A VC - Latest Comments in Founder Dilution - How Much Is "Normal"?

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Fri, 27 Feb 2009 08:48:17 -0000

And I am sure if we did a deal together, we'd figure out how to structure the vesting in a way that makes both of us and the entrepreneurs comfortable

Re: Founder Dilution - How Much Is "Normal"?

basilpeters — Fri, 27 Feb 2009 00:45:12 -0000

Fred, I respect your position. What I love about this business is that nobody has come close to figuring it all out. I believe the best way we can all move entrepreneurship and early-stage investing forward is through an open, constructive dialog. You are doing an exemplary job of stimulating the discussion and providing the platform.

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Thu, 26 Feb 2009 20:09:27 -0000

I've been doing VC for about the same time you've been doing it Basil and I
don't feel comfortable tying that much equity to an exit

But I understand your point

Re: Founder Dilution - How Much Is "Normal"?

basilpeters — Thu, 26 Feb 2009 16:16:43 -0000

Yes, I think that is most fair for two reasons:

1. When an investor invests, I believe the implicit agreement is that the entrepreneurs will work to increase the share price AND to execute an exit. In a significant number of exits as much as half of the ultimate value is created during the final transaction (in public companies they call that a control premium, but it's even more significant in private company exits.) If someone who is part of the team leaves before that value is created, I don't think it's fair that they take that value with them.

2. If someone leaves, the board has to find a replacement. If the person leaving doesn't leave some of their equity behind to incentivize their replacement, then all of the other shareholders have to suffer the full dilution effect of their departure (whether it's equity or cash).

I've used this formula in virtually all of my early stage investments for over 15 years. Many of the benefits are psychological and extremely difficult to prove, but I am convinced this formula creates a fundamentally better alignment between founders and early stage investors (especially in this exit environment.)

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Thu, 26 Feb 2009 15:34:20 -0000

So if a founder works for ten years but there is no exit and then leaves, he/she is only half vested?

Re: Founder Dilution - How Much Is "Normal"?

basilpeters — Thu, 26 Feb 2009 15:27:24 -0000

Great post and outstanding discussion as usual, Fred. I believe the optimum vesting formula is to vest half of founders' stock linearly over three years and the other half only on an exit. This creates the best alignment between the founders and early stage investors (in my case, angels). This is my post on why I believe this is most fair to everyone http://www.angelblog.net/Sh...

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Tue, 24 Feb 2009 06:41:07 -0000

I would not dilute for anything other than talent or money, period

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Tue, 24 Feb 2009 06:24:09 -0000

We are allowed to disagree and it's really important for people who disagree
to understand the other's perspective. So this dialog has been valuable to
us and to everyone who reads it

Re: Founder Dilution - How Much Is "Normal"?

leigh — Mon, 23 Feb 2009 11:33:43 -0000

I know of some cases where "incubators" can take up to 25% in exchange for 'services' and/or investing consulting. I think some (especially these days ) younger founders may end up being taken advantage of. It would be great for you to do a post at some point giving some practical advice and boundaries (i.e. when they are being presented with 'it's this or nothing' fear plays a role - but when do you think it's not worth it no matter what....)

Re: Founder Dilution - How Much Is "Normal"?

David Semeria — Mon, 23 Feb 2009 10:07:35 -0000

Clearly, each situation should be judged on its own merit.

And whilst I disagree with you on the issue of preferred stock, and as I've made clear above, I really respect your willingness to engage the entrepreneurial community - especially on thorny issues such as this.

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Mon, 23 Feb 2009 09:53:26 -0000

Shareholder agreements are about blocking deals. That's not a good answer. I hate vetos and blocks and much prefer creating an understanding upfront about how the pie will get divided and let the entrepreneur call the shots in terms of exit

There might be some investors who will buy common in an early stage venture they control but I am not one of them

There's a reason that pfd stock exists and its the market standard

Some investors got hosed a long time ago and learned from it

Re: Founder Dilution - How Much Is "Normal"?

David Semeria — Mon, 23 Feb 2009 04:19:22 -0000

That's what shareholder agreements are for.

What about: founder confers 1m lines of code, patents, trademarks etc and the investor confers some money. Things don't work out and the company gets acquired for less than the investor put in. The investor exerts his 1x preference and keeps all the money.

That's even less fair, especially if the acquirer is purchasing the company for the original code and IP.

Re: Founder Dilution - How Much Is "Normal"?

