
VC Decries Airbnb’s Recent Funding for Founder Control and Cashout - sriramk
http://allthingsd.com/20111001/vcs-unite-chamath-palihapitiya-decries-airbnbs-recent-112m-funding-for-excessive-founder-control-and-cashout-in-email/
======
grellas
A few thoughts:

1\. It is bad form for this sort of thing to be aired publicly. It may give us
a voyeuristic fascination on something that is depicted as an internal
intrigue within a prominent up-and-coming startup but this is fundamentally
company confidential information that is not capable of being aired publicly
without significant distortion. Who can answer the implied charges of
impropriety? Those most directly affected by whatever is happening can’t do so
without violating duties of confidentiality. Yet what are they supposed to do?
Sit by while people now start making invidious comparisons of their activities
with, say, the increasingly notorious Groupon venture? Come out and declare "I
am not a crook"? Start attacking the author of the email, who may have
intended it as a confidential communication and not even have had a role in
its being leaked? Or start to spread over the public record all sorts of
confidential discussions in hopes of trying to defend their reputations? I
don’t know how this got leaked. But it amounts to an inherently unfair attack
that is almost impossible to defend just by the nature of the case. In law, we
learn early on that a one-sided story can almost always be made to sound
compelling, while on a full airing it can just as easily be shown as just the
opposite.

2\. There is a long-time tension in the startup world between founders and VCs
and, as someone who has worked closely with founders for nearly three decades,
I can say unequivocally that it has not been the VCs who have tended to get
the short end of the stick when the inequities arise. Now that fact does not
justify founder abuse, _if_ that is what happens in a given case (I say
nothing about this case - we really don’t know the facts). For decades,
investors categorically refused to let founders take even a penny out of the
company as they were urged to "swing for the fences" to ensure that the
investors got their projected minimum 10-to-1 one return on investment. And
when they missed, it was the investors who would force a merger or sale of the
company, take out their liquidation preference to get a return on their money,
and leave founders with a zero-equity return after perhaps years of working
for little or no salary and putting in 20-hour workdays in the process. This
value proposition may have paid in a big way for founders in select companies
but it has also left large numbers of seriously harmed founders in its wake
over the years. Today, this is changed somewhat and founders at times have
opportunities to balance their risks along the way as they strike their
bargains with the VCs. How, when, and to what extent they take any money out
along the way is a completely legitimate issue to be fought for by founders
and resisted by investors as circumstances dictate. But the overriding goal of
letting founders spread some of their risk is completely bona fide. The
details get resolved by the founders, the company, and the investors through
private negotiation, not through a public airing. If investors choose to
accept something that sounds aggressive to the rest of us, that is their
calculated risk. Last I checked, they qualified as "sophisticated investors."

3\. Is it good policy to have a dividend declared for the benefit of insiders
and for founders to take significant cash out of a company in the early stages
even while other employees may not have that opportunity? Maybe, maybe not.
That is a legitimate question for debate and it should be cast as a _policy_
debate, not as a perverse prying into the details of a particular company
whose circumstances we do not really know. The traditional justification for
requiring founders to ride it out to the bitter end with no prospect of any
real return unless the company hit it big is that it is important that
founders have "skin in the game," i.e., show a real commitment to the venture
as opposed to making opportunistic short-term moves that further their
immediate gain at the expense of the venture. That is a legitimate concern at
all times in a startup but so too is the idea of fairness to founders. Why,
when founders have the power to assert more control, should they voluntarily
accede to a historic policy the keeps them in handcuffs and leaves them with
basically an all-or-nothing proposition in whether they ever get anything
significant out of the venture? This makes no sense and it is natural that
founders would want to change this older pattern and practice. We can debate
to our heart's content whether this is good for startups or not - that should
be a _policy_ debate (including over where exact lines ought to be drawn on
cash take-outs), not an excuse to take what might amount to cheap shots at a
founding team that certainly deserves better treatment than to have a one-
sided debate carried on at its expense.

~~~
vladd
The 3 points you make forget the little guy: that early employee, whose
employee number has 1 digit, who trusted the founders when he accepted the
option grant and put 60 hours of work or more each week in the hope of not
being screwed when the founders negotiate confidentially with the investors on
how the company will move forward.

There's no SEC for privately-held companies, there is basically no oversight
and the confidentiality clauses make it almost impossible for this little guy
to find out how he's getting screwed and by whom. Learning and talking about
it is the only way to fix it, and I'm a bit concerned that you completely
overlooked this aspect in your comment.

~~~
keeptrying
Your "little guy" has been earning a salary for the last 3 years in the
startup - in fact he makes more money than the founders.

