

The Tricks Investors Use Against Founders - flmyngo
http://www.theprivateequiteer.com/investor-tricks/

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lacker
It's important to note that these things are common in the private equity
world, not the angel investment or venture capital world. The VC world has
totally different tricks, like 3x participating preferred, "independent" board
members, collusion, and option pools.

Also, if the PE firm is using a 20% discount rate to evaluate the merits of
vendor finance, they are likely fooling themselves more than they are fooling
the founders.

~~~
todsul
There are a few ways you can look at this 20% discount rate:

    
    
      * Cost of capital for the fund
      * Cost of capital for investors in the fund
      * Cost of capital for the business
    

If you can't earn 15-20% on a business, you really should invest the capital
in a less risky investment. Additionally, most PE funds look to double their
investments in 5 years. So using a 20% discount rate is somewhat conservative
with this in mind.

However, I tend to agree that you wouldn't want to be throwing a 20% discount
rate around against yourself in deal. It's certainly not outrageous though.
Think of it as opportunity cost too.

~~~
lacker
_Additionally, most PE funds look to double their investments in 5 years. So
using a 20% discount rate is somewhat conservative with this in mind._

PE funds tell themselves they can achieve a 20% return, but in reality they
are on average no better than index funds. See:

[http://www.google.com/search?sourceid=chrome&ie=UTF-8...](http://www.google.com/search?sourceid=chrome&ie=UTF-8&q=average+pe+fund+return)

I stand by my claim that in assuming 20% returns for vendor finance, PE funds
are tricking themselves by a greater magnitude than they are tricking
founders.

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jjm
These tricks are depressing and bolsters my attitude more toward a profitable
yet slower growth start-up, doing without the sleazy investors...

By no means am I saying all are sleazy, but a slower growing startup will not
attract the better of the lot.

~~~
rdl
This list is basically irrelevant to startups.

PE firms don't invest (generally) in early stage tech startups. By the time
you get to dealing with PE (as an alternative to IPO, or as a path to
turnaround if you're company is fucked like Yahoo), you can hire your own
lawyers and such to buffer from the sleaze.

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smhinsey
How do you find the right lawyer to vet your agreements, as a founder, to make
sure something like this doesn't happen to you? Is a lawyer even the right
person to look for?

~~~
jpdoctor
> Is a lawyer even the right person to look for?

It's very tricky.

If you find a lawyer that sees many deals, then he/she likely knows many VCs
and knows who butters his bread.

If you find a lawyer that doesn't know many VCs, then they likely don't know
as well the in's and out's of term sheet tricks.

More fundamentally, the problem is that founders are technical (by and large),
and they are up against people who do term sheets for a living. It is a very
asymmetrical-knowledge situation.

~~~
chernevik
I would expect a banker / financial advisor to pick up on value and risk
points. A really good, experienced lawyer should, but it isn't entirely in
their expertise.

(BTW, if the lawyer does see a lot of deals, I would wonder how much of their
business is representing investors, and how that colors their thinking. Their
duty is to their client, but it's just human nature to see things in the same
terms as your client base.)

These negotiate for a living, but investors shouldn't be intimidated. Take
your time, think the thing through. DO NOT BE AFRAID TO SAY NO. Always have a
plan to walk away, and never get committed beyond your comfort with the terms
of the deal. Always have some plan to bootstrap, if only to prevent
psychological commitment to _this_ funding deal.

I'm sure the fundraising process is a pain, but a lot of the preparation and
strategizing is stuff that management should be doing anyway.

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mkramlich
One of the cardinal rules of software development I've decided over the years
is to seek to reduce complexity and reduce risk. With respect to
entrepreneurship I go in with a similar philosophy. Therefore as a general
rule I think it's wise to avoid outside investment. Because it exposes you to
unnecessary additional complexity, risk and sleaze. If you can start and grow
a business without it, strongly prefer to do so.

 __* Note that I speak in general terms. I love YC and trust PG so they would
be an exceptional case where it can be a clear net win.

~~~
gfodor
"unnecessary" is the key word here. sometimes (often?) it is necessary to take
on investment.

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T_S_
Folks, this article is about private equity. 10 to 1 odds it doesn't apply to
you. Not tips for dealing with VCs. Interesting if you like finance.

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URSpider94
This is only marginally relevant for venture funding. All of the discussions
in the article are about how to value a company based upon its current
earnings and earnings growth -- your average start-up has zero (or, more
accurately, negative) earnings, so the value equation is completely different.
Start-ups don't have EBIT.

That said, I wouldn't really qualify any of the items mentioned in this post
as "tricks" or "sleazy". Any halfway decent CFO or attorney can run the
numbers and explain the outcomes. Instead, the bigger point is that any deal
has to be viewed through the lens of the needs of both sides. For a
businessperson who desperately needs $7 million today to pay for a new factory
to fill an order, it may be worth giving up something down the road vs.
foregoing the investment and losing out on the opportunity.

