In Venture Capital Deals, Not Every Founder Will Be a Zuckerberg

http://dealbook.nytimes.com/2013/04/30/in-venture-capital-deals-not-every-founder-will-be-a-zuckerberg/

by npalli • 13 years ago

72 37 13 years ago

dealbook.nytimes.com

yangez• 13 years ago

When the Internet bubble burst, the company underwent rocky times. By 2000, [the founder] was gone from the company, as were four other members of his founding team.
For the next decade, Bloodhound recovered and slowly grew, raising seven more rounds of financing. In April 2011, the company was sold for $82.5 million.

11 years is a long time. How much do they think they deserved?

FireBeyond• 13 years ago

Right. The founders were there five years, then pushed out during the dotcom crash, then the company made a substantial “pivot” (in the same field, but the product being offered and created by the founders was gone, and new ones introduced).

Two years after the founders are gone, the company begins to make money again.

Then 11 years, the company is sold for a lot of money.

And the founders feel they are entitled to a large chunk of that, despite their non-involvement in operation of the company and their diluted ownership (unsurprising, but common with multiple rounds of financing that they were in favor of).

It’s worth noting that many of the founders claims have been dismissed as egregious, lacking in evidence and otherwise.

cabinguy• 13 years ago

My thinking is a little different than most of those who have commented...probably because I'm a bootstrapper.

After reading all of these comments - my thought process goes like this: If the founders output from 11 years ago is worthless, why isn't the investors' money from 11 years ago equally worthless?

If the founders' sweat equity didn't create value, the early VC money didn't either. Should the early VC's lose their investment, or just the founders?

I'm not naive, I understand that these deals are structured this way...I'm just saying that the structure is bullshit (imo).

saumil07• 13 years ago

That's not quite right. It's unclear how much total the VCs put in, at least from the article. But it sounds like they continued to fund the company while the founders' involvement ceased over 10 years ago.

"For the next decade, Bloodhound recovered and slowly grew, raising seven more rounds of financing." <-- if the insiders participated in follow-on rounds they stayed involved all the way through. Once again, that's what seems to be indicated but it isn't spelled out.

mathattack• 13 years ago

There's a problem in asking "How much did they deserve?" because there are so many hard to answer questions.

- Did they uncover some unique IP, or was the exit the work of subsequent management?

- How much did the VCs influence the exit?

- Did the founders trade downside protection for more upside?

It's hard to know the answers.

nraynaud• 13 years ago

I guess in five years they worked harder than the investors in 16, since well workers work while investors put money on the table.

argumentum2• 13 years ago

I don't feel too bad for these founders, regarding the outcome. It looks like the majority of value was created after they were at the company (by people other than them).

Aqueous• 13 years ago

There's no detail too big to gloss over for the sake of a good headline.

mattmaroon2• 13 years ago

Yep. You know the risks when you take VC funding. Their responsibility is to the company, not you, and it looks like in this case they fulfilled that well.

enjo• 13 years ago

Does the initial market exploration and proving that they did count for nothing? They built the groundwork for a successful company, and (at least in spirit) I think they deserve to share in that.

It's pretty hard to tie down when the "majority" of the value was created. The majority of the "success" may have happened after they left. I have no idea of the specifics.

In these cases there are often two types of "right". Contractually "right" and morally "right". These founders probably deserve a lot more than they got. That's just the breaks when you get yourself involved with the wrong venture capitalists.

argumentum2• 13 years ago

It depends, but 8 years is a very long time. The founders were present for about 1/3rd of the company's existence, according to the article.

I was going off the fact that the company raised VC money 7 times after the founders were gone (following 2 raises with the founders present).

Anyway, I agree there's not enough information.

As the article references Facebook quite a bit, it's ironic that in that case 2/4 co-founders got a lot more than they deserved .. they didn't even leave Harvard, but they reaped billions for a few months of part-time work.

joshmlewis• 13 years ago

The title is somewhat misleading (wow I hear that a lot around here.) Basically the founders raised a bunch of money (almost $2M in '99 and $3M in 2000) right before the dot com bust.

The article gives no indication how well they did, how they were able to raise so much money, what happened with it, etc. So really it's hard to judge if the founders were really put on the street like the title suggests. Like someone else mentioned, it seems as though a lot of the value was created after they were gone. Who knows if they blew the money, sucked at managing and scaling the company, etc. WE DON'T KNOW without doing more research.

