I have been hoping for a liquid secondary market for private company securities to emerge for some time. Existing attempts (SecondMarket) are overwhelmingly geared toward players in the present paradigm. The stakes are so high, they simply HAVE to be like Sotheby's.
But we need the eBay version to exist: Sotheby's doesn't serve the Beanie Baby market -- I want to be able to buy a share of something I use (from Facebook down to Foursquare), get my family paid back fairly for that money they gave me while I was trying to get ramen profitable, trade shares for stuff we need to get off the ground (traffic, a piece of technology) -- all for eBay-sized transaction fees rather than large legal fees.
I am optimistic that the early adopters of this Beanie Baby version of the liquid secondary market will be consumer web companies. Its way too easy now for a buyer to see product success (compete.com, appstore charts), follow the people iterating on it (blogs, twitter), liquidate attention (ad networks), share information transparently. For those of us sick of waiting for the random day of getting a random amount of liquidity, it should be a faster, predictable, more rational way of being compensated for wealth creation.
Yes, people need to be protected, the SEC and Securities law exist (and so does copyright law, but...). I'd like to see the US's Securities Exchange laws revised enough to enable this transformation, how entrepreneurship can be done.
fredwilson
· 3 months ago
If this is going to happen the federal govt is going to have to allow it. I'm all for it too
kidmercury
· 3 months ago
lol, well i guess it won't be happening then! too bad, because i think an entirely new economic/financial framework is what is needed.
Shane
· 3 months ago
I couldn't agree more. Further, I think we need a P2P investment marketplace, like Prosper.com for early stage companies. There was a UK company not too long ago that raised a "crowd sourced" round of funding. I wish we could do this in the US...
Pete
· 3 months ago
How about a VC model where the economics of the VC are perfectly aligned to the economics of their portfolio company founders. If a VC takes millions a year in management fees through their 2%, then portfolio company management and employees should have an opportunity to share this through early liquidity. Or, if the VC takes "subsistence" management fees in favor of a higher carry %, then founders should also expect subsistence salary and upside through their equity.
Let's have transparency and alignment across the entire chain, and then everyone can feel comfortable. At the end of the day we're all working for the LPs, so why shouldn't we all be in the same boat?
Daniel Weinreb
· 3 months ago
Keeping interests aligned is great. I don't know how many VC's would be willing to put themselves in the position of a company founder, though. That 2% annually must be nice to get. And getting 20% of the profits without a corresponding downside is pretty sweet, too.
fredwilson
· 3 months ago
Seems complicated and hard to arrange and enforce
dherman76
· 3 months ago
"Seems complicated and hard to arrange and enforce"
With all due respect, weak answer. If we can lay out the road map to this with all the hurdles, then it can be enforced and arranged.
This is is purely in a theoretical world of course, but could be interesting to dig deeper into.
fredwilson
· 3 months ago
There's a simpler solution. Let the market work.
Nat Kannan
· 3 months ago
Fred,
I think the idea of using market signals to set Founder's comp is a rational one. If a Founders role is rewarded with ownership stake, then his or her leadership role should be based on comparable comp plan to attract an outside CEO to run the company. This would set the Founder's comp plan on a fair basis as per market signals. As regards selling shares to third parties, all shareholders including Founders should be free to do so as they would be in a free market. There should be no contractual restrictions for any shareholder. If a Founder is not motivated and energized by his business then he should not be counted on to build it. The Board need to replace him.
Nat
fredwilson
· 3 months ago
I disagree about the ability to sell to anyone without restrictions. That's how craigslist got its competitor eBay as a 25pcnt shareholder
OMA
· 3 months ago
For a company to succeed it must be a good business deal for everyone around the table, including founders.
-The risk for founders is significantly higher, their company is typically their only investment. -The investment founders put in the company is higher, often founders "invest" in the company, by taking low salaries, post round B or C, getting no equity for their invested money. -The real dilemma for experienced founder CEOs is that they can get 3-5% in a mature low risk company or found their own company (and get 5-6% of it at exit time). It's a loosing deal to start one unless you are addicted.
10 years ago I raised $3m with a nice deck of slides and a good idea, the pre was $10m. Today it takes some sales to raise seed money. 10 years ago it was much easier (e.g. possible) to take a company to an IPO, today... well. 10 years ago the situation differed.
For the deal to be profitable to a good founder it must pay at least the "fair market value" of the founder's sweat with a reasonable probability.
Assuming a "reasonable probability" for a risk taker founder is 40%, and assuming the guy looses about $100K every year he works for the company, and assuming this happens over 3-4-5 years. Founders should be able to cash back at least their "fair market value" salary as soon as it is possible for the company to pay it.
ShanaC
· 3 months ago
That's very true and makes parts of the barrier for entry harder. Not sure if that is a good thing or a bad thing
Steven Kane
· 3 months ago
Amen.
But, how does this square with earlier position advocating that founders and early team members should only take “subsistence” salaries/compensation?
Daniel Weinreb
· 3 months ago
At my two startups, we didn't do "subsistence salaries"; we got perfectly reasonable salaries. Especially on the second one, when the average age of the founders was higher, we had spouses, kids, mortgages, etc. "Get rich on the equity" is fine; nobody expected to get rich on the salary. But deferring any reasonable compensation until a liquidity event just is not feasible for most people. (Sure, some founders of companies are quite well off, but many are not.)
ShanaC
· 3 months ago
Give em something to drive for so that they can have something to take off the table later? Only thing I can think of...
fredwilson
· 3 months ago
Get rich on the equity not the cash. As it should be with GPs as well but it isn't
markslater
· 3 months ago
we just closed a financing and we enforced a certain amount of what we called 'employee debt' - Us four founders agreed to take half salary (the total salary amount was also under market) with a view to converting up to 50% of the outstanding debt to common - at a discount to the financing price. This worked for us and for the institutions for a whole bunch of reasons - we were all founding investors anyway - so the new investors had no issues with our 'commitment' - any one of us would have had a material adverse affect on the company were we to leave - and it was plainly obvious to them the amount that we had committed coming in to the financing.