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Iv
I think all of these are easily trumped by the ol' bit of common sense : "a
bird in the hand is worth two in the bush". Don't trust someone who is a
professional crook to propose you a deal that includes long term promises.

If people want to pay half later, find a way to cut what they want to buy in
half and give it to them at this time and make no promises yourself either.

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kposehn
Makes sense. I've dealt with a few PE funds and always had my gut screaming at
me to run away quickly. Explains a lot.

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misterbee
Corruption in investing doesn't just hurt founders. It hurts everyone in the
end.

Every time one of these articles about "how investors screw founders" or "how
employee stock option are never going to pay out", the pool of employable
staff are a little more likely to say "These stock options are worth nothing
to me but a lottery ticket, so I'm not going to work hard at this job beyond
my salary, and maybe I'll get my win for getting some sliver of equity if the
company goes big on someone else's effort or sheer luck." In the end, in a den
of thieves no one puts in an honest day's work, and nobody wins.

Bootstrap your business with your own money and your own customers' money, and
leave the sharks behind.

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shoham
Wow. Thank you for the insight, as someone who is working on getting funding
for my business.

~~~
joshu
This advice is about PE deals, not you.

~~~
shoham
I think you're mistaken. The title of the article is "The Tricks Investors Use
Against Founders". I'm a founder, working on attracting Private equity from
investors, and trying to make sure I don't get tricked. I think that this
advice is for me!

~~~
joshu
Heh. You mean private investment.

This refers to large scale deals from PE shops.

I've personally raised twice and have invested in 50+ startups. None of this
stuff happens in early stage VC or angel land.

~~~
shoham
My original comment:

"Wow. Thank you for the insight, as someone who is working on getting funding
for my business."

I don't see any conflict, even if it's 20 years before I need to worry about
these issues, I'm just thanking the OP, and author for the heads up...

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hamidnazari
So, what's the best solution here? To pay $39 and buy "Private Equity Secrets
Revealed" eBook or to hire a seasoned lawyer? And then, how much are you going
to end up paying the lawyer? Are the lawyers going to pull the same tricks on
you as well?

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dools
_"While you have very limited sources of potential funding, we have virtually
unlimited investment opportunities"_

Interestingly, in his interview on Mixergy [1], Oren Klaff (author of Pitch
Anything) describes money as the ultimate commodity. You can get money
anywhere, there's only one of ME.

He discusses this as "prizing". It's definitely worth a look (the book is also
pretty interesting).

[1] <http://mixergy.com/oren-klaff-pitch-anything-interview/>

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simon_weber
Seems to me that an undergraduate Econ education (or equivilant) would go a
long way in seeing through some of these. These look like questions I've seen
on exams.

~~~
snowtiger
The most of it was dealing with PV (present value) and Expected PV of the
deal, so the first point would be learning concept of PV and discount rates

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bignoggins
Sorry for the n00b question, but can someone explain the distinction between
PE investor & angel/VC? Is angel/VC a subset of PE investor?

~~~
DevX101
PE investors buy mature companies and extract profits via cost cutting,
mergers/acquisitions, re-organizations. A PE firm may buy a paper
manufacturing company if they thought they could increase profits by cutting
unnecessary costs.

angels/VCs fund growing companies and extract profits as the company value
grows and is to sold to a company or the public market. A VC would never fund
a paper manufacturing company unless this were a wholly new way of making
paper and had potential to transform the entire industry.

~~~
bignoggins
so how relevant is this article for startups? Seems to me this is more for
owners of mature companies. Or am I missing something?

~~~
pg
Hardly at all. It was probably posted by mistake.

~~~
tptacek
Are you sure the article didn't just flip the relevance bit for you when you
read "investors are looking for good companies with low risk, not great
companies with high risk"?

The stuff in there about how earnouts are structured seems germane. I have
friends who have sold tech startups where earnout structure was a material
issue.

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jpdoctor
There are things that one learns only by going around the block a few times.
This article is a good starter list.

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misterbee
This post is an unsponsored advertisement.

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suking
Brad Feld's blog should be the first thing you read if you get a term sheet
(or even better - if you start trying to raise $). He helps explain these
things in plain english and what they look like in lawyer terms as well.

~~~
joshu
Jesus, no. You go talk to your experienced lawyer about the term sheet.

Not that Brad is wrong about anything.

It's just that this isn't a software package where you can google around and
read a few blog posts and get up to speed.

A good lawyer will be familiar with what is going on, current terms, etc.

~~~
suking
Of course you use a lawyer, but you should understand it as well.

~~~
wnight
And you should do your part first so that you can ask the lawyer the tough
stuff instead of paying $X00/hour for Law 12.

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ScottWhigham
Am I the only one in 2011 who just isn't interested in an ebook? I have a
Kindle - can't really bond with it. I have an iPad - can't bond with it either
for books or long reading sessions.

I would buy the printed copy of this and read it but I won't buy the ebook. I
just like printed books better.

