Giving money to the founders: In 2009, is this still absurd?

by sam_in_nyc • 17 years ago

65 41 17 years ago

sam_in_nyc• 17 years ago

I'm curious to know if anything of this sort has happened since the article was published.

pg8• 17 years ago

Yes, it seems to be increasingly common for founders to sell a little stock personally in the course of a funding round. At least, it was till the market crashed.

I don't have enough data yet to say how the recession will affect this practice. But my guess is that if it did decrease, the decrease would be temporary. The long term trend is that founders are increasingly powerful. Which means they'll tend to get not just the option to sell stock (if they want to) but other things they want, like remaining CEO.

huhtenberg• 17 years ago

Can you elaborate on what "a little stock" is ? I.e. is it 50K, 250K, 500K, etc in cash equivalent ?

Just curious. Thanks.

budu3• 17 years ago

If I'm not mistaken the Founders Fund allows the founders to get paid.

CalmQuiet• 17 years ago

I'd love to hear pg do a follow-up on this. Every couple years.

gcheong• 17 years ago

I'm especially interested in seeing if companies where the founders are allowed to cash out a bit up front actually do better and do better because they were allowed to cash out a bit. May take a while to get that data though.

jorgem2• 17 years ago

In an age when anyone can do a startup, the word "startup" here on YC has somehow been distorted to mean "small software business that was started in the last two years on a shoe string budget."

I think the VC should instead concentrate on businesses where their investment can make a real difference: Business plans that require a factory, or expensive custom hardware, thousands of servers, gigantic customer education, etc.

I know it's heresy on YC, but real VC's shouldn't be involved in companies where only $20k is required to start the business. Founders are taking the VC for a ride when they convince them to fund extravagant startups that should be started without big investment.

VC investors, if they still have cash, need to think bigger. They're not needed for software startups.

The amount of funding required to start a business is one of the best barriers to entry, and the VC should exploit that.

pg8• 17 years ago

Real VCs shouldn't invest in Google?

VCs should choose their investments by the expected return, not the amount of money they require.

lliiffee• 17 years ago

Do you seriously mean to suggest that Google got to profitability on 20k?

danteembermage• 17 years ago

Maybe there's ground in the middle that looks something like this: VCs have a stronger bargaining position in capital intensive startups than in software. Stronger bargaining leads to more power to direct the returns to their pockets rather than the founders'. So the model is VCs maximize their after-costs (founders and otherwise) rate of return which is likely to be higher in non-software ceteris paribus.

However all is not equal, the extraordinary returns in recent memory have come from the web, and so venture capital firms will likely still be putting their thumb in the pie, even if it means cashing out to founders, letting them be CEO, giving them smaller rounds, etc. for software start-ups.

jorgem2• 17 years ago

No, Google is the perfect investment for VC. Most founders (or anyone for that matter) can't afford the huge data centers that Google needs.

That server farm costs a lot, and therefore the required investment is a huge barrier to entry.

That business model is perfect for VCs, and that is where they should focus.

nostrademons3• 17 years ago

The idea that VC's shouldn't be involved in companies that only require $20K to start is fairly popular here on HackerNews. Just ask the TicketStumblers, or the VirtualMins.

It seems more popular to think of VC as working capital here: start the company on $20K, prove that it works, then take VC money to scale. Hell, that's the whole YCombinator model.

fallentimes2• 17 years ago

We've actually had a fair amount of help from VCs...it just hasn't been in the form of money :).

vc_investor4• 17 years ago

I work at a brand name venture capital firm which is actively investing.

In this market, where 'flat is the new up', I'd regard having founders cash out at early institutional rounds as unusual. There is comparatively little money being invested at the moment, and its a "buyers' market" which is to say that entrepeneurs have less negotiating power at present than they did when things were frothy.

swombat2• 17 years ago

Are you seeing any trend of investments getting smaller? E.g. would your firm invest $200k into a promising company, or is that still out of the question even in these "tough times"?

vc_investor4• 17 years ago

My firm would do and always has done pre-Series A stage, with a view to building a relationship and following-on in due course. However that is and has always been a less common strategy: most 'bulge bracket' firms (active fund of $300-600m) don't invest such small amounts.