I am currently considering a new real time texting opportunity, and would want this situation to repeat. As chris sais below - if you run in to a VC that would not consider this - get another one. If you don't have this kind of leverage - than that spells trouble for both parties.
In this day and age - some measure of pay back for my sweat and toil - is not Liquidity - its the conclusion of shared risk, cash flow for founders who have put their families likely through the ringer, and a true sign that the new guys get it, and are going to do right by everyone going forward.
If the salary was $150k - lets say it went 6 months that would provide for - 75k/2 ($37.5k) - lets say that 50% of that goes out in cash, the remainder converted in to common at a discount to the financing. is that so dislikable to a VC? given that this amount is far far less than the cash already in by the founders.
bottom line is - i don't want liquidity for my founding stake at an institutional financing. And if a VC were to try and tell me its a re-start - or no credit for past work - then its a short conversation - i've heard these lines before. If there is 'employee debt' and the situation is properly audited, and the amount is (it should not be FYI) palatable (less than 7% of financing) and the terms require a founder re-commit in addition to a small amount of cash - to ease the pain - then it should work for all concerned. The problem comes if you have a PPT and an idea and $xxx,xxx of 'employee debt' - then you will legitimately be fighting the 're-start' or 'no credit' game.
chrisco
· 3 months ago
Some founder liquidity is hard to argue against anymore, IMHO. It's so 80s/90s. If your VC says differently, get a different VC. Same thing if they try to tell you that other old school crap is "standard."
See this WSJ article from 2007 about Peter Thiel and his Founders Fund: "VC’s New Math: Does Less = More?": http://tr.im/y2ny
"Structuring deals differently from how traditional venture capitalists do. Significantly, the fund often buys only a 5% or 10% stake in a company and sets up a special class of stock that start-up founders can sell while they are building their companies — and before venture-capital investors see profits. That way, the thinking goes, the company founders can reap some financial reward and stay motivated to build the company before an IPO or company sale, which can take years."
Also see Basil Peter's book "Early Exits": http://tr.im/y2nO. Basil is a progressive, experienced, and long-time angel investor based in Canada. Besides his book, I also recommend his blog: http://www.angelblog.net/ (most of what's covered in his book is also covered on his blog, including vesting, term sheets, and more.
Mark Essel
· 3 months ago
I share Dave's sentiment, will defintely review what you are sharing chrisco. Thanks for adding to the discussion, the early investment market is as mysterious to me as it is diverse.
bfeld
· 3 months ago
What Fred and Mark said.
chris dixon
· 3 months ago
I think founders should only take money off the table when 1) they have an acquisition offer or 2) the company is profitable or could be profitable if they weren't pushing for rapid growth. Some of these really early stage deals where founders got rich before they were even generating revenue are a really bad idea.
LIAD
· 3 months ago
subject it being done at a sensible quantum - allowing founders a little liquidity doesn't necessarily result in them getting rich but should result in them obtaining a little financial cushion which results in them being able to wholeheartedly concentrate on growing their business and not having to worry constantly about personal cash flow issues. (specially for young/1st time entrepreneurs)
if the investors goal is to help bring about the optimum environment for its investments to succeed, ensuring the founders can concentrate fully on the task at hand must be of major importance.
i read somewhere lately, i cant remember where but may have been on your blog, in regards where to peg founders salaries and the opinion was that founders pay should be set at a level which allowed them to live comfortably based on their circumstances/family/kids needs etc (i.e. pay their bills and not have to stress too much about day to day living expenses) but not be enough to allow them to save a single penny. That way once again allowing them to concentrate on building the business without unnecessary hindrances.
Providing them a little share liquidity follows the same lines.
(entrepreneurs who already have personal wealth and have a financial cushion - shouldn't really be given liquidity as it would serve only as an added distraction - just the opposite of what the liquidity event should accomplish)
chris dixon
· 3 months ago
can't you let founders not focus on cash flow issues by giving them livable salary?
ShanaC
· 3 months ago
Define livable. That's very contextually oriented. Starting up in the Valley or in New York immeidately has higher living costs than starting up in, Des Moines. Cultural factors as well, some people would never live in xyz or do abc. That should be talked about beforehand. People have a psychology of money- and you can't negotiate that with them and hammer it out. You sort of have to coach them through it.
Better question for you all- how many boards were willing to work with founders and upper level employees just about the psychology of money weirdness? Since clearly people are using the money in all sorts of strange ways to get at the companies and not grow them.
chris dixon
· 3 months ago
I agree what is livable depends. In NYC it is probably 2x what it is in Ohio where I'm from.
ShanaC
· 3 months ago
And there are cultural things to take in consider as well. Something I've noticed just visiting places around the country- we all do different things in different places. Not that I'm advoctating conspicuous consumption, but you should know what is conspicuous consumption is for that founder in that place, what is livable, and what is dirt poor. That can be a difficult equation.
fredwilson
· 3 months ago
Right, but the board needs to determine when that is. I don't think this is something you can bake into documents
chris dixon
· 3 months ago
oh totally agree. shouldn't bake it into documents.
what i don't like for example was one situation I saw where it was a pre-revenue company run by 22 year olds and they had 2 term sheets which were basically identical except in one half the money went into the founders pockets. Felt a bit like a bribe.
another situation I saw that was bad was company doing super high valuation, again at pretty early level of traction, and founders taking many millions off table. now there are lawsuits.
David Semeria
· 3 months ago
As long as the buyer has a choice then it's their problem. Caveat Emptor. Although, I agree with Fred when he says that founders shouldn't be allowed to just shop the VC cash.
