of getting either their money back, or the shares. $POOL -= $NOTE. At this point, if there is anything left in the pool it gets distributed to common shares. A nice rule of thumb is that the most common liquidation preference is 2X (these days anyway) so if the price is < 2X the amount of money raised to date, the common stock will not have any money allocated to it. And in those situations it makes no difference if your stock 100% vests on acquisition or not, it is still worth 0.

hamburglar 12y ago
Tell me if I have this right: given a list of all the investors and note holders and their liquidation preferences, you can calculate a fixed dollar amount that gets subtracted from $POOL before it's divided up among the common shareholders. In the example above, if you've got $2M in $LIQUIDATION and $NOTE is $1M, that means that common shareholders dreaming about buyout money should simply subtract $3M mentally from any sale price they hear. That about it?
- ChuckMcM 12y ago
  Yes, pretty much. It is always possible to work backwards from the capitalization table and the termsheets from previous funding and other notes, to figure out how much has to be subtracted off before common sees any return.
bradleyjg 12y ago
The implicit question is—where the acquisition allocates $0 to common, in what sense are the board of directors fulfilling their fiduciary duty to common shareholders in approving the deal?
- dkfmn 12y ago
  Well, their fiduciary duty is to all shareholders and common generally holds a minority ownership interest. It depends heavily on circumstances, but in a less than amazing sale the acquiring company often wants an incentive for employees to stay. So the acquisition offer will ensure that common gets nothing but they'll be covered by an earn-out over the next year(s). As you can imagine the negotiation gets very tricky because investors do not generally participate in the earn-out.
  - bradleyjg 12y ago
    This 2009 case from the Delaware Chancery Court seems on point: In re Trados Incorporation Shareholder Litigation (http://courts.delaware.gov/opinions/download.aspx?ID=193520 http://courts.delaware.gov/opinions/download.aspx?ID=193520) The whole thing is well worth reading for anyone involved with VC funded startups. It involved an acquisition with a management incentive plan and preferences that together left nothing for common. Among other things the court held that where there is a conflict of interest the board must prefer the interests of common shareholders over those specific to preferred (the interests of preferred over common being contractual). It also found that the board had acted procedurally unfairly and in several places suggested outright dishonesty. For those reasons it applied the harshest standard under Delaware law (entire fairness). In the end however, it found that the company's value as an ongoing concern though not nothing, was not enough to overcome the large liquidation preference and cumulative dividend. Thus, since prior to the deal common stock was worthless a deal valuing them as worthless was fair within the meaning of Delaware law. Note that the litigation lasted 8 years, and at the end of the linked decision it was an open question whether the defendants were going to have to pay plaintiff's legal fees despite having won. (I couldn't find any information on what was ultimately decided there.)

sgk284 12y ago

Suppose the following scenario: A VC invests $10MM at a $100MM valuation and owns 10% of the company with preferred shares. For simplicity, we'll assume they are the only holders of preferred shares. An employee is given $500,000 in common stock, equal to 0.5% of the company at the same $100MM valuation. The company then sells itself to an acquirer for $11MM, substantially below the $100MM valuation. The VC, with preferred shares, gets paid first. So they get their $10MM back. The remaining $1MM would then be divided among common stock holders. The employee above would get $5,000, instead of the $55,000 that 0.5% of $11MM would imply. In the real world, founders, executives, and VCs often get preferred shares, which ultimately screws regular employees.

harryh 12y ago
Correct up until your last sentence. Founders & executives do not often get preferred shares.