

Zappos Deal Shows VCs Hate Entrepreneurs - BrandonWatson
http://www.manyniches.com/entrepreneurs/zappos-deal-shows-vcs-hate-entrepreneurs/

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mattmaroon
This is actually pretty stupid. There's a literal 0% chance that Tony Hsieh
got a bad deal here. The guy's a successful repeat entrepreneur who had been
through the whole thing before and was dealing with a top-notch VC firm. He
knew the game way too well to be getting burned by participating preferred or
some absurd liquidation preference. Hell, I knew the game well enough to have
avoided that before I even got in it, just from Googling around. (Thanks PG!)

He may have been forced to sell perhaps, but he gave up that right when he
took the money and he knew it was a very real possibility. He also knew that
if it happened, he'd be making a bundle off of it. If he feels screwed right
now, which seems highly unlikely, it's his own fault.

VCs don't hate entrepreneurs, most of them love them. They just have a
business to run and look out for themselves. The good ones, like Sequoia, do
it by aligning their interests with the founders as much as possible.

~~~
BrandonWatson
Matt, yours is an opinion that I hold in high regard, and am a frequent reader
of your blog. I am not in any way insinuating that the cash out deal for Tony
is bad. What I am suggesting is that perhaps this wasn't the deal he wanted.
It sounded like he wanted to stay the course and try to go public, which would
have yielded a far higher pay day (presumably) and would have allowed him more
autonomy than a sale to Amazon.

True he gave up the right to block a sale (I say this without any knowledge of
the definitive documents) when he took the money, but I don't think it's too
far afield to suggest that Tony thought he was getting a partner that would
allow him to see this through.

The VC in this case was most likely acting in economic self interest, but not
in the interest of the entrepreneur (or so it would appear).

~~~
ryanwaggoner
_The VC in this case was most likely acting in economic self interest, but not
in the interest of the entrepreneur (or so it would appear)._

This is a far cry from your headline that VCs "hate" entrepreneurs. VCs have a
fiduciary responsibility to act in the best interest of their LPs. The best
VCs work to align the interests of all parties involved, but when they
conflict, the VCs have a duty to act in the best interest of their investors,
just as entrepreneurs have a duty to act in the best interest of theirs. Using
phrases like "VCs hate entrepreneurs" is beyond sensational and distorts the
relationships and responsibilities of all parties.

For the record, I'm not a huge fan of the VC model, but for entirely different
reasons.

~~~
BrandonWatson
VCs, if they sit on the board, have a fiduciary responsibility to the
shareholders - all of them. If they took a deal that benefitted themselves to
the detriment of common shareholders, well, draw your own conclusions.

~~~
ryanwaggoner
It would _seem_ that the deal in question offered the same benefit to all
shareholders: an exchange of their stock in the company for Amazon stock.
IANAL, but I doubt that the fiduciary responsibility includes ensuring that
the founders get to keep their brand independent, especially when it makes
more financial sense for the shareholders to sell.

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donaldc
Their interests may differ, but VCs don't hate Tony Hsieh. Indeed, if he ever
starts another company, I bet they'll be falling all over themselves wanting
to fund him.

Also, while the founder/CEO of Zappos may not have wanted to sell, were I an
early employee with a lot of vested stock, I might be happy that my stock was
finally liquid. Zappos has been in existence for 10 years, and I just might be
interested in cashing out enough stock to buy a nice house.

Tony already had enough money, and made a big enough salary, that the
independence of Zappos was worth more than having Zappos stock liquid, but I
doubt this was true for all of the early employees.

~~~
gleb
Good point. In general, in the VC backed business, the interests of employees
tend to be aligned with interests of VCs not with interests of founders. Both
VCs and employees need an exit and both make too little money to matter on a
small exit.

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ajju
Hate is just the wrong word to use. Do you think Sequoia had a personal
dislike for Tony? Or do you think they just wanted to cash out earlier? Even
the latter is speculation based on un-named sources, but assuming it's true -
where does hate figure into any of this?

~~~
BrandonWatson
Perhaps "hate" is too strong a word, but the more I think about this, I find
it hard to understand why Sequoia would force a sale here. Tony is a very
successful guy, who has built something quite amazing and unique. The public
market would most likely be very receptive to the Zappos story. Their unique
blend of customer focused service has erected quite a defensible market
position, and I suspect that once they acquire a customer, the customer
lifetime value is quite high.