I still think its okay to compensate the founder for getting the app to this
point.

~~~
steve8918
You should probably read this prescient thread a few weeks back. If you go
through the comments, the majority of early employees got screwed by the
founders. The ones that benefited are the best-of-breed companies like AMZN,
GOOG, etc. They took care of their employees.

<http://news.ycombinator.com/item?id=2958766>

~~~
keeptrying
I'm not talking about the final exit. I'm talking about an award to the
founders if they can get the company to a billion dollar valuation. That's all
I'm talking about. And not Fu money but something of the order of 1million
which would give the entrepreneur a small nest egg for having gotten this far
but doesn't really make him financially secure.

And I agree that shafting employees is reprehensible and downright despicable.

------
patio11
I must have missed the post where a VC said "Guys, sorry, love your company
but I couldn't in good conscience participate in a round where the rich people
get paid and the poor people are told to wait for an exit." I must have missed
that post quite frequently, because that describes _every VC round ever_.

A $120 million investment round means that about $2.4 million in cash money
just moved from the limited partners (universities, pension funds, wealthy
families) into the pockets of the VC firm's partners. Not stock, not options:
cash money. This is the way the system has always worked, since time
immemorial. VCs get paid a management fee (about 2%) win or lose, and a
percentage of the profits when they win.

Just something to keep in mind when someone mentions their strong principles
in the course of a discussion over how dang expensive butter is these days.

[Edit to add: My description of management fees is slightly simplified and
ignores salient things like the fact that they recur annually.]

~~~
jack7890
No, that money doesn't go directly into the partners' pockets. It also goes to
pay the VC firm's rent, travel cost, salaries of associates and support staff,
legal/accounting costs associated with the deal, and a bunch of other things.

It is generally accepted that a vast majority of a VC partner's income comes
from their share of the fund's return, not from the management fee. It is not
unheard of for a VC firm's costs exceed the management fee, such that the
partners loose money unless the fund has a positive return.

~~~
patio11
_legal/accounting costs associated with the deal_

Industry standard practice is that startups pay for costs associated with
deals, not capitalists. That one is virtually universal. The grapevine tells
me that it is not uncommon to see VCs travelling as board members. Some of
them don't exactly fly coach.

~~~
staunch
The management fees do pay for the swanky offices, assistants, expensive
meals, strippers, golf, computers, very significant travel expenses (unrelated
to board meetings), etc.

And fees are not necessarily split equally across partners. One senior partner
might take 20-50% in some cases.

------
cletus
Absolutely 100% agree.

Founders cashing out is a big red flag. I said it about Groupon. I've said it
before. This really is taking it to the next level: cashing out with a
dividend to retain control and ownership.

I absolutely agree that for any cash out it should be open way beyond the
founders. In fact, this is a good way for larger startups to kick the
500-shareholder limit can just a bit further down the street.

I see Airbnb as a fundamentally risky business. At some point Airbnb will be
large enough to warrant the attention of local and state authorities because
many people offering places to stay are doing so illegally or in violation of
their own lease agreements.

This woman who had her apartment wrecked is just the tip of the iceberg. It is
only a matter of time before a headline about a serious physical assault _or
worse_. Airbnb can count their lucky stars it was "only" a ransacking and
vandalism.

~~~
portman
>> _Founders cashing out is a big red flag._

No, it's not. Palihapitiya agreed that there should be a secondary component
to the financing.

When a company is "shooting for the moon" and has a chance at a >$1B exit,
investors _want_ the entrepreneurs to cash out a portion of their stock,
because it gives them the financially flexibility to swing for the fences. It
aligns the founders and management team with the late-stage investors.

Fred Wilson does a great job explaining why founders and early investors
cashing out in late-stage financings is a Good Thing for everyone.

[http://www.avc.com/a_vc/2010/01/the-tug-of-war-between-ma-
an...](http://www.avc.com/a_vc/2010/01/the-tug-of-war-between-ma-and-vc.html)