It kind of sucks the article was so vague on their actual business value. That would've given more insight. If it said they put all their blood, sweat, and tears and created value for years before it was ripped out of their hands and given to the big bad VCs, then I would've had more sympathy.

redschell2• 13 years ago

The rule of thumb among venture capitalists is that some 20 percent to 30 percent of companies fail, returning nothing to any investor, including the venture capitalists.

Earlier in the article, it mentions the statistic that I'm familiar with, which is that roughly 75% of venture-backed companies fail.

What gives?

dragonwriter• 13 years ago

Perhaps two different definitions of "fail"; the "returning nothing to any investor" is a fairly strong definition of failure, and I suspect the common 75% number is based on a weaker definition of failure (e.g., returning less than 1:1 on investment is a plausible weaker definition of failure for a company, though I don't know if that is what the 75% number is based on.)

tempestn• 13 years ago

"An unpublished study by Shikhar Ghosh at the Harvard Business School found that three out of four companies backed by venture capital did not return the investment. Again, it is in these cases where the founders and employees typically are entitled to receive no payment."

In 75% of cases, the founders and employees receive nothing. In 20-30% of cases, the VCs also receive nothing.

redschell2• 13 years ago

Ah, I see. Thanks for the clarification.

ig1• 13 years ago

1) Always get an experienced lawyer to review paperwork you sign.

2) It's pretty normal for people who give you money (be it a loan or an equity investment) to get their money back before you do in event of a sale.

Imagine the situation where you raised $5m for 20% of your company and then the next day you sold the entire company for $5m. You'd get $4m and the investor would get $1m, you'd be very happy and your investor very unhappy.

Hence no rational investor would give you money without a clause that ensured that in the case of an exit that they had priority upto the amount they invested.

YokoZar• 13 years ago

Unless those people giving you money are employees vesting their stock options. Perhaps I've been misled, but I don't think it's common for employees to be given preferred stock.

prostoalex• 13 years ago

In the case where you have this situation where an employee is both putting his money by investing in a round and working to vest some ISOs, the stock he would get through the round would be whatever the round lead negotiated, the call options though would still be for common stock.

james_alonso• 13 years ago

Right, employees are getting common stock so they don't get to jump to the front of the line when a company is sold. But they are also paying the common stock price, which is a fraction of the price paid by the preferred stock, so it makes sense that each share they own has less rights associated with it vs. the shares the investor pays a premium for.

larrys2• 13 years ago

"Always get an experienced lawyer to review paperwork you sign."

Always make sure you read, understand and question what the experience lawyer is telling or suggesting to you.

Don't assume they will catch everything and/or will not make mistakes. They do and they will.

Even jockey for who gets to draw up the agreement first.

From my experience (others may differ in opinion although I'd like Grellas to weigh in on this one) it pays to have your attorney draw up the agreements (even at added expense).

Then it's up to the other side to catch any issues and it's hard for the other side to insert things without you noticing (because they stand out as insertion and are obvious).

bruceb• 13 years ago

While one would have to know a lot more details but the basic take away is control, control, control.

mattmaroon2• 13 years ago

Really? I thought every startup went just like Facebook!

contextual• 13 years ago

Zuckerberg must be a traffic-drawing keyword for them to put it in the headline. It's such an obvious statement for an otherwise informative article.

larrys2• 13 years ago

"The rule of thumb among venture capitalists is that some 20 percent to 30 percent of companies fail, returning nothing to any investor, including the venture capitalists."

I believe that number is the mirror. It should say "20 to 30 percent" succeed.

winterchil• 13 years ago

The number that return <1x is significant too. Out of 10 investments typically you'll have 1 big hit, 2-3 decent returns (2-5x on investment) and a bunch of "failures" which would be anything less than 1x.

Depending on the VC it's possible anything less than 3x is considered a failure because of the opportunity cost and their inability to re-invest proceeds.

tthomas48• 13 years ago

I think this goes back to the fact that start-ups are not get rich quick schemes. I was at a successful start-up that was acquired by a fortune 500 company. I got north of $500. From talking to many other software engineers, that is a pretty fantastic payout. Most people will never be in a start-up that yields much of value. You've got to do it because you love it.

ChuckMcM• 13 years ago

My first startup I made enough money to buy a car, the second, a car radio. Not an uncommon outcome. But I did well on Sun, NetApp, and Google shares as an employee.

When a startup goes years and years and years the likelyhood of a "big" payout goes down. Especially if there has been a number of rounds because later rounds often restructure the terms if the company is in a 'do or die' sort of situation. No matter what you sign you may be out of the money even with a big initial grant.