One thing I don't understand in this discussion is why the buyer must be the VC? Assuming the VC has and doesn't exercise a ROFR, the cash could come from anywhere, right?
chris dixon
· 3 months ago
it doesn't have to, but VCs are normally the ones proposing these kinds of transactions.
David Semeria
· 3 months ago
Sure, and on further reflection, I would assume the VC would have to agree not to exercise the liquidity preference if it's a 3rd party sale.
fredwilson
· 3 months ago
Yes and it sometimes does
fredwilson
· 3 months ago
Both of those sound like bad situations. I don't see how it would be wise to provide founder liquidity in an early stage round
OMA
· 3 months ago
A stock transaction between founders and investors may have some tax benefits compared to payment of salaries out of investor's money.
The founders in any startup sells stock for cash. Typically the money goes into the company and typically the company pays the founders some salaries which the founders transfer to the IRS in turn.
At the end of the day the founder's have agreed to have a little smaller stake in the company in return for some money in the bank.
If instead of (part of the) salaries founders could sell their stock to the VC, everybody, except the IRS, would get roughly the same. Sounds like a good deal to me.
VCs would buy some common (instead of the preferred) shares, but will keep almost all the associated benefits of preferred shares (you can't cash out all your stock on day 1 after an IPO anyway).
ShanaC
· 3 months ago
Working on it? Do you know how difficult it is these sorts of problems, it's amazing that we're even willing to talk about it.
bijan
· 3 months ago
Chris
generally I tend to agree with you on those rules.
I have seen some exceptions that were okay though because the founder liquidity wasn't excessive and/or because the VCs wanted the entrepreneurs not to flip. I've also seen it where the VCs can't own enough so that how they get more
The scenarios I don't like it are
1- the company balance sheet needs the money and fund raising isn't a slam dunk for most companies.
2 - or when it's too big and messes up the incentives.
Fred brings up a good point about how secondary deals can have an adverse impact on strike price for employee options.
aarondelcohen
· 3 months ago
Bijan, makes very key points here.
1. Big Funds should put more money to work and buy bigger pieces of companies by granting founder liquidity. Gone are the days when VCs own 70% or more of companies. I think this is the best way to do it. And the only fair way.
2. In Boston, NYC, and SV even a few million dollars of liquidity per founder would not qualify as retirement. It does remove desperation for the founders who think it's all or nothing without liquidity. I don't think this discussion has covered whether entrepreneurs who have nothing are better than entrepreneurs who have something, but not retirement money.
I've certainly see some great entrepreneurs retire because they don't want to manage startups anymore. Very few of them moved to some super cheap place to live and are living frugally to preserve the one time they made a million or two. In general they made enough money to stay where they are.
BTW, twice I've participated in founder liquidity events, and all it ever did was make me hungrier to build even more valuable companies that would produce even greater returns investors and for me. But Bijan is right. If that was say, $20mm in liquidity (say Angie's List) then maybe I would do something different. Angie's List met Chris' criteria of being profitable and they had acquisition offers.
David Semeria
· 3 months ago
It's down to risk management. The VC is diversified, the entrepreneur isn't. As Mark took a lot of time to point out, there are lots to variables to take in account, mainly on the founder side.
Being too rich can de-motivating, but so can being too poor.
ShanaC
· 3 months ago
A lot of it is also relative- you can only compare yourself to what you see. If you see a bunch of venture capitalists, you will feel poor.
David Semeria
· 3 months ago
No Shana, that was not my point at all. It's not a competition. I'm saying that if founders have worked hard (on low salaries), have family or other important commitments, and have generated value (as evinced solely by the valuation of their stakes) then they should be allowed to take some profit or diversify their risk.
The VC's absolute or relative level of affluence is entirely irrelevant.
DaveinHackensack
· 3 months ago
David,
If the founders are more concerned with diversifying their risk than taking a profit, might it make sense for the VC firm to exchange a portion of the founders' equity stakes in their company for a basket of smaller equity stakes in the VC firm's other portfolio companies? E.g., the founders of portfolio company A each give up $X of their equity stakes in their firm, and in exchange, the VCs give each of the founders $0.1X of equity in Portfolio Company B, $0.1X in Portfolio Company C, etc., for a total amount of $X in a basket of ten other portfolio companies? Maybe there would be regulatory issues with this if the founders aren't qualified investors, I don't know. In theory, it sounds interesting though.
David Semeria
· 3 months ago
I can understand your rationale, but from a diversification POV the founders would still be heavily focused on one specific (and high risk) asset class. Surely it's simpler to let them raise some liquidity which they can invest (or spend) how they please.
Mark Essel
· 3 months ago
I prefer the everyone wins situation of a sustainable exit (the company is healthy after liquidity). This topic has come up before and in the end for Dave and Fred it was a discussion best over beers at a table.
Everything is negotiable, if the move helps all parties involved (lowers distractions, rewards hard work at growing value, gives investors greater stake in something great), then by all means the rules/laws of business shouldn't get in the way. Just gotta be careful of scams, and abuse. Power and wealth can corrupt the most altruistic if the alternative is desparate poverty/bankruptcy.
Aren't the risks part of the attraction to founders? The challenge in building long term value is what they feed off of.
David Semeria
· 3 months ago
Mark, the beer thing was for liquidation preferences - but to be honest I don't think we'd agree on that one even if we had a bong in the room!
The whole point of allowing founders to take a little profit is that, under the right circumstances, it should actually *increase* the likelihood of everyone winning, since the founders would be less edgy about swinging for the fences.
fredwilson
· 3 months ago
I don't love exchange funds for a variety of reasons. I should post about them sometime
DaveinHackensack
· 3 months ago
I can imagine one reason you wouldn't like them, but I'd be interested in reading your post.
