The “take the deal or not” debate

Pat Moore, of Amplafi, put up a good response to my post regarding do you really want Venture Capital.  I’ve 'promoted it’ here because it raises some interesting points which I’d like to expand/share.

I’ve put my comments inline with his.

Respect you a lot but I think you are flat out wrong here.

[Yeah, I used to get the you’re a nice guy, but… a lot in school, always knew the next sentences weren’t exactly coming up roses.]

1) so would you object to a 5x, 10x, 100x ?

In theory? No, I really don’t care provided that there is a provision where at a certain price, everybody converts and nobody can stop a sale unilaterally. So, if somebody has a 5x and the deal says at a sale of over $50 million, everybody converts, no double (or 5x) dip, you just line up at the pay window and get your share.  If a VC says downside only, okay, cool.  The $50 million number, in this example is arbitrary but it makes my macro point.  I don’t care about downside, what I care about is the upside fairness.

2) maybe you wouldn't because as a founder perhaps your starting percentage is high enough that you still see bucks on the horizon - but what about employee #40. He does the math. Math tells him that unless the company sells for $1B he isn't getting much. Instead of stock motivating -- becomes demotivator. Now as CEO you have 9-5 employee and a real gulf between the haves ( founders) and the have-nots ( everyone else ).

I’m looking at my ending percentage not my starting percentage.  I believe what I am working on is a zillion dollar company. I truly do. I’ve written a personal check, bet the house so to speak, and I believe that if I own 5% – 10% of this puppy when we win, I’m a seriously happy bunny.  So, armed with that attitude, I’ve got lots of stock (mine) and an option pool to reward the key people in my company.  Let me also say that if the tech gods above shine onto me a billion dollar exit, I’m locked and loaded to reward the people who got me/us there.

3) I gather you are pretty well off. If this company fails, or you get screwed by investors -- you are not financially devastated. The rest of us are not so lucky.

To this I can only say that if this fails (it won’t) I’d be on the street looking for another gig or maybe another kick at the startup can.  At this stage, yes, for a certain period of time, I can pour every dollar back into the company, take no salary, eat capital expenses, and generally make Ebenezer Scrooge look like a drunken sailor when it comes to spending.  I’m not on food stamps but I’m bringing my own lunch to work and gladly letting other people buy.

4) you have enough connections that an investor thinking about screwing you will know that it will get around hard and fast -- the rest of us not so connected.

I don’t think my connections are any better than yours when it comes to ‘thinking about’ anything.  The fact is that you can post, tweet, comment, and share a VC screwed me story and it will get picked up since the VC community is a magnet for bad stories.  I appreciate the thought, but I’m just not that connected nor able to scream louder than you. I wish I was actually.

5) If the investor demands so much downside protection then is the investor really convinced about the idea?

VCs, for the most part are driven by spreadsheets and returns once they get past that first instinct of wanting to do something.  This is important.  A VC jumping up and down on a deal after a meeting or two do, will eventually have to settle into whatever the firm’s style/rules/plans/IRR/state of the fund/etc is.  Reality bites but in my experience, Pat, they bet on you and the firm layers on top of it those things they need for the committees, the LPs, and everything else. As I said before, I’m interested in closing the deal with the lowest legal costs possible and only worrying about things that are going to materially impact my ability to be successful.  The rest is noise to the extent that if there a shit pile or things don’t work out, it blows already. If this doesn’t work out (it will) and I’ve taken, say $2 million of other people’s money, aren’t I supposed to get it back to them before I get coin?  They placed the financial bet and if the downside says, we’re covered, I’m fine.  It’s just me, you clearly disagree.

If I got such a proposal, I would demand upfront money going into my pocket, all previous investors, and all current shareholders. Additionally, the investors would lose the ability to force the sale of the company, and the provision would only kick in after a certain percentage of their money was spent. If it ends up just sitting in the bank because current revenue is adequate then the company gets to return it as a loan.

Do I think any VC would take such a harsh "deal" -- no... but then again why should I take such a harsh deal from them?

This would be a broader definition/debate on what’s harsh.  For me, harsh would be a double/triple dip on a major, out of the park, home run.  A VC who say, I’m protecting against a flip and if it is a dude, I get my money back, etc, is not (in my opinion) being harsh.  A VC who says, 5x participating pref REGARDLESS of exit, yeah, that’s harsh and no, I wouldn’t do it.  Your sitting in bank comment points to a disconnect with what a VC would want and what they would do regardless of terms.  I hope that I take in the coin under legal review now, and that’s it. I hope it never gets spent and I exit with a billion dollar company.  I’m not thinking about loans, returning money etc, rather I’m thinking about the win and joining the ‘blank check’ club.