There was this quote: "Bloodhound also paid a $15 million bonus to its current management team." which is probably the retention incentive/earnout bonus. Basically you don't want the folks who know how to run the engine to bail as soon as the check clears the bank, so you put some sort of constraint on that.

As for the original founders, hey they went on to do other things and suddenly from their past a check dropped in their lap, that is something at least.

arbuge• 13 years ago

I believe VC terms are a bit more founder friendly these days than they were in 1999. Founders have become more educated and double or triple dipping isn't as common as it used to be, in my experience.

That, and VCs are less likely to fire the founder as a matter of course to replace him/her with professional management, ever since The Social Network came out.

comrade_ogilvy2• 13 years ago

The founders were pushed out because the VCs perceived the founders were not running the company all that well. The VCs may have been wrong in that assessment, but the VC controlled board did go through the hassle of bringing in new management for fun.

adventured2• 13 years ago

I think the improvement has more to do with the cost of starting up these days.

You can get a lot further down the road now vs 1996/99, before VC is necessary. By the time you take VC, properly, you can command a lot more and give up a lot less.

If the costs today still demanded giving up your soul to get started, then despite the improved access to information, I'd say that founders would still be giving up vast chunks of equity early to pursue their startup.

There's a story, that in the process of creating Excite, the founders needed to buy a hard drive that cost $10,000 to store 10gb just to test their indexing at scale. Well, Vinod Khosla gave his blessing and they went ahead. Obviously today you can test a massive data set for 1% of that cost.

http://bnoopy.typepad.com/bnoopy/2004/09/persistence_pay.htm...

Vinod: "Can the technology scale? can you search a large database?"

...

Team: "We don't know, we can't afford a hard drive big enough to test."

"Then, an amazing thing happened. Ten minutes into this meeting, his first introduction to the company and us, he [Vinod] pulls out his his cell phone, dials his assistant and buys us a $10,000, 10Gb hard drive."

founder4fun• 13 years ago

No doubt Zuckerberg is a smart guy, but he hit the start-up lottery jackpot.

npalli• 13 years ago

Slightly disappointing to see the anti-founder sentiment expressed here. To recap --

1. The founders started from zero with their own equity and worked for six years on the startup. They took funding during '99 and '00 when it was a very easy time to get funding. Completely unremarkable investment (risk-wise) for the investors.

2. The dot-com crash and 9/11 meant that many many businesses collapsed post 2000. So, it wasn't just founder incompetence. There are many startups that almost went under but slowly managed to get out and have exits during the late '00s.

3. Apparently the investors thought the company was good enough to continue investing under the same name with new management. If the idea was so useless why didn't they shut it down in 2000?

4. Most of the value of startups is created after the first several years. Many lessons are learned that give direction to future opportunities. Many of the startups that almost went under and came up, learned to pivot (same management).

The lesson to learn here is that the founder were not diligent about control over their company. It is not like the investors did some calculation of value demonstrated to come up with the numbers. They automatically started adding 8% of company shares every year based on the 2000 agreement.

To give a counter example to make things clear, Microsoft started in 1975 with Bill Gates and Paul Allen. Allen was diagnosed with Cancer and pretty much stopped working at Microsoft after 1982. After six years. How much audit-able value did Microsoft created post Paul Allen?. I would say about 99%. Does that mean he should be zeroed out? No. He kept his stake (worth tens of billions). That's how it should be.

Most of the value in a startup is latent during the early stages. Even things that don't work out teach you things. If you go by audit-able value, that pretty much guarantees early founders (who don't stay) will get wiped out. For people who are cheering on the investors, how many of you have bootstrapped a startup for six years?

adventured2• 13 years ago

A few things.

1) I'd argue it is fair to say that Microsoft - in all its ultimate scale - wouldn't have existed without Paul Allen. The 99% post value creation doesn't mean much if it wouldn't have existed to begin with. I know you weren't arguing otherwise, but I think this is worth pointing out.

2) Gates and Ballmer discussed wiping out Paul Allen's holdings in Microsoft, in a move that would have perhaps been similar to what was done to Eduardo Saverin in Facebook. Not to say that's morally right, but rather that the story you refer to isn't so cut & dry.

pocketstar• 13 years ago

At first I read: "In Venture Capital Deals, Not Every Founder Will Be a Zoidberg"

mani04• 13 years ago

I was reading the comments under original article, and came across this book - "Venture Deals".

With a bootstrapping mindset, I probably may not need it. But posting the info here for anyone who might be interested in VCs... Search for it in amazon or your favorite bookstore.

In Venture Capital Deals, Not Every Founder Will Be a Zuckerberg

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