ShanaC
· 3 months ago
Not totally- people compare themselves to what they see. I'm assuming that's why we all blog, to talk about the money so that people aren't going to go flip out and build resentments.
In fact, I would hedge that in part the Pollyanna problem mentioned in the original is because one is hanging around corporate types too much with more money who are on your board. And the comparison in part, sounds like it is driving people nuts. Work for work. It would probably help if everyone had parity- however that's not the way it works. Why else would you want to take liquidty in the first place? If one was really coldly rational, everyone would be paid close to nothing (including the Venture Types) and everything would be shoveled back into the companies to make whatever widget they make today.
It is the way one feels. And talking about it in productive manners clears problems up. I learned that the hard way. Why else would such a resentment occur in the first placement?
Jeff Pester
· 3 months ago
There seems to be little disagreement among the enlightened that providing some liquidity to founders based on either some predetermined metrics and/or unanticipated financial hardship is appropriate. Having founders under financial stress/duress hurts everyone in the long run.
I'm beginning to think that this perspective/willingness regarding founder liquidity provisions on the part of Angels/VCs might soon become a differentiating factor in term sheet evaluation. No doubt that in certain deals founders are going to be in a position to insist on it. As always, it's whatever you can negotiate.
David Semeria
· 3 months ago
I'm gradually beginning to see how a lot of related issues (founder liquidity, vesting, liquidation preferences, etc) could all be rolled-up into one single and more transparent arrangement.
chrisco
· 3 months ago
If you want to see some discussion and links on that: "Yokum Taku’s Take On Vesting": http://tr.im/vesting.
Yokum is a corporate and securities partner in the Palo Alto, California office of Wilson Sonsini Goodrich & Rosati.
He is the attorney on the Y Combinator's open source Open Source Series AA Equity Financing Documents. Link on the blog.
He was also the attorney on the The Funded Founder Institute's model documents and sample term sheet. Again, links on the blog, including to all the documents, TechCrunch articles, contrasting opinions on vesting, alternatives to convertible notes for angel investors (exchangeable shares), early exits (without VCs), and more.
PS: Not trying to plug my own blog, it's just that I just recruited and am in the process of drafting documents and signing teammate number one for our startup. That blog post includes a lot of information, reasoning, and ideas I used to put together the deal. If you (or anyone) are putting a deal together, it might help you too.
-Chris Comella
PS: My background includes MBA, venture finance (direct investing), going through an IPO, and over $1 billion in debt and equity investments. And still, putting together this deal was a challenge. Once I refine the model, I may release it for comment and further refinement by the community. We need more transparency, and concise, clearly articulated reasoning, road maps, and documents. Sure, every situation is different, but people need a better point of departure than we got now. We're not there yet. That's partly because the status quo and food chain of VCs, lawyers, consultants like things just the way they are, thank you. But, like other old-school business models, that's changing. People can either lead that change or get run over by it. Some people have partially cracked the nut, but most of them have conflicts of interests. Regardless, I've not yet seen the unified theory or even small set of resources that fulfills the demand. Please share your resources here (and hopefully also in the comments to my blog post). Thanks.
David Semeria
· 3 months ago
Thanks Chris, that was interesting.
FWIW, I was thinking along the lines of a $ cap on what the founders could take off the table per year. For example: $0, $100k, $250k...etc. This could be rolled-up with the vesting schedule, and would in theory reduce the need for a liquidation preference. VCs would have the right to match any offer for founder stock, but no obligation to trade.
chrisco
· 3 months ago
Interesting, and good, refinement idea, David.
Ivan Kirigin
· 3 months ago
I cringe when I hear VCs talk about "keeping founders hungry". This is usually from people who are already rich talking about people who aren't. It also betrays a deep misunderstanding about what motivates good founders. Wanting to win is a reason I do a lot of things. I would still be doing them if I were rich, but with greater risks. Your point about swinging for the fences makes complete sense.
I also think this issue is going to be less and less about what the investors want. The shift towards cheaper companies means that founders should just take control of this issue from the beginning, and not work with people against them.
I do appreciate the perspective of people like Ron Conway who say the money a founder gets from a personal sale is what could have gone to the company, but doesn't. I happen to think it is bullshit, because plenty of VCs have the problem of not being able to allocate their funds well. There is enough money for the company and the founder.
robyncowie
· 3 months ago
Well said. There's a lot of easier ways that I could have made more guaranteed money than I'm making now. Money that would have allowed me to buy a house, have a new car, afford to start a family - like all of my friends have done. My main motivation for my business is clearly not money - it's making something, that I passionately believe in, work.
Over the last four years I've gone from investing all my money and taking no salary, to taking a "keeping my head above water" salary, understanding that while we are not making significant revenues I'm still being paid by other people's money, so they shouldn't have to pay me to save.
In the next six months, we need to decide whether to concentrate on a profitable business in Oz, or a raise for a more aggressive push internationally. Clearly an aggressive push O/S gives us all the potential for greater blue-sky in the future, but probably pushes my ability to have a house and start a family off for a couple of years more - an especially tough call for a female of my age.
Getting some liquidity would clearly allow me to make a call on what's best for my business, without compromising what's best for my family (partner and 11-yo Russian Blue).
I agree that it shouldn't come in the form of salary, rather as a reward for making a revenue milestone PLUS having the guts/determination to grow more aggressively. I disagree that we should have to be profitable, since in our case it would be a disincentive to go after the large growth that would benefit us all the most in the end.
ShanaC
· 3 months ago
I admire you. Good luck with that decision. Being female, though betting younger, and with a few married friends with children, I can see how hard that is. You sound like you'll do the right one for you in the end.