 

In reading Pat’s comments over a couple of times, I think he has done an excellent job of making my point about do you really want to sign up to the life of a VC funded company.  Thinking in terms of being screwed, giving money to people as it comes in, etc, all point to, well,  not being actually ready for a VC investment.

Again, the debate shouldn’t be about the terms, etc, rather about the basics of taking the money in the first place.

Thanks Pat, I appreciate your comments.

Comments

[(the) Pat Moore]

@Rick --

That was quick!

I *still* respect you and not because you are a "nice" guy. You may be - I just have no personal data. I *respect* you because in all the years reading your blog you back up your statements and you don't seem to have an holier-than-thou attitude. As a Java developer, I even forgive you for working at Microsoft ;-)

My world view is different than yours - not better - different.

1) Worked at too many startups with featherbedding CEOs and indifferent VCs.

2) VCs have a reputation ( stereotype alert ) of being there to yell and scream but not there to solve problems. Most VCs that I have met in person have this shark look about them. Met you in person a few years ago ( Startup Camp I ) - you just looked tired. Seems like you might have been working !

3) VCs are investing other people's money. They have no skin in the game. Carry pretty much guarantees that heads-they-win-tails-you-lose.

4) Time >> money. Time you never get back. Money is an infinite "resource" ( U.S. Government can create more "money" but no one can create more time. ) I only have a certain amount of time with family, friends and kids. Unless an investor is putting in their life-energy (not just money ) I am less than enthusiastic about them as investors. Would rather use credit cards, board meetings less stressful.

5) Long hours. I am writing the code for amplafi so that I can still have a family-life. *I write better code when I have a family life.* I made fundamental design decisions so that everyone working for amplafi would be working reasonable hours. Do I want a VC demanding everyone working long hours just to satisfy their fund's time schedule/ego?

Would I take investment dollars - yes - but only from someone who was willing to be part of the solution to any problem. As Barack would say, "Get a Mop!". ( http://thehill.com/homenews/administration/64027-obama-urges-gop-to-get-a-mop-and-clean-up-mess )

Who would be that mythical investor? An investor (preferably a customer) interested in creating a business that will be generating growing revenue for the next 30 years. Someone who has grown their own business. Not an investor looking to flip in 7 years when they need to return the money to the LPs.

Sorry if a bit of a rant, but damn it - I demand that Amplafi be successful. I will be damn if I am going to let anyone get it the way of making that happen. I will run up and over anyone's ass (VC or otherwise who tries to f*k it up ).

And I will absolutely go toe-to-toe with anyone who tries to f*ck loyal people who helped me get this far. At the end of the day, I have only my reputation and my self-respect. I will not let any VC take that from me. So when I see 4x liquidation preferences ... it gets my inner pitbull up.

I have discovered that being an entrepreneur requires a fair degree of insanity...and I guess it shows. :-) Fortunately I have a wife who supports me.

Good luck!

[Bruno Morency]

A big "Amen" to your comment Pat!

[Rick Segal]

Pat,
I do appreciate the comments and drive as an entrepreneur. I wish you the best of luck. Good guys can make it and be successful! As Bruno said, amen!

Rick

[Pat Quixote]

@Rick --

Follow-up.

"A VC jumping up and down on a deal after a meeting or two do, will eventually have to settle into whatever the firm’s style/rules/plans/IRR/state of the fund/etc is."

I try to not bring my personal problems into work. I would ask that any board members / investors be able to keep the same separation. In my mind, a VC's problem with managing his firm/LPs is his/her *personal* problem. And if he can't separate the two, if it is too much of a distraction maybe he shouldn't be on the board of a company.

I know this is "idealistic" but reasonable people never changed the world. I have discovered that there is more to be gained by challenging the status quo no matter how "inconvenient" than it is to be "reasonable".

(BTW - yes I have fought city hall - and yes I have on occasion won)

May be the law should be changed to demand that a BoD member's primary fiduciary responsibility be to the company not to the fund he represents - twud be interesting me thinks.

[BlogReader]

I’m looking at my ending percentage not my starting percentage.

You didn't answer his question. How do you motivate saavy employee #40 that is getting 0.001% of the company?

By not telling him what percent of the company that he owns and instead give out some made up number like 70,000 shares (out of what?)

Or do you saw that 1 out of X startups fail but this one is guaranteed so the X-1 jokers out there are trying to rip you off and I'm really giving you a better deal?

Or do you have a mysterious second class of shares that are "the reals" shares in the company while the other ones you're handing out don't really have any value in a buyout?

Not to pick on you but I just went through all of that, and it was for employee #4 ;) So while those points might not apply to you the original question is still there.

Oh and thanks for being so open about this, it is refreshing to see someone talk about this instead of trying to make it the stuff of smoke filled backrooms.