More generally, no, I do not see any trend in rounds getting significantly smaller. I do see a trend in pre-money valuations coming down, of course, but that's entirely different.

The economics of bulge-bracket VC work when you invest say ~5% of your fund in each portfolio company, in the hope that 1/10 or 1/20 of your companies will hit it out of the park. Total fund size equilibriates when drivers for scale (partners' remuneration, principally, less relatively invariable overheads) balances with diseconomies from political inference effects which kick in when too many partners try to reach consensus and cut the cake. That's why top tier firms with a 'plain vanilla' strategy have roughly comparable fund sizes.

FUD aside, nothing I'm seeing at the moment that gives me any reason to believe that underlying model is 'broken' or failing (though of course '07 and '08 vintages will be shot). Almost all successful start-ups need a lot of money to scale beyond a certain point. Free software doesn't really change the cost of airtime, or a VP bus dev. I'm writing anonymously so I have no real axe to grind in saying that.

What is certainly happening in the industry is a shake-out. Good firms with strong reputations are raising quickly and comfortably (if quietly because it's not a time to be above the parapet), and will continue to invest without interruption. That is because there are well-priced deals to do in this environment, and innovation doesn't stop in a recession.

A number of 2nd tier firms, on the other hand, are finding fundraising very difficult. Many will not survive.

Firms that are thriving seem to be investing more slowly just at the moment. This is because there is a lot of noise in the market, and visibility is currently low. Analogy: when it's foggy you drive slower. (Economically: transaction costs rise as expectations less aligned, so liquidity declines.)

What is tough is the squeeze at the bottom end for start-ups. I get the impression (though have less direct evidence of this) that there is a bit less easy money on offer from HNWs sub $500k as many are licking wounds, etc.

triplefox• 17 years ago

I think that increasingly, software-based businesses will be starkly divided by the "application" and the "infrastructure" realm. While the former is made by a single person or a small group and runs on preexisting systems, the latter builds and maintains said systems, and has to pull in serious resources to do so.

For the app-writers, it won't just be seed funding anymore - it'll be no funding at all. The most they have to do is pay for some hosting, legal and financial services, but their burn rate will be so tiny as to do it on part-time wages.

As for the remainder, they'll still be operating a traditional startup with real funding needs.

potatolicious• 17 years ago

I don't see your model as being intrinsically separate pieces. IMHO we're already at the stage where pushing out software is cheap, and can be done with zero investor funding. Scaling on the other hand, is still as expensive as ever. Your next Twitter can only go so far on a single box, and there will be a time where it's make or break - you'd have to sink some serious money into building out infrastructure to keep growing the business.

Retric• 17 years ago

A single box can handle a lot of traffic. A well tuned web server should be able to handle enough web pages that your making about 1$ / second in peek times from advertising. That much revenue should let you double your number of servers each month should you need to. EX: In 2007 Slashdot used 16 web servers with 2 Xeon 2.66Ghz processors, 2GB of RAM, and 2x80GB IDE hard drives. (http://meta.slashdot.org/article.pl?sid=07/10/18/1641203) today that's cheep.

PS: Twitter's cost's have far more to do with SMS traffic and staff than hosting their website.

wschroter• 17 years ago

The reality is that the Web is so big now that you can start smaller firms for next to nothing in lots of niche markets. That doesn't mean VC is broken, it just means that smaller firms can exist without it. You're not going to start Amazon or NetFlix without follow-on capital. You can start a Web gadget company that makes $50k just fine though.

mattmaroon• 17 years ago

The reason that founders cashing out on big rounds was never absurd, and will never be absurd (though market conditions may make it less common for a time) is that in many respects it aligns the interests of the founders with the investors.

Money has diminishing marginal utility, and most people would be just as happy (or unhappy) with $10m as they would with $50m. That's not true at all for VC firms or their limited partners. Twice the profit is roughly twice as good for them, in fact in the competitive industry, it might be more than twice as good. If everyone is getting 15% returns, the difference between 10% and 20% for a VC fund can be tremendous the next time they're out raising funds.

By allowing the founders to cash out, it gives them the cushion they need to swing for the fences, rather than trying to sell their company as soon as it will make them independently wealthy.

Giving money to the founders: In 2009, is this still absurd?

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