Dave Broadwin — Mon, 23 Feb 2009 03:24:55 -0000

It is always good to be reminded of the effects of dilution and to hear the related concerns. One point that sometimes is lost on my clients is the difference between ownership dilution and financial dilutions. 25% of $100 milliion is better than 75% of $10 million.

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Sun, 22 Feb 2009 21:01:19 -0000

are you sure he could even get into HBS?

Re: Founder Dilution - How Much Is "Normal"?

Prof. Noam Wasserman — Sun, 22 Feb 2009 20:37:57 -0000

Or HBS case studies about them. :->

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Sun, 22 Feb 2009 20:18:14 -0000

If shakespeare was alive, he'd be writing tragedies about VCs and founders

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Sun, 22 Feb 2009 20:13:11 -0000

i hear that all the time, but let's say you invest $1mm in my company and you negotiate for 10% fof the business (a $10mm valuation)

you have one board seat but i control the business

i decide to sell the business for $5mm, i take $4.5mm and you get $500k.

is that fair?

no, it is not

that's why preferred stock exists, plain and simple

Re: Founder Dilution - How Much Is "Normal"?

Ido Dubrawsky — Sun, 22 Feb 2009 19:31:50 -0000

I disagree to a certain extent. I think that Tom Friedman's position is more of taking the $20 billion dollars that the government would pour into trying to save GM and Chrysler and using it for the basic research to take help take ideas from the drawing board to the point that VCs would be more interested in it. Yes there will be some duds but as with any emerging field there will be some entrepreneurial efforts that need just a bit more incubation before it's "ready for prime time." As long as the taxpayers and Congress were aware of and on-board with the idea that some of these will fail and that this could be an overall losing proposition and that there won't be any Congressional witch-hunt should things not work out for the best. It's still a better gamble than pumping this money into GM's and Chrysler's carcasses...there the odds are much higher against success without costing the taxpayer more

Re: Founder Dilution - How Much Is "Normal"?

Dan Cornish — Sun, 22 Feb 2009 16:44:37 -0000

Fred,
Thanks for the link. I have learned quite a few things. Some highlights include: First time Founders provide better returns to VC investors, RIch vs. King is the basic question a founder should ask themselves before raising VC and finding the right VC is the most important thing to do while raising money. It dawned on me that a lot of the tension in the VC - Founder relationship comes from a mismatch. A VC who knows a founder is interested in being a king is dishonest if they invest money with the idea that the founder(or founder team) can be kicked out but make them rich. The VC should just pass on this kind of investment. A Founder(Founding team) is dishonest if they think that a VC will not try to remove them if they are not focused on large monetary returns regardless of what happens to the business. The rare relationship is when the goal of building a great business and a great monetary are shared both by investor and Founder.

Thanks again for providing such a great community.

Re: Founder Dilution - How Much Is "Normal"?

Dorian Benkoil — Sun, 22 Feb 2009 16:18:27 -0000

this kind of info is very useful and exactly the kind of transparency that needs to come to the investment world. Thanks for it, Fred.

Re: Founder Dilution - How Much Is "Normal"?

David Semeria — Sun, 22 Feb 2009 15:57:37 -0000

People like you, Guy Kawasaki, Robert Scoble etc, demonstrate that you don't have to behave like JR Ewing to make your mark.

That said (and before the violin playing starts) I would still argue strongly in favour of all stockholders owning only common. A lot depends on what the founders initially bring to the table, and how much value the VC adds.

In the same way that some people believe a handshake is worth more than a contract, I believe that any multi-owner business should be founded on equality, trust, and a general feeling that if you push the other guy too far he'll moydah ya.

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Sun, 22 Feb 2009 14:58:10 -0000

Are you sure about that scott? I've seen a lot of term sheets over the years and participation and liq multiples have been in the minority of them

Re: Founder Dilution - How Much Is "Normal"?

fredwilson — Sun, 22 Feb 2009 14:54:20 -0000

Maybe there's a reason for that. The best companies listen to their customers. And entrepreneurs are the VC's customers

Re: Founder Dilution - How Much Is "Normal"?

rafer — Sun, 22 Feb 2009 13:29:44 -0000

That's a fair exception to take. I was stereotyping and should have made clear that USV, FRC, and maybe a couple of others were consistent exceptions. What I described is median behavior for funds, particularly large ones, except at the top of the cycle.

Re: Founder Dilution - How Much Is "Normal"?

David Semeria — Sun, 22 Feb 2009 13:17:50 -0000

Thanks Fred.

It's ironic that entrepreneurs (like me) voice our gripes here when you yourself display a level of openness and honesty far above the industry average.

Chapeau!