<http://www.avc.com/a_vc/2010/08/angel-liquidity.html>

~~~
georgespencer
> Palihapitiya agreed that there should be a secondary component to the
> financing.

Agreed. I think what OP meant was "founders cashing out [using this method
rather than a secondary sale]" is a big red flag.

------
0x12
If you don't like the terms of the deal, don't do the deal (he doesn't want to
do the deal, see third and next to last paragraphs of the email).

A VC complaining about the terms under the pretense that 'the little guy is
treated unfairly' is a bit like royalty complaining about the price of cake.

Nobody forces him to do this deal on these terms. He's just scared to miss out
on a big hit, he'd like the ring side seats to be cheaper by keeping all the
money in the company or by buying out some of the founder stock.

Too bad, you can't have it both ways.

He may have a point about early employees (a 'special dividend' that excludes
certain shareholders is not very elegant) but it is not his to make, and the
dividend in this case was to 'common stock' which seems to imply that anybody
with vested shares participates in that dividend.

His 'concern' is about the unvested employees, but that's a nonsense argument,
as long as your stock is unvested, you don't have any stock.

Options do not participate in dividends until you exercise them, they never do
because they _are not stock_ and that's a pretty clear-cut thing.

Pretty low-class to dump this email in the public domain, I think that people
will remember this when dealing with this particular investor in the future.

------
ispivey
The problem Chamath is highlighting is not that the founders are cashing out.
Or that early employees are not getting cash -- everyone with vested common
stock gets a proportional amount of the cash.

The big difference is that since the founders aren't selling stock, they
aren't being diluted, so the employees with unvested stock don't get more of
the company.

Basically, vested common gets paid, common doesn't get diluted at all,
unvested common gets relatively screwed (they'd own more of the company if it
were a secondary sale).

Of course, dividend vs secondary also affects the investors' price, but I
can't see Chamath making such a stink about a simple matter of price.

------
Hitchhiker
The Vanity of Wealth and Honor

" If you see in a province the oppression of the poor and the violation of
justice and righteousness, do not be amazed at the matter, for the high
official is watched by a higher, and there are yet higher ones over them. But
this is gain for a land in every way: a king committed to cultivated fields.

He who loves money will not be satisfied with money, nor he who loves wealth
with his income; this also is vanity. When goods increase, they increase who
eat them, and what advantage has their owner but to see them with his eyes?
Sweet is the sleep of a laborer, whether he eats little or much, but the full
stomach of the rich will not let him sleep. " - Ecclesiastes 5:8-12

------
rdl
This looks like two issues:

1) Founders de-risking a successful but still growing company at a series b or
later financing (or even a late series a). I really don't see a problem with
founders diversifying their personal portfolios (otherwise, many have 100% in
company stock AND debt from school, etc.). You don't want them to get
distracted, but being short on cash doesn't help you make a successful
product.

2) De-risking via a special dividend, vs. secondary sale of stock. Yes, it
lets founders avoid selling some shares. If you're doing it at a $1b
valuation, it doesn't seem like a major factor either way, but if there could
be a precedent for people raising $20-50mm rounds, dividend vs. sale might be
a better way to put $1-2mm in the pocket of each founder after a few years, so
they can shoot for a >$1b exit.

I'm curious if this form was suggested by the AirBnB side (or their law firm)
or the VCs.

------
gojomo
The special one-time-dividend to vested early stockholders seemed a little
fishy when I noticed in Groupon's S-1... but maybe it's just an efficient way
to reward existing value without larger dilution/valuation.

If employees with unexercised but vested options were given a heads-up that
such an unusual early dividend was coming – so that they too could choose to
qualify – that might address much of Palihapitiya's concern about fairness.

~~~
canistr
I'm probably wrong or misunderstanding the whole issue, but if it is true that
new investors are simply paying early stockholders a special dividend, then
wouldn't that make this a Ponzi Scheme?

~~~
ssx
This is not the definition of a Ponzi Scheme, you should probably look it up
on wikipedia.

But I do agree with the article, dividend's like this are not the spirit of
building a good company. Just founders who want a huge pay-day. I would have
understood 1m-4m, but not 21m, thats a huge percentage of their investment.

~~~
gojomo
No, it's not a huge percentage of their stake. They still retain massive
stakes in a risky private company with a $1.2B+ valuation.

They're just diversifying a little. You wouldn't ask an investor to prove
their commitment by putting 100% of their net worth in a single venture.
Investors are diversified. Smart founders should be, too, as soon as they are
able.

~~~
jtbigwoo
The difference here is that the founders are somehow diversifying without
actually parting with any of their investment. This is simply a massive bonus
to the founders treated as a dividend (probably for tax-avoidance purposes.)
The fact that it's not available to most employees, even those with stock
options, if problematic, if you ask me.

------
tworats
It's important to note that the VC is not objecting to the founders taking
cash off the table. He's objecting to the method (dividends as opposed to a
secondary sale). His arguments are convincing to me - and I'm a founder so my
bias is naturally for the founders.

------
paulkoer
I think the interesting question here is who leaked this email to allthingsd.
If the VC really wanted to give the Airbnbs a heads up (as he makes it sound
in the email ... take care, let's keep in touch, etc) then I don't think there
was any necessity to leak this and I am quite sure the Airbnbs wouldn't want
it out in the open either.

And then... the Groupon comparison kind of sticks in your mind, doesn't it? I
don't know, I get the feeling there is more behind this ...