(I mean that I am younger)
robyncowie
· 3 months ago
Thanks Shana. I'm still confident that we'll (partner, business) be able to come to some arrangement that lets me do both.
markslater
· 3 months ago
the way we addressed this robyn i mentioned i a post above. We started the company 2.5 years ago - invested 7 figure sum at founding - and ran for a year with no salary before completing a second financing in april of this year, at which point we re-upped along with a syndication of institutions. What we did and continue to do is to 'defer' a portion of a board approved salary (lower than market but lights on level) - and seek to re-coup a portion of this at the next financing event or profitability.
some institutions will balk at this as they simply see this as a payable and they want their money to 'pay forward' not 'pay off' - but if you have chips in (like it sounds like you do) as we all do, and simply want a 'top up' as part of a go forward strategy - not a liquidity event, then this is a sensible way to address this. the reality is no founder can go really beyond a year at no or little salary - with out a recourse milestone thats achievable. Its extremely tiring and can get very frustrating.
robyncowie
· 3 months ago
Mark, great solution. I see you've had the benefit of having been on both sides of the fence. Although my co-founder and I had been in business together for 8 years before we started this venture, I think we were just grateful for the investment and didn't really understand what we could or should ask for. Having said that, our investors are incredibly supportive and do try to look after us. They volunteered extra options in-lieu of salary without us having to ask, and I think they would be open to something like the path you are suggesting.
Shane
· 3 months ago
I agree. I think that if you are in entrepreneurship only for the money, you are in it for all the wrong reasons. If some cash to the founders is going to derail the company, you funded the wrong people.
Jerry Vandesic
· 3 months ago
I agree, and based on their actions, so do most VCs. Otherwise a VC would never back a (successful) serial entrapreneur in the second venture. If the founder got enough out of their first company, why would they be hungry for success again?
martinowen
· 3 months ago
This is moving the bar too far. You are suggesting that it is not enough to create one successful company but they should remain poor until they have created a second? third? fourth? - how much hunger do you expect? " A hungry man is an angry man" (Marley, B.)
Jerry Vandesic
· 3 months ago
I think you misunderstood my point. I was simply saying that being hungry for a cash payout is not al that motivates successful entrapraneurs. If it were, there would be no motivation to do a second startup once you have cashed out. And the VCs know this, since the are happy to back founders who have seen prior success.
ShanaC
· 3 months ago
I agree, so what are good reasons, beyond passion and ideas (since lots of people have that) to start a company.
fredwilson
· 3 months ago
I agree
Sean Kelly
· 3 months ago
What about if the founders were granted a "fee" of say 3-5% of the funds raised much like a spotters fee.
markslater
· 3 months ago
conflict of interest.
jasonspalace
· 3 months ago
read this and Mark's post earlier, still resonating, so here i am.
in addition to other things i have said to you Fred, hearing this from you instills a sense of trust in me. my aim is to show the world a first technology alone, then build several more with a team. this first tech has had me now for close to a year, building it ~14/7, 0 pay, yet with a huge =) because i'm building things that i'm certain you and everyone else who sees it will have $$$ in the eyes, especially if they align with my vision for clear paths to profitability/exit.
no, this is not enough to feel i have earned anything, because one day ill be a VC, so i always attempt to see it from your pov. and i hope noone mistakes the exit mindset for selling out, because as the internet age begins, many of us will focus on building automated scalable internet machines, and i feel there is nothing wrong with leaving them in the hands of the quality people we hire to manage their business models.
the farthest i have gone to seek funding is build a relevant billboard you can find by Googling seeking venture capital, and sending 3 tweets out to you and 2 other VCs months back. this is because this head full of schematics is not looking to stand in line for board members who aren't on the same page, or at least in the same book. i've planned a long career of many products ahead of me, and finding people who align with me is more important than finding people who just stuff cash in my pocket, though 2009 is fortunate because we are still in a time when someone can build a tech that profits without funding.
i'm happy to hear this as your view on the topic, at some point it i know ill be financially content with just enough to not think about money till after the first exit, an amount in the range Mark mentioned. between this, the vesting, and your view on entrepreneur/investor relations, ill stay happy working psycho hours on my babies to create great products and earn mm$ for my investors, the team that gets built, and myself when that time comes.
just a few more steps before i attempt to reinvent the small business with suredone
fredwilson
· 3 months ago
Is that what you are calling it? Suredone?
jasonspalace
· 3 months ago
yes Fred, and the last thing i want to say about it before you see it is by please Googling it =)
sachmo
· 3 months ago
Thanks for posting a link to the original and even bringing up the subject.
martinowen
· 3 months ago
Currently there is my angel/partner and me. At this point I am my own VC. Investment goes in paying patent lawyers/agents and USPTO and EUPO etc, development kits and kitchen tables. I do not expect any liquidity from this. It justifies my equity share.
However as soon as some external investor arrives I am no longer working "just for me". I would expect some of my "pain" to be relieved. I understand that going to meetings the investor may travel business and I may travel economy - however investors has no right to keep me in penury - I am "working" for them as well as myself. The labourer is worth of his hire.
Mark Essel
· 3 months ago
I'm worried that leaders are distracted by the nuances of financial deals. Every successful business could have been even more of a hit, so this distraction applies equally to the winners and losers. The distraction of cash to "pay the bills" is a cost any business has to bear.
The desire to tap into undiscovered value is primary motivation for a company founder. I like to think of entrepreneurs as hacking our society by doing something better, or novel, or with a completely superior style. There is an art one uses to establish a business, to build relationships, and to deliver more than a user, cobuilder/member, or investor has a right to expect. A sustainable healthy business has a life of it's own, and when the founder can walk away confident of this vitality, society can reward their efforts with a humble pension (high standard of living).
