

Later-stage rounds and “setting the bar too high” - sahillavingia
http://cdixon.org/2011/12/13/later-stage-rounds-and-setting-the-bar-too-high/

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ajju
The key point in the article lies towards the end:

 _An important point to keep in mind is that, in order to maintain
flexibility, entrepreneurs shouldn’t give new investors the ability to block
an exit or new financings. Investors can get this block in one of two ways –
explicit blocking rights (under the “control provisions” section of a VC term
sheet) or by controlling the board of directors. These are negotiable terms
and startups with momentum should be very careful about giving them away._

There's the rub.

Founder control of the board is hard but possible.

I really can't imagine a VC fund being happy about an exit below the valuation
at their round, especially when they have deployed a big chunk of their fund
via a big round.

Any experienced VCs/founders want to comment on how common it is for startups
to be able to negotiate a term sheet where VCs have no explicit blocking
rights?

For reference, YC's AA round template documents for _angel investments_ ,
widely considered to be very founder friendly, include the following:

 _So long as any of the Preferred is outstanding, consent of the holders of at
least 50% of the Preferred will be required for any action that: (i) alters
any provision of the certificate of incorporation if it would adversely alter
the rights, preferences, privileges or powers of the Preferred; (ii) changes
the authorized number of shares of Preferred; or (iii) approves any merger,
sale of assets or other corporate reorganization or acquisition._

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notbitter
Sure, the VCs know how to take care of themselves, but what about the risk of
putting your employees underwater?

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tptacek
That's every financed startup, regardless of whether the company gets a
spectacular valuation or not.

This point feels pedantic (sorry), but it's worth pointing out that underwater
employee options aren't some weird corner case. It's the common case.

~~~
notbitter
Startups are risky to begin with, but raising a big round shifts the risk from
founders to employees.

Based on the emails I get from recruiters bragging about how much money their
companies have raised, it's clear that most engineers don't understand this,
even if it's obvious to founders.

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tptacek
I'm not even disagreeing with you, so much as I'm saying "it is probably a
common misunderstanding that less capitalized startups have lower 'employee
risk'†".

No; the reality is that the "employee risk" is complex and has as much to do
with revenue growth and market conditions as with capitalization. Some firms
capitalize on spectacular growth, and some huge capitalizations also create
strategic leverage for the whole company that improves outcomes for employees.

But in _every_ case, equity in a financed startup is freighted with enormous
risk. The fundamental issue is simple: corporations are managed by boards of
directors chartered with looking after the good of the shareholders, but, in
_virtually every financed startup in the world_ , the actual board puts
employee outcomes low on the list, invariably below investor outcomes.

This is actually as it should be. You could no more demand a more "protective"
board for employees as you could a 50% increase in valuations; market
conditions and pricing are what controls board makeup.

One of the few gratifying memes emerging on HN over the last two years (just
after "use bcrypt") is the notion that startup employee options are very
risky. I'm writing noisily to combat any implication on this thread that you
can mitigate that risk by picking undercapitalized startups to work for. If
you want to avoid the conflicting interest risk with startup boards, avoid
financed startups.

Or, don't; financed startups are also the ones that (rarely, very rarely, but
still) return huge rewards.

† _Imprecise, but let's have it stand for "risk that employee stock options
are worth zero"._

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notbitter
The most likely exit for today's startups is a talent acquisition. In that
event, would you rather be at an "undercapitalized" startup or an
"overcapitalized" startup?

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tptacek
What's the difference? The "valuation" of a talent acquisition is about
retaining talent. No matter what your shares are worth on paper, your outcome
is going to be the same; if the paper itself doesn't say so, the retention
grant will.

Why would a company do a "talent acquisition" at all if the best team members
were immediately going to leave for a better upside elsewhere?

Similarly, if the outcome for the company is "talent acquisition", the outcome
for an employee who leaves before that exit is probably zero.

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AznHisoka
That DropBox example is not typical though. What about the case when investors
want to invest a couple of million, and make the valuation 10-20 million.
Wouldn't that rule out a potential acquirer who wants to acquire it for $5
million after a couple of years? Because the investors want a bigger return?
Investors are looking for home-run. You, as a normal Joe are happy with a
base-hit and some fu money.

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tptacek
Uh, yes?

As a rule of thumb: you can't take a VC round expecting to exit for $5MM. If
you're looking to exit at $5MM ( _which is totally reasonable, in fact more
reasonable than shooting the moon_ ), you're looking to bootstrap.

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rokhayakebe
Why do founders and VCs get different stocks? I just do not get this logic. I
am fine with you getting your money out first, however if that is the case,
you shouldn't have any sort of vote on the outcome of the company. You should
just be a silent partner.

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tptacek
Why is one startup worth $10MM and the other $20MM?

Because prices, like terms, are set by the market.

Is there any fundamental reason a VC gets participating preferred stock? No!
By all means, when you fund your next company, refuse that term.

Obviously, every VC you talk to may then walk away. But maybe not.

The question of "why do VCs demand this term" is closely related to your
question (and maybe what you intended). The answer appears to be "to protect
from the risk of putting $5MM into a company and having an outcome that is
lucrative for the founders but loses money for the VCs". The idea is to align
the interests of the company operators and the investors, by taking the money
the VCs themselves put into the company out of the equation for the outcome.