~~~
veyron
Here's what probably happened:

1) Chamath talked with airbnb, and he _felt_ that he was scoffed or otherwise
disregarded

2) Chamath talked with Reid Hoffman, and both concur on the matter

3) Reid and others talk with AirBNB but the airbnb people stuck to their guns

4) Chamath believes that he is right in his view, and hopes that by going to
the public, others (i.e. PG) will pressure airbnb to reconsider (especially
with the groupon comparison)

Now, I don't know the airbnb founders directly, but I'm certain that if they
felt that other investors were concerned about the arrangement, they would
either change the terms or decline to take the opportunity. If Chamath doesnt
want to participate, its his prerogative, and expressing his concern to the
public really doesn't help his prospects of investing with airbnb or any other
yc company.

------
shawnee_
_Separately, when you look at successful tech companies, it seems that
dividends are an approach used by cash rich operations to distribute excess
earnings — in fact, the most successful, cash rich tech company in the world,
Apple, hasn’t issued a dividend and they have more than $75B in cash!_

The fact that companies can get away with something like this is absolutely
ludicrous. It illustrates just how far the stock market has gone from its
original purpose.

Back before companies had the ability to sweet-talk investors with bulging
pockets, companies wanting capital had to raise it the good-old-fashioned-way:
IPO. IPO used to have the ability to allow a company to access as much capital
as it would reasonably need to grow. But with the preponderance of heavily
privatized companies milking both the private AND the public side of the
investment machine, the value-creating just cannot be accounted for properly.
Something in the gears here needs to be tweaked.

A company like Apple with $75B cash (if that's true) should have a legal and
an ethical obligation to pay out dividends to its shareholders. Tight-fisting
cash doesn't do anything to the wealth-creating mechanism in our capitalistic
society.

~~~
nerfhammer
Ah, but if they paid it out in dividends, it would be taxed!

Apple's cash hoard is functioning as a giant insurance policy against Apple's
stock price, which if you buy and hold, never gets taxed.

~~~
megablast
Also a lot of Apples "cash" is overseas, where it would lose a lot to be
bought back in.

------
kposehn
This is a very interesting article! I do think that he makes a very good point
that if you are already 90% vested, why be so concerned about dilution? I
definitely think that, as founders, when we get liquidity we need to make sure
the people that helped get us where we are get a slice as well.

After all, we aren't the only people that make a company succeed.

------
kloncks
How uncommon are dividends like these happening within a VC-round?

------
crazyfoo
Cross-posting from my Quora answer:

[http://www.quora.com/Airbnb/Why-are-Airbnbs-founders-
excludi...](http://www.quora.com/Airbnb/Why-are-Airbnbs-founders-excluding-
their-employees-from-the-21M-cashout-in-their-112M-round/answer/Josh-
McFarland)

I have no knowledge of specifics outside of the ATD article mentioned, but my
read says that the dividend will go to all common shareholders. So employees
who have both vested and exercised shares will receive their pro-rated portion
of the proceeds as well. It just seems that the founders must hold 93% of the
vested shares (21/22.5), which is reasonable given that they started vesting
years ago, when they were still in their cereal-selling phase.

Addressing the founders' decision to dividend-to-common instead of secondary
selling some of their common shares:

In a typical venture financing, only preferred shares are sold, and there is a
price per share that is set by the round's valuation. After closing, the price
per share of the common shares/options is determined by external auditors in
what is called a 409A valuation process. This process is a little bit of a
game, whereby the company tries to come up with reasons (financial models,
market comps, etc.) to depress the price of the common shares relative to
preferred. This has the benefit of giving subsequent hires a lower exercise
price on their options (and eventual higher profit upon exit.)

The price delta between the classes can be as high as 10:1, though it's
usually closer to 3:1 and narrows as a company approaches IPO. However, were
anyone (founders or employees) to sell common stock in the round, the common
price per share would jump to exactly this new clearing price. Since Airbnb is
a hot company, it's reasonable to think that buyers would be willing to pay a
market price for common that's not far below preferred. And that would mean
less upside for all future employees. A dividend-to-common avoids this.

Because Airbnb is so young and fast growing, they still need the allure of the
upside of stock options to recruit and retain talent. Any sophisticated
investor should understand this dynamic. And yet this dividend annoys them
because it means there's a wealth transfer occurring that doesn't increase
their ownership.