Daniel Weinreb
· 3 months ago
At the Business of Software conference last year, someone made the point that if the founders are financially struggling personally, it might be a good idea to let them take some money off the table so that they can concentrate more on the business and less on how to pay the bills. Obviously this depends a lot on knowing the personality of the founder in question and his or her circumstances, so you can have some confidence that the desired outcome will occur.
Nick Oliva
· 3 months ago
It's easy to distinguish, within a market and reasonable personal circumstances, between getting rich on salary, getting by, and starving. Anyone working at a startup is taking significant risks already, and it takes much longer to accomplish things than first-time founders or early employees expect when they commit. A fair wage is the only reasonable approach unless the founders are able to get by without compensation (e.g. serial entrepreneurs); in which case, they are also investors and for that deserve a larger share.
Andrew Warner
· 3 months ago
If you think Mark Suster's blog is helpful, you should see what he's doing to the SoCal startup scene.
He's energizing the community here by helping event organizers, talking to entrepreneurs, connecting promising entrepreneurs with mentors and giving feedback.
fredwilson
· 3 months ago
I smelled it when I read his blog for the first time. He's an action oriented person. Nice
All Comments
But we need the eBay version to exist: Sotheby's doesn't serve the Beanie Baby market -- I want to be able to buy a share of something I use (from Facebook down to Foursquare), get my family paid back fairly for that money they gave me while I was trying to get ramen profitable, trade shares for stuff we need to get off the ground (traffic, a piece of technology) -- all for eBay-sized transaction fees rather than large legal fees.
I am optimistic that the early adopters of this Beanie Baby version of the liquid secondary market will be consumer web companies. Its way too easy now for a buyer to see product success (compete.com, appstore charts), follow the people iterating on it (blogs, twitter), liquidate attention (ad networks), share information transparently. For those of us sick of waiting for the random day of getting a random amount of liquidity, it should be a faster, predictable, more rational way of being compensated for wealth creation.
Yes, people need to be protected, the SEC and Securities law exist (and so does copyright law, but...). I'd like to see the US's Securities Exchange laws revised enough to enable this transformation, how entrepreneurship can be done.
Let's have transparency and alignment across the entire chain, and then everyone can feel comfortable. At the end of the day we're all working for the LPs, so why shouldn't we all be in the same boat?
With all due respect, weak answer. If we can lay out the road map to this with all the hurdles, then it can be enforced and arranged.
This is is purely in a theoretical world of course, but could be interesting to dig deeper into.
I think the idea of using market signals to set Founder's comp is a rational one. If a Founders role is rewarded with ownership stake, then his or her leadership role should be based on comparable comp plan to attract an outside CEO to run the company. This would set the Founder's comp plan on a fair basis as per market signals. As regards selling shares to third parties, all shareholders including Founders should be free to do so as they would be in a free market. There should be no contractual restrictions for any shareholder. If a Founder is not motivated and energized by his business then he should not be counted on to build it. The Board need to replace him.
Nat
-The risk for founders is significantly higher, their company is typically their only investment.
-The investment founders put in the company is higher, often founders "invest" in the company, by taking low salaries, post round B or C, getting no equity for their invested money.
-The real dilemma for experienced founder CEOs is that they can get 3-5% in a mature low risk company or found their own company (and get 5-6% of it at exit time). It's a loosing deal to start one unless you are addicted.
10 years ago I raised $3m with a nice deck of slides and a good idea, the pre was $10m. Today it takes some sales to raise seed money.
10 years ago it was much easier (e.g. possible) to take a company to an IPO, today... well.
10 years ago the situation differed.
For the deal to be profitable to a good founder it must pay at least the "fair market value" of the founder's sweat with a reasonable probability.
Assuming a "reasonable probability" for a risk taker founder is 40%, and assuming the guy looses about $100K every year he works for the company, and assuming this happens over 3-4-5 years. Founders should be able to cash back at least their "fair market value" salary as soon as it is possible for the company to pay it.
But, how does this square with earlier position advocating that founders and early team members should only take “subsistence” salaries/compensation?
I am currently considering a new real time texting opportunity, and would want this situation to repeat. As chris sais below - if you run in to a VC that would not consider this - get another one. If you don't have this kind of leverage - than that spells trouble for both parties.
In this day and age - some measure of pay back for my sweat and toil - is not Liquidity - its the conclusion of shared risk, cash flow for founders who have put their families likely through the ringer, and a true sign that the new guys get it, and are going to do right by everyone going forward.
If the salary was $150k - lets say it went 6 months that would provide for - 75k/2 ($37.5k) - lets say that 50% of that goes out in cash, the remainder converted in to common at a discount to the financing. is that so dislikable to a VC? given that this amount is far far less than the cash already in by the founders.
bottom line is - i don't want liquidity for my founding stake at an institutional financing. And if a VC were to try and tell me its a re-start - or no credit for past work - then its a short conversation - i've heard these lines before. If there is 'employee debt' and the situation is properly audited, and the amount is (it should not be FYI) palatable (less than 7% of financing) and the terms require a founder re-commit in addition to a small amount of cash - to ease the pain - then it should work for all concerned. The problem comes if you have a PPT and an idea and $xxx,xxx of 'employee debt' - then you will legitimately be fighting the 're-start' or 'no credit' game.
See this WSJ article from 2007 about Peter Thiel and his Founders Fund: "VC’s New Math: Does Less = More?": http://tr.im/y2ny
"Structuring deals differently from how traditional venture capitalists do. Significantly, the fund often buys only a 5% or 10% stake in a company and sets up a special class of stock that start-up founders can sell while they are building their companies — and before venture-capital investors see profits. That way, the thinking goes, the company founders can reap some financial reward and stay motivated to build the company before an IPO or company sale, which can take years."