With all that in mind, why would Sequoia force a sale? They wanted to report a
liquidity event. They put a short term profit motive above the desires for
building an even more successful business, which, according to all accounts,
Zappos stood a very good chance of doing.

~~~
ajju
Assuming, again, that the speculation that this was a forced sale is true,
there could be any number of reasons for it - ranging from the simple (Sequoia
needs a good exit in this bleak environment for their limited partners and
don't have any better alternatives) to the complex (Sequoia's analysis of the
macro-economic conditions and their understanding of Zappos' business disagree
with your own).

~~~
tonystubblebine
I wouldn't be surprised if "forced" is even too strong of a word. What would
you do if some folks who had loaned you millions of dollars and who had
presumably worked with you to make your company successful, said, "hey, is
there any way we could get our money out?"

VCs aren't servants to the entrepreneurs, they're partners. When you take $20
from a customer, do you feel a sense of obligation to make sure they get
something in return? That sense of obligation doesn't get smaller when the
amount goes up.

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jasonlbaptiste
Yes, Sequioa capital hates entrepreneurs. Somehow they hate them soooooo much
they were able to attract founders who made successes such as Apple, PayPal,
EA, Google, Yahoo, Youtube, and over 10% of the Nasdaq.

Please leave linkbait and uninformed articles like this to other places. Maybe
they didn't want to sell, but it was not a homerun exit, and there are rules
of engagement when taking on VC.

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mrduncan
I agree with ajju, hate is totally the wrong word to use. Both parties simply
have different interests. In this case, Sequoia wanted liquidity on their
investment (the economy is in a downturn after all), while from what I
understand Tony wanted to stay independent so that he could continue to run
his company. I don't think that this in any way shows that Sequoia hates Tony
though.

If the articles are true, it definitely casts a bit of a shadow on Sequoia.
Having a reputation for wanting to cash out at any moment certainly isn't good
when trying to court entrepreneurs.

~~~
BrandonWatson
Yes, both parties have different interests. One commenter pointed out that the
employees could have really wanted this, as they likely don't have the
financial security Tony has. I am sure there are more than one Twitter
employee wondering when they can cash out some shares.

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tvon
Isn't it the role of a VC to give a company funding so they can get a big
return on their investment later one when the company sells, or something
along those lines? I mean, isn't that something everyone expects when they get
involved with a VC? Isn't that what they're for? Am I misunderstanding
something here?

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dan_the_welder
Venture Capitalists are capitalists. They believe that all wealth flows from
capital.

Entrepreneurs believe in free enterprise, that wealth flows from one's
efforts.

There will always be tension between the two camps.

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BRadmin
"...but that liquidation preference (3 or 3.5X!!) is meant to ensure that no
matter what, Sequoia actually gets a guaranteed return."

Since when does liquidation preference confer a guaranteed return?

~~~
BrandonWatson
The guaranteed return is in the interest rate that their security undoubtedly
had...prob around 12% to 15%. In the event of a sale, the liquidation
preference creates a scenario where the equity is being treated like debt -
their money comes out first, and does so with an increased return. If they
invested $100 with a 12% paid in kind interest, after 1 year, that's $112, and
with a 3x liquidation preference, that's a $336 return for a $100 investment.
If the sale of the company was under $336, the VC gets a guaranteed return,
and all of the capital. It gets even worse over time. With a seven year
horizon and the same return and liq pref, the sale price would have to be
greater than $663 for the preferences to not come into the decision tree.

People cry foul over the payday loan places, but no one is crying foul over a
3x liq pref. 1x is palatable, but 3x (or even 3.5x) is crazy.

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quoderat
If they don't put DRM in the shoes, then break into my house and steal them
back in the middle of the night, I might consider buying something from Zappos
again.

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pclark
there has to be another side to this story.

~~~
BrandonWatson
There certainly may be, and I would love more info. My experience as an
investor and entrepreneur, however, has been that the interests of investor
and management can have a tough time aligning when money is on the table.

~~~
pclark
Quite. seems rather unusual that the founders want to grow _larger_ and the
investor wants to take the money offered though ...

~~~
BrandonWatson
It doesn't seem all that unusual at all. Let's assume (I have absolutely no
information here) that the valuation of the Sequoia round was $100M. This is a
9x valuation jump, and they are getting cash and AMZN stock, which is almost
as good as cash. That's a great win for Sequoia, and it's not too unlikely
that their limited partners were looking for any liquidity event to ease the
pain of the losses over the last 12 months. In fact, the more I think about
it, that's not an unreasonable explanation at all.

~~~
pclark
the CEO has had a great exit under his belt, Zappos had strong revenues, and a
founder that wanted an IPO.

I'm not sure a VC could find a "safer" bet for a startup aiming large.