[Rick Segal]

BlogReader,

Thanks for dropping by. First, the 40th employee issue is noted and I agree that at a certain point if the option pool or exit isnt big enough, getting a few extra few bucks as reward, meh, no big deal. I agree. To movitate/reward said 40th person, an IPO, merger with a mega-company, insane sale, etc, all increase that amount but it isnt going to be killer as a matter of statistics, right? The number of Microsofts or Googles, etc, make that 200 millionaires out of the gate long odds.

So, heres what I can do. I reward the top people, the key people, those first ones, as best I can with the largest option pool I can. When I said my ending percentage, I meant it from the perspective if I own 50% of the company, Im able to give out 40% of my own and not impact the other 50% which is owned by investors. Im making the numbers up but that is what I meant by I have lots to use. I also can set up a system where employees are part of an exit bonus pool which comes out of my share so that those that help me get rewarded.

But, again, Im making numbers up. In a 20 person company my ideas can work. In a 100 person company, not so much.

We should avoid the numbers and focus on the attitudes. After being a VC for 8 years, I get the slams and negative opinions as well as understanding why many people hate the group as an investor class. I do understand and thats why I posted these things out in the open with some extreme examples because you have to decide if you want to live with this kind of thing as you grow your company. For me, no problem, I get it. For you and others, big problem. Either way, lots to talk about and I appreciate you coming by.

[Rick Segal]

@Pat
That is the law. Board members have a responsibility to the company. Thats why there are things called matters requiring special approval which fall to the investors. You could have a case where the board member says yes and the fund says no. Ive never, ever, seen it happen but the board member is supposed to (by law) act in the best interests of the company.

[Watch Winder]

I really like this post regarding take the deal or not. Debating minutia only bogs down negotiations.

[Pat]

@Rick --

Re: Fiscal responsibilities

Yeah. I know the law says that the directors are supposed to have the company's interest primary. However, unless there is a "smoking-gun" proving malice or intentional indifference - such a conflict is difficult to prove.

However, I would suspect (but have no data) that VC directors vote for what is best for the VC's fund even if this means a less ideal result for the company.

Something I remind people about constantly: (Pat's Law of Politics :-) ) "The law is only about good process, not good results."

Many people convicted of white-collar crime would have avoid any charges if they just had been forthcoming on page 750 of the annual report that the board of directors had approved the purchase of $7500 bathroom curtains. As Nixon learned, sometimes the only crime is the cover-up.

So all a VC has to do is make sure the proper vote was taken and then yes they can screw the company.

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Re: False modesty (aka "I have just as many contacts as you")

Really? How many people read your blog? How many people read mine? How many well connected people do you know?

Lets not pretend - a false modesty is dishonest.

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Re: Reward the "best" people.

Hmmm... so this means that the "non-best" people are going to be screwed? How many people can be the "bestest"? Or is everyone in your organization the best?

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Re: Fundamental problem with liquidation preferences

VC invests $15m with 4x liquidation preference owning 40%. Employee #40 has 0.01%

#40 is not Rick's BFF. #40 is good, competent capable - but does not blow the doors off the hinges. Rick sees #40 in the hall and is vaguely aware of #40's existence.

#40 believes in the RickSDream, Inc. product. However, #40 knows that unless *he* believes that the company is will sell for at least $60m, he gets nada. If the company sells for $100m #40 gets a mere $10000.

But the real killer in motivation is the gap where the higher-ups make out like bandits and the late arrivals/low-level people get nothing. Saw this happen at a few startups (friends and my own).

*****Its not a case of getting rich, its the disincentive of getting nothing when people who are not pulling the long hours get the reward. (The "haves" v. "have nots" - your own class warfare in your own startup -- how fun :-) )*****

When the shit hits the fan and everyone needs to be pitching in - this is when this problem rears its head. #40 has to work the kid's birthday. The wife is grumpy about #40 coming home at 9pm for 7 straight days. The basic math gets done and #40 jumps ship for a slightly higher salary to TheNextBigThing Co. Now #40 isn't a superstar but he was the reliable guy that made sure the production site "wheels" are greased. Time/energy now spent hiring replacement. Production site goes down, documentation was less than complete.... Paychecks are not correctly processed. Payroll taxes not handled correctly. The wheels start wobbling and falling off. #40(A) is hired and realized that she is not going to be Rick's BFF. Downround happens. More math gets done. More lifeboats are scattered behind the listing ship.

A much better corporate structure is one where the money men get paid *last* and the janitors and secretaries get paid first.

That would send the right message about valuing the employees who keep the lights on.

*Bottom line: 4x liquidation preferences w/ participating sends the message to everyone id #30+ that they are second-class citizens*

People don't mind so long as they believe RickSDream, Inc. is the next YouTube - as soon as it is clear that is not the case. (i.e. when they are needed the most - they bail.)