Also see Basil Peter's book "Early Exits": http://tr.im/y2nO. Basil is a progressive, experienced, and long-time angel investor based in Canada. Besides his book, I also recommend his blog: http://www.angelblog.net/ (most of what's covered in his book is also covered on his blog, including vesting, term sheets, and more.
if the investors goal is to help bring about the optimum environment for its investments to succeed, ensuring the founders can concentrate fully on the task at hand must be of major importance.
i read somewhere lately, i cant remember where but may have been on your blog, in regards where to peg founders salaries and the opinion was that founders pay should be set at a level which allowed them to live comfortably based on their circumstances/family/kids needs etc (i.e. pay their bills and not have to stress too much about day to day living expenses) but not be enough to allow them to save a single penny. That way once again allowing them to concentrate on building the business without unnecessary hindrances.
Providing them a little share liquidity follows the same lines.
(entrepreneurs who already have personal wealth and have a financial cushion - shouldn't really be given liquidity as it would serve only as an added distraction - just the opposite of what the liquidity event should accomplish)
Better question for you all- how many boards were willing to work with founders and upper level employees just about the psychology of money weirdness? Since clearly people are using the money in all sorts of strange ways to get at the companies and not grow them.
what i don't like for example was one situation I saw where it was a pre-revenue company run by 22 year olds and they had 2 term sheets which were basically identical except in one half the money went into the founders pockets. Felt a bit like a bribe.
another situation I saw that was bad was company doing super high valuation, again at pretty early level of traction, and founders taking many millions off table. now there are lawsuits.
One thing I don't understand in this discussion is why the buyer must be the VC? Assuming the VC has and doesn't exercise a ROFR, the cash could come from anywhere, right?
The founders in any startup sells stock for cash. Typically the money goes into the company and typically the company pays the founders some salaries which the founders transfer to the IRS in turn.
At the end of the day the founder's have agreed to have a little smaller stake in the company in return for some money in the bank.
If instead of (part of the) salaries founders could sell their stock to the VC, everybody, except the IRS, would get roughly the same. Sounds like a good deal to me.
VCs would buy some common (instead of the preferred) shares, but will keep almost all the associated benefits of preferred shares (you can't cash out all your stock on day 1 after an IPO anyway).
generally I tend to agree with you on those rules.
I have seen some exceptions that were okay though because the founder liquidity wasn't excessive and/or because the VCs wanted the entrepreneurs not to flip. I've also seen it where the VCs can't own enough so that how they get more
The scenarios I don't like it are
1- the company balance sheet needs the money and fund raising isn't a slam dunk for most companies.
2 - or when it's too big and messes up the incentives.
Fred brings up a good point about how secondary deals can have an adverse impact on strike price for employee options.
1. Big Funds should put more money to work and buy bigger pieces of companies by granting founder liquidity. Gone are the days when VCs own 70% or more of companies. I think this is the best way to do it. And the only fair way.
2. In Boston, NYC, and SV even a few million dollars of liquidity per founder would not qualify as retirement. It does remove desperation for the founders who think it's all or nothing without liquidity. I don't think this discussion has covered whether entrepreneurs who have nothing are better than entrepreneurs who have something, but not retirement money.
I've certainly see some great entrepreneurs retire because they don't want to manage startups anymore. Very few of them moved to some super cheap place to live and are living frugally to preserve the one time they made a million or two. In general they made enough money to stay where they are.
BTW, twice I've participated in founder liquidity events, and all it ever did was make me hungrier to build even more valuable companies that would produce even greater returns investors and for me. But Bijan is right. If that was say, $20mm in liquidity (say Angie's List) then maybe I would do something different. Angie's List met Chris' criteria of being profitable and they had acquisition offers.
Being too rich can de-motivating, but so can being too poor.
The VC's absolute or relative level of affluence is entirely irrelevant.
If the founders are more concerned with diversifying their risk than taking a profit, might it make sense for the VC firm to exchange a portion of the founders' equity stakes in their company for a basket of smaller equity stakes in the VC firm's other portfolio companies? E.g., the founders of portfolio company A each give up $X of their equity stakes in their firm, and in exchange, the VCs give each of the founders $0.1X of equity in Portfolio Company B, $0.1X in Portfolio Company C, etc., for a total amount of $X in a basket of ten other portfolio companies? Maybe there would be regulatory issues with this if the founders aren't qualified investors, I don't know. In theory, it sounds interesting though.
This topic has come up before and in the end for Dave and Fred it was a discussion best over beers at a table.
Everything is negotiable, if the move helps all parties involved (lowers distractions, rewards hard work at growing value, gives investors greater stake in something great), then by all means the rules/laws of business shouldn't get in the way. Just gotta be careful of scams, and abuse. Power and wealth can corrupt the most altruistic if the alternative is desparate poverty/bankruptcy.
Aren't the risks part of the attraction to founders? The challenge in building long term value is what they feed off of.
The whole point of allowing founders to take a little profit is that, under the right circumstances, it should actually *increase* the likelihood of everyone winning, since the founders would be less edgy about swinging for the fences.
In fact, I would hedge that in part the Pollyanna problem mentioned in the original is because one is hanging around corporate types too much with more money who are on your board. And the comparison in part, sounds like it is driving people nuts. Work for work. It would probably help if everyone had parity- however that's not the way it works. Why else would you want to take liquidty in the first place? If one was really coldly rational, everyone would be paid close to nothing (including the Venture Types) and everything would be shoveled back into the companies to make whatever widget they make today.
It is the way one feels. And talking about it in productive manners clears problems up. I learned that the hard way. Why else would such a resentment occur in the first placement?
I'm beginning to think that this perspective/willingness regarding founder liquidity provisions on the part of Angels/VCs might soon become a differentiating factor in term sheet evaluation. No doubt that in certain deals founders are going to be in a position to insist on it. As always, it's whatever you can negotiate.