Let's assume for a second that I'm right and that all vested/exercised common
shareholders will see some of the dividend. As food for thought, what if
Airbnb had instead said they were going to spend $21M of their newly raised
capital for cash bonuses for anyone who had worked for them more than a year
-- distributed per employee via this equation: total hours worked * total
value created... would the Valley's response have been less uproarious?

------
bond
Follow up: [http://allthingsd.com/20111002/airbnb-investor-chamath-
palih...](http://allthingsd.com/20111002/airbnb-investor-chamath-palihapitiya-
settle-differences-with-employees-to-get-liquidity/)

------
munaf
Chamath's response: [http://uncrunched.com/2011/10/01/chamath-palihapitiyas-
state...](http://uncrunched.com/2011/10/01/chamath-palihapitiyas-statement-on-
airbnb-email-fiasco/)

~~~
nhangen
You mean "Arrington's response?"

Oh how Michael loves to insert himself into every piece of drama he can get
his hands on.

------
trim
Didn't Chamath make most of his money cashing out Facebook stock early? Does
anyone remember the story about him from a few weeks ago?

~~~
polymath21
From what I understand, Chamath is okay with cashing out by selling your
stock, but what the AirBnB founders are doing is just paying themselves a
dividend of $20M (essentially just paying themselves a lump sum out of their
funding round and not affecting any of their stock). Please correct me if I'm
wrong.

~~~
steve8918
This is my understanding as well. Chamath says that it's fine if all employees
have access to this ability to cash out shares, but it sounds like AirBnB is
essentially withdrawing money directly from the company, with no opportunity
from employees to participate. He says it's basically a cash-grab that only
the founders are participating in. I have a hard time disagreeing with him.

Did any founders of great companies ever do something like this? From my
recollection, I don't believe Bezos, Jobs, Gates, etc ever did anything like
this.

~~~
tptacek
So, I assume you'd agree also that the VCs shouldn't be able to take a dollar
out of a deal until employee common stock is liquid? And that they shouldn't
be able to take a dollar in management fees until their capital has created a
pro-rata amount of liquidity for the employee common stock of one of their
investments?

No? That's ridiculous? I agree.

------
bigohms
Perhaps a rethink is needed of bringing the public sentiment into the equation
by making this communique open. I appreciate that it does shed more light into
the strong dilution resistant finance. However, the round particulars are
private and the fair play would go privately to the guys with it.

Seems to be a lot of this going around these days.

------
pheaduch
Interesting that he brings up Apple as during their IPO, if it wasn't for
Wozniak and his "Woz Plan" the majority of Apple employees and the former
earlier employees would have been frozen out of the IPO. Jobs was very much
against giving up his share of the pie.

To me, being greedy is hardly the worst trait to have as entrepreneur.

~~~
abbott
what traits are worse than greed for (successful) entrepreneurs? you highlight
woz's intervention, but then say greed isn't as bad as...?

~~~
philwelch
It's strange that wanting to get rich is even considered a bad trait for an
entrepreneur.

Off the top of my head, I'd say stupidity, laziness, cowardice, and soft-
headedness are probably worse traits.

------
gabaix
Why do the founders want to cash out?

It looks to me you can increase your salary to live a good life, while waiting
for the big exit. I understood Groupon did this because they thought Groupon
was at its peak. Is that the same thing for AirBnB? Am I missing something
here?

~~~
SoftwareMaven
The founders aren't getting diluted in the deal, since they are being
distributed as dividends. This will give them the opportunity to run past
third to slide home instead of taking the standing triple, since they won't be
left with nothing if the umpire calls them out.

~~~
gabaix
Got it. Also dividends are better than higher wages for tax purposes.

------
NY_Entrepreneur
Ah, what a morality play -- secrecy, power, greed, collusion, dirty dealing,
guilt, shame, etc.!

If HN can't outgrow the fascination with morality plays, then what hope is
there for the rest of society and society as a whole?

We need a new Web site: VC_secret_confessions.com!

------
sek
A founder who believes in his business, will never cash out early. period.

He would always get more after an IPO or exit. So why would he?

I assume the founders are not stupid, they know their valuation is not
justified.

~~~
Murkin
You missed the point, they take the money as dividens.

They are not selling their stock for that $20M lump.

The only 'foul' thing here, is that their employees (option holders) will
probably get nothing.

~~~
sek
They sold shares for 20 Million to the investors to pay out this dividend, so
the outcome is the same.

~~~
sek
Am i wrong?