Yokum is a corporate and securities partner in the Palo Alto, California office of Wilson Sonsini Goodrich & Rosati.
He is the attorney on the Y Combinator's open source Open Source Series AA Equity Financing Documents. Link on the blog.
He was also the attorney on the The Funded Founder Institute's model documents and sample term sheet. Again, links on the blog, including to all the documents, TechCrunch articles, contrasting opinions on vesting, alternatives to convertible notes for angel investors (exchangeable shares), early exits (without VCs), and more.
PS: Not trying to plug my own blog, it's just that I just recruited and am in the process of drafting documents and signing teammate number one for our startup. That blog post includes a lot of information, reasoning, and ideas I used to put together the deal. If you (or anyone) are putting a deal together, it might help you too.
-Chris Comella
PS: My background includes MBA, venture finance (direct investing), going through an IPO, and over $1 billion in debt and equity investments. And still, putting together this deal was a challenge. Once I refine the model, I may release it for comment and further refinement by the community. We need more transparency, and concise, clearly articulated reasoning, road maps, and documents. Sure, every situation is different, but people need a better point of departure than we got now. We're not there yet. That's partly because the status quo and food chain of VCs, lawyers, consultants like things just the way they are, thank you. But, like other old-school business models, that's changing. People can either lead that change or get run over by it. Some people have partially cracked the nut, but most of them have conflicts of interests. Regardless, I've not yet seen the unified theory or even small set of resources that fulfills the demand. Please share your resources here (and hopefully also in the comments to my blog post). Thanks.
FWIW, I was thinking along the lines of a $ cap on what the founders could take off the table per year. For example: $0, $100k, $250k...etc. This could be rolled-up with the vesting schedule, and would in theory reduce the need for a liquidation preference. VCs would have the right to match any offer for founder stock, but no obligation to trade.
I also think this issue is going to be less and less about what the investors want. The shift towards cheaper companies means that founders should just take control of this issue from the beginning, and not work with people against them.
I do appreciate the perspective of people like Ron Conway who say the money a founder gets from a personal sale is what could have gone to the company, but doesn't. I happen to think it is bullshit, because plenty of VCs have the problem of not being able to allocate their funds well. There is enough money for the company and the founder.
Over the last four years I've gone from investing all my money and taking no salary, to taking a "keeping my head above water" salary, understanding that while we are not making significant revenues I'm still being paid by other people's money, so they shouldn't have to pay me to save.
In the next six months, we need to decide whether to concentrate on a profitable business in Oz, or a raise for a more aggressive push internationally. Clearly an aggressive push O/S gives us all the potential for greater blue-sky in the future, but probably pushes my ability to have a house and start a family off for a couple of years more - an especially tough call for a female of my age.
Getting some liquidity would clearly allow me to make a call on what's best for my business, without compromising what's best for my family (partner and 11-yo Russian Blue).
I agree that it shouldn't come in the form of salary, rather as a reward for making a revenue milestone PLUS having the guts/determination to grow more aggressively. I disagree that we should have to be profitable, since in our case it would be a disincentive to go after the large growth that would benefit us all the most in the end.
(I mean that I am younger)
some institutions will balk at this as they simply see this as a payable and they want their money to 'pay forward' not 'pay off' - but if you have chips in (like it sounds like you do) as we all do, and simply want a 'top up' as part of a go forward strategy - not a liquidity event, then this is a sensible way to address this. the reality is no founder can go really beyond a year at no or little salary - with out a recourse milestone thats achievable. Its extremely tiring and can get very frustrating.
in addition to other things i have said to you Fred, hearing this from you instills a sense of trust in me. my aim is to show the world a first technology alone, then build several more with a team. this first tech has had me now for close to a year, building it ~14/7, 0 pay, yet with a huge =) because i'm building things that i'm certain you and everyone else who sees it will have $$$ in the eyes, especially if they align with my vision for clear paths to profitability/exit.
no, this is not enough to feel i have earned anything, because one day ill be a VC, so i always attempt to see it from your pov. and i hope noone mistakes the exit mindset for selling out, because as the internet age begins, many of us will focus on building automated scalable internet machines, and i feel there is nothing wrong with leaving them in the hands of the quality people we hire to manage their business models.
the farthest i have gone to seek funding is build a relevant billboard you can find by Googling seeking venture capital, and sending 3 tweets out to you and 2 other VCs months back. this is because this head full of schematics is not looking to stand in line for board members who aren't on the same page, or at least in the same book. i've planned a long career of many products ahead of me, and finding people who align with me is more important than finding people who just stuff cash in my pocket, though 2009 is fortunate because we are still in a time when someone can build a tech that profits without funding.
i'm happy to hear this as your view on the topic, at some point it i know ill be financially content with just enough to not think about money till after the first exit, an amount in the range Mark mentioned. between this, the vesting, and your view on entrepreneur/investor relations, ill stay happy working psycho hours on my babies to create great products and earn mm$ for my investors, the team that gets built, and myself when that time comes.
just a few more steps before i attempt to reinvent the small business with suredone
However as soon as some external investor arrives I am no longer working "just for me". I would expect some of my "pain" to be relieved. I understand that going to meetings the investor may travel business and I may travel economy - however investors has no right to keep me in penury - I am "working" for them as well as myself. The labourer is worth of his hire.
The desire to tap into undiscovered value is primary motivation for a company founder. I like to think of entrepreneurs as hacking our society by doing something better, or novel, or with a completely superior style. There is an art one uses to establish a business, to build relationships, and to deliver more than a user, cobuilder/member, or investor has a right to expect. A sustainable healthy business has a life of it's own, and when the founder can walk away confident of this vitality, society can reward their efforts with a humble pension (high standard of living).
He's energizing the community here by helping event organizers, talking to entrepreneurs, connecting promising entrepreneurs with mentors and giving